Friday March 19, 11:55 am Eastern Time
FOCUS-Greenspan favors less derivatives regulation
(Previous WASHINGTON, adds details in paragraphs 7-10, 12-14)
BOCA RATON, Fla., March 19 (Reuters) - Although financial derivatives heighten uneasiness in times of economic instability, there was no reason to impose heavier regulations, Federal Reserve Chairman Alan Greenspan said on Friday.
Instead, banks should stress test their own models to assess the potential losses from derivatives in future financial panics, he said in a speech delivered by satellite to the Futures Industry Association in Boca Raton, Fla.
He said that at the end of 1998, there were $33 trillion worth of derivatives -- contracts that derive their value from an underlying commodity or financial instrument -- outstanding.
There was no sign the Asian financial crisis, which began in 1997, was slowing their growth, he said.
Only $4 trillion worth are traded on exchanges and the rest change hands in over-the-counter (OTC) or off-exchange deals with little difficulty, Greenspan pointed out.
''As I have noted previously, the fact that the OTC markets function quite effectively without the benefits of the Commodity Exchange Act provide a strong argument for development of a less burdensome regime for exchange-traded financial derivatives,'' he noted.
Greenspan suggested derivatives were still poorly understood and their role in the nation's financial system had come under undue suspicion.
He said there was ''a deep-seated fear that while individual risks seem clearly to have been reduced through derivative-facilitated diversifications, systemic risk has become enlarged as a consequence.''
But looking at last year's third quarter, when derivatives dealers lost huge sums, it was apparent that most of the loss came from the underlying trading positions. One firm, Long Term Capital, lost billions of dollars and forced the New York Fed to step in to help arrange a private bailout.
''Derivative instruments were bystanders,'' Greenspan said. ''They may well have intensified the losses in underlying markets, but they were scarcely the major players.''
Greenspan said it would be ''a major mistake'' to impose a heavier hand from regulators in assessing the risk banks are subject to from derivatives contracts.
But he said banks should do more to prepare themselves for possible future losses, remembering ''the violence of the responses to what seemed to be relatively mild imbalances in southeast Asia in 1997 and throughout the global economy in August and September of 1998.''
Greenspan urged ''stress testing'' by banks of the models they use to weigh their own risks because there was always a possibility that future financial panics could mean losses for them.
''Scenario analysis can highlight vulnerabilities to the kind of flights to quality and flights to liquidity that seem increasingly apparent,'' he said. That would give banks a clearer picture of the risks they were taking so they could decide what prudent measures were needed to balance them. |
