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Non-Tech : Derivatives: Darth Vader's Revenge -- Ignore unavailable to you. Want to Upgrade?

To: Worswick who wrote (6)	8/31/1998 4:17:00 PM
From: Henry Volquardsen	Read Replies (1) \| Respond to of 2794

Worswick, Believe it or not I am very familiar with "the Herstatt effect" and remember it at the time it happened. Also I started in the business in the mid 70s when Herstatt was a very recent memory. So I know the phenomenon. I have also been in the industry for over twenty years dealing with derivatives. I've lived through the fallout of Herstatt, Franklin National, Penn Square Bank, Continental Illinois etc. I have also had very close exposure to several emerging market currency crisis. I've survived all of this and learned a bit along the way. And I am not alone as the banking industry has learned a lot about identifying, controlling and limiting risks. The risk you identify as "the Herstatt effect" is what the industry refers to as settlement risk. Banks generally set at least three types of risk limits; gross exposure, mark to market exposure and settlement risk. In the $750bln in derivatives exposure you list for LTCB only a small portion would be settling on one day. Payments on the balance could be stopped well in advance. In addition there are things most banks will do to specifically reduce settlement risk. Banks now routinely net payments. When Herstatt went the system was not able to net payments so it greatly exacerbated inter bank exposures. Since that time the bankruptcy laws have been changed to permit netting to hold up, computer systems have been developed that allow the huge number of trades in question to be netted and the central banks have encouraged such agreements. So the amount of settlement risk has been reduced. In addition banks carefully monitor settlement risk so they can take action quickly. So whil settlement risk is really it is something the banking system has worked to reduce and control this risk. Another aspect of Herstatt was the failure caused a cascade of payment failures throughout the system as banks who were failed by Herstatt failed other counterparties. The central banks have gotten this one under control. There have been several failures bigger than Herstatt since then. In every instance the central bankers have immediately made it clear they would provide as much liquidity as needed. This has eliminated the prospect for such cascade failures. I am not trying to minimize the risk of derivatives. My point is that it is not the obvious risks that are going to catch us, we are focused on those. The banking system knows the problems with LTCB and remembers Herstatt. It is something that we haven't seen before that will catch people.