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COMPTROLLER OF THE CURRENCY ADDRESSES THE HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS ON FINANCIAL DERIVATIVE INSTRUMENTS

 WASHINGTON, Oct. 28 /PRNewswire/ -- Eugene A. Ludwig, comptroller of the currency, made the following oral statement before the Committee on Banking, Finance and Urban Affairs of the U.S. House of Representatives, today:
 Thank you, Mr. Chairman and members of the committee; I appreciate this opportunity to testify on financial derivative instruments. I have submitted detailed answers to the questions the committee asked -- and I am prepared to elaborate on those answers or address any other questions that members of the committee may want to ask on this subject.
 Today, I would like to emphasize several points:
 One -- When properly used, financial derivatives can provide banks and the public with substantial benefits. By separating out the risk components of traditional financial instruments, derivatives can -- and do -- lower the risk of financial transactions for banks and others.
 Two -- When properly used, financial derivatives -- like other financial instruments -- could lead to significant problems for banks. Further, because of the way derivative products link market participants, a failure at one bank might threaten the solvency of other institutions.
 Three -- Fully appreciating the concern present in many quarters about bank involvement in derivative activities and about the adequacy of regulatory supervision of those activities, I have given particular attention to national bank involvement in derivatives. I am determined that the OCC remain fully up to speed in this area. Moreover, I recognize the OCC's responsibility -- not just to monitor -- but to take effective steps to ensure that national banks engage in derivative activities in a safe and sound manner.
 As the first step in this effort, I formed a task force to review all of our policies and procedures in this area and to recommend changes for improvement.
 One of the first fruits of that task force is guidance to national banks on what we expect from banks that are active in derivatives. We issued that guidance yesterday and sent it to every national bank and all our examiners.
 This guidance -- Banking Circular 277 -- addresses the types of systems and controls that the OCC considers appropriate at this time to manage derivative risks. It also alerts national banks to significant legal issues associated with derivatives transactions.
 Our basic approach in this area can be summarized in two words: no surprises. Specifically, we are, in effect, requiring that national banks engaging in derivatives activity adopt a "no surprises" risk management policy that is backed by adequate systems and controls.
 More specifically, we are, in effect, requiring banks active in derivatives to adopt policies and procedures that include: (1) an independent unit to assess risks in their derivative activities; (2) systems to ensure that senior management -- including the CEO and board of directors -- understands and controls risks in the derivative business; (3) appropriate monitoring and capital levels; (4) periodic reviews of systems and personnel by management and the OCC; and (5) a responsibility that the bank selling a derivative assess its appropriateness for the bank's customer.
 Mr. Chairman, if an OCC examiner concludes that a national bank's risk management processes are inadequate for current or planned activities, the OCC will require management to correct the problem promptly or face sanctions for not doing so. Further, if an examiner believes a bank has taken on too much risk in connection with derivatives, the examiner will raise this concern first to OCC and bank management and then, if appropriate, with the bank's board of directors. Where appropriate, the OCC will require the bank to reduce its risk to a more modest level or to raise additional capital to compensate for the risk level it has assumed.
 In closing, Mr. Chairman, any regulatory approach we take to derivatives should recognize and respect the important and legitimate functions that these financial instruments serve, but it is our responsibility to ensure -- and we are committed to ensuring -- that banks take the necessary steps to manage the risks that accompany their increasing use of these instruments. I look forward to addressing your questions.
 -0- 10/28/93
 /CONTACT: Office of Comptroller of the Currency Public Affairs, 202-874-4970/


CO: Office of the Comptroller of the Currency ST: District of Columbia IN: FIN SU: LEG

DT-DC -- DC008 -- 7822 10/28/93 11:00 EDT
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Date:Oct 28, 1993
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