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OCC: Deriv fears are an overreaction

Wednesday 25 January 2012 – by Karina Whalley

The head of US regulator the OCC has lashed out at critics of derivative instruments saying their fears are a “vast overreaction”.

John Walsh, acting head of the Office of the Comptroller of the Currency, warned of the misconception surrounding the controversial products and said derivatives are incorrectly viewed as being more risky than they really are.

“For some they [derivatives] are not just a sophisticated component of a bank’s product portfolio but toxic instruments that should be pushed out of the banking system entirely,” Walsh said on Tuesday.

“That is a vast overreaction and it worries me that misperception could motivate redesign of the system.”

Speaking before the American Securitisation Forum annual conference, Walsh said that in terms of risks and the size of the market, derivatives are generally not well understood, even by top policymakers.

The notional value of derivatives contracts was estimated at $248tn (€188.78tn) at the end of September in the OCC’s most recent quarterly report, which is a multiple of the world’s annual economic activity.

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This figure is used by the public to describe both the size and risk of the derivatives market but “of course that’s far from the mark”, he said.

“I’m not trying to suggest that this isn’t a big market or that it doesn’t involve sizeable risks, but the risks ascribed to derivatives is often many orders of magnitude greater than the reality,” said Walsh who has been acting Comptroller since 2010.

The biggest risk from derivatives is not market risk but credit risk and at the end of the third quarter of 2011, insured US commercial banks had $504bn (€383.6bn) of net current credit exposures from derivatives contracts, just 0.2 per cent of the notional value, according to Walsh.

Although OCC data shows that banks have effectively managed credit risks over time, Walsh does acknowledge the importance of central clearing of derivative transactions to further reduce credit exposures.

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