Caution over regulation

The inevitable calls for tighter regulation of derivatives met with a cautious reaction from banking supervisors yesterday. Shadow chancellor Gordon Brown called for tougher rules. Kenneth Clarke, Chancellor of the Exchequer, told the House of Commons the regulatory system would be thoroughly reviewed but it was too early to draw firm conclusions.

Most observers thought the problem at Barings had probably been poor internal controls rather than inadequate regulation. In theory, all banks trading derivatives use similar controls. In practice, standards vary.

In most cases, individual traders are set limits to the losses they could expose their bank to and report their trades daily. From their reports the bank calculates its global exposure to possible losses using a computer model of risks.

US banks are acknowledged to be more sophisticated than any others in their risk-monitoring. Bankers Trust is well-known for its continuous monitoring of world-wide trades. Chase has upgraded its risk management system in the past year, while Citibank is halfway through an upgrade. British banks are behind the Americans, but considered to be well ahead of the Europeans and Japanese.

John Hargreaves, a specialist consultant on risk at the Coba Group, said: "All banks keep some kind of running tally of their net risks, but there are different degrees of sophistication. There is a lot of room for improvement."

The success of a monitoring system also depends on checking that traders report their deals honestly and accurately. Jacques Langerstaey, head of market risk research at JP Morgan, said it uses a computer model to generate a daily report on possible losses. A day later it double-checks the information through back-office records.

Many observers rejected the notion that a rogue trader could evade proper controls. Most banks yesterday were either unwilling to comment on their own management controls over derivatives trade, or insisted that they could not be hit by a disaster such as the one that sank Barings.