Derivatives still pose huge risk, says BIS

Derivatives still pose huge risk, says BIS
The global market for derivatives rebounded to $426 trillion in the second quarter as risk appetite returned, but the system remains unstable and prone to crises, according to the Bank for International Settlements (BIS).
By Ambrose Evans-Pritchard, International Business Editor
Published: 7:57PM BST 13 Sep 2009

The BIS said in its quarterly report that total turnover of derivatives rose 16pc, mostly due to a surge in futures and options contracts on three-month interest rates.

Stephen Cecchetti, the bank’s chief economist, said over-the-counter markets for derivatives are still opaque and pose "major systemic risks" for the financial system. The danger is that regulators will again fail to see that big institutions have taken far more exposure than they can handle in shock conditions, repeating the errors that allowed the giant US insurer AIG to write nearly "half a trillion dollars" of unhedged insurance through credit default swaps.

The misjudgement was to think the banks and insurers were safe because their "net" exposure was modest. That proved to be an illusion.

"The crisis has cast doubt on the apparent safety of firms that have small net exposures associated with large positions," Mr Cecchetti wrote. "As major market-makers suffered severe credit losses, their access to funding declined much faster than nearly anyone expected. When that happened, it was gross exposure that mattered.

"The use of derivatives by hedge funds and the like can create large, hidden exposures," he added, citing the discovery that firms in Brazil, Korea and Mexico held huge foreign exchange contracts in late-2008.

More…
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6184496/Derivatives-still-pose-huge-risk-says-BIS.html