ISDA PRESS REPORT - JUNE 11, 2001

RISK MANAGEMENT
BIS: Development Of Credit Risk Mkt An "Enormous" Benefit - Dow Jones
Capital cushion fight - The Economist
OTHER
Players Await Forint Swaps, Options - Derivatives Week

BIS: Development Of Credit Risk Mkt An "Enormous" Benefit
Dow Jones - June 11, 2001
By Henry J. Pulizzi

BASEL -(Dow Jones)- The Bank for International Settlements said Monday that
the development of new techniques to transfer credit risk may be the most
important new financial trend with possible implications for financial
stability.

The BIS said a more developed market for credit risk will improve risk
management and allow participants to set appropriate prices for accepting
credit risk.

"This will be of enormous, perhaps revolutionary, benefit," the BIS said in
its annual report.

Credit derivatives are said to be the fastest growing segment of the
over-the-counter derivatives markets. The complex instruments let investors
trade and hedge credit risk outside of the loans in which the risk is
embedded. They allow lenders to lay off credit risk while keeping assets on
their balance sheets and give investors exposure to credit without a
position in the actual debt.

A recent Goldman Sachs report put the notional value of the credit
derivatives market at about $1 trillion.

The BIS cautioned, however, that the development of a more active market for
credit risk could give rise to supervisory problems by making the
distribution of risk less transparent and possibly concentrating risk among
market participants.

The BIS also raised concern about insurance companies becoming increasingly
involved in credit risk markets.

"This implies the need for ever closer collaboration between banking and
insurance supervisors to prevent the possible growth of regulatory arbitrage
and to ensure that risks are monitored and priced correctly," the BIS said.


Capital cushion fight
The Economist - June 9, 2001

INTERNATIONAL banks, and their regulators, are wrangling over the level of
additional capital that banks should be made to carry, as a cushion, against
so-called "operational risk" that might damage a bank's health or even the
financial system. Operational risk includes anything from computer failure
and postal strikes to fraud and cock-ups of Baring-style proportions.
Insurance companies, which you might think would steer well clear of this
debate, have joined the fray, offering to replace bank capital with
new-fangled insurance cover. They were in Washington this week trying to
sell the idea to bank regulators from the Group of Ten countries.

Under present rules, banks carry capital against the credit and market risks
that they run. Bold proposals by the Basel Committee of bank supervisors now
seek to refine the charges for credit risk, as well as to add new charges
for operational risk. The banks' responses to " Basel 2", which had to be in
by May 31st, are almost all critical of the proposals for operational risk.
Few agree even with the committee's definition of such risk: "the risk of
direct or indirect loss resulting from inadequate or failed internal
processes, people and systems, or from external events." Many dispute the
inclusion of indirect loss, since it is so hard to quantify. Some say that
"strategic" and "reputational" risks should be added. And that is just for
starters, before even getting to the level of charges.

The committee has suggested that operational risk should account for roughly
20% of a bank's regulatory capital. Since it has also said that the overall
capital charge should stay about the same, banks have been looking for a 20%
reduction in charges for credit risk. In vain. Hong Kong complains that its
banks will face a capital charge 2.5 percentage points higher if the Basel
proposals are applied in their crudest form - with most of the increase
being for operational risk.

Privately, regulators agree that the 20% figure is too high and will come
down, but by less than the banks would like. The horse-trading can be
followed on the Basel Committee's , where many bank responses are posted.

The banks' biggest beef with the charge for operational risk is that the
levels, by the most basic method, are set according to a bank's gross
income. What kind of incentive is it that rewards banks for reducing their
income? The proposal offers three further levels of sophistication in
measuring operational risk, all of which the banks find either flawed or too
complex. A "standardised approach" would rely on industry-wide loss data
divided by business lines - such as corporate finance, trading or retail
banking - providing a standard factor by which a bank's volume or gross
income in that business would be multiplied to arrive at a capital charge.
Then there is an "internal measurement" approach, using a bank's own loss
data, multiplied by a formula for "expected loss" and by a factor for how
the supervisor rates the bank's risk controls. Finally there is a "loss
distribution" approach, which allows the bank to use its own probability
analysis, although neither supervisors nor banks think the technique can be
used yet.

The big problem is insufficient data. There are plenty on so-called
"expected" losses, such as predictable levels of credit-card abuse, failed
trades, even petty fraud. But the aim of the charge for operational risk is
to cover the unexpected, such as a bomb blast or big losses by a rogue
trader. How many events like that have there been over the past decade? How
statistically relevant is a decade-old event?

All the same, data collection and data-pooling are going ahead. There are
even some commercial databases on offer. One comes from NetRisk. It is based
on data that Bankers Trust, an American bank now owned by Deutsche Bank,
began to collect in 1993. That is being added to by the MORE consortium, a
joint effort by a dozen big banks, and by PricewaterhouseCoopers, an
accounting firm. The other offering comes from a subsidiary of Zurich
Insurance, called Zurich IC Squared, which offers a ten-year database
online. The source of its early data is, once again, Bankers Trust.
Supervisors find themselves using the same data too.

Banks worry that some operational risk will be double-counted as credit or
market events - for example, bad documentation that leads to credit failure.
There is also a debate about where to put reputation risk, since a blow to
reputation can sink a bank. The regulators exclude reputation risk, says an
insurer, because it happens slowly, and a bank can be unwound or sold - as
in the case of NatWest, a British bank sold to Royal Bank of Scotland.

The debate on this and other topics could run for years; the banks,
certainly, want more time for consultation. Yet deadlines loom. A framework
for Basel 2 and its equivalent in the European Union, a draft
capital-adequacy directive, is meant to be ready by the end of the year, in
order to be implemented in 2004. Banks and supervisors will need at least
that time to prepare themselves, once they know what to prepare for.

A debate with the insurance industry has only just got serious. Insurers do
not normally lobby together, but two lobby groups, BAIWG and PCIIWG (do not
ask what they stand for) are presenting bank regulators with ideas for
lightening the capital charge that banks must bear for operational risk. Big
chunks of banks' operational risk, such as professional liability and
computer fraud, are already insured. Regulators agree that this already
merits some offset against a capital charge. If insurers can concoct
insurance cover for a wider range of risks, then the capital offset would be
bigger.

For that to happen, regulators want to be satisfied that there would be
immediate payouts (not a hallmark of insurers), and that there would be
legal certainty, with no weasel clauses to let insurers off the hook.
Insurers must be satisfied that they will not be left as a lender of last
resort in a systemic crisis. At the discussions in Washington, the very
definition of operational risk was still a sticking-point.

On the fringes, but maybe destined some time to take centre stage, are ideas
to let the market impose discipline on the banks, at least as far as
operational risk is concerned. Catastrophe bonds linked to earthquake and
storm risk have been sold to investors, and so has contingent capital, in
the form of callable equity. Adriana Cronin of Blanch Crawley Warren, an
insurance-broking firm, would like to see an "opbond", based on a portfolio
of operational risk covering the combined risks for a number of banks.
Rating agencies would be needed to analyse and rate the portfolio backing
the bond.

Most insurers think a capital-markets solution for operational risk is a
distant goal. The nearer one is to bring their centuries of actuarial skills
to bear to help banks save capital, and so to tap a rich new market of,
potentially, 30,000 banks.



Players Await Forint Swaps, Options
Derivatives Week - June 11, 2001

The Central Bank of Hungary's recent move to widen the band in which the
forint trades to 15% from 2.25% is seen as a step towards the development of
a liquid derivatives market, according to Budapest market watchers.

"Currently, investors who want to play in the local Hungarian market can
only do so via non-deliverable forward contracts," said Amir Ben Gacem,
London-based local-market analyst at BNP Paribas. "With the prospect of
further liberalization, we will start seeing swaps, etc.," he continued.

Added a London-based derivatives professional: "We're getting ready to see a
real options market in Hungary with the liberalization of the [foreign
exchanged] bands." Such a development would be consistent with Hungary's
aspirations to join the European Union. Poland and the Czech Republic
already have developed local options markets.

The forint has appreciated roughly 7% in the last month against the euro on
the back of the move, and analysts expect further appreciation as central
bankers bid to continue with reforms.

The prospect is significant to investors, who currently must buy
longer-dated Hungarian assets without the options available that would allow
them to play on the currency. Observers said demand is likely to come from
Western Europe, especially Germany. "We expect non-residents to buy any part
of the Hungarian curve; it's another way to diversify in the region," BNP's
Ben Gacem said.





**End of ISDA Press Report for June 11, 2001**

THE ISDA PRESS REPORT IS PREPARED FOR THE LIMITED USE OF ISDA STAFF, ISDA'S
BOARD OF DIRECTORS AND SPECIFIED CONSULTANTS TO ISDA.  THIS PRESS REPORT IS
NOT FOR DISTRIBUTION (EITHER WITHIN OR WITHOUT AN ORGANIZATION), AND ISDA IS
NOT RESPONSIBLE FOR ANY USE TO WHICH THESE MATERIALS MAY BE PUT.

I am filling in for Scott today only.  Any questions, please direct them to
Scott at smarra@isda.org.  Thank you.


Ms. Barbara Hanlon
Database Administrator
International Swaps and Derivatives Association, Inc.
600 Fifth Avenue, 27th Floor
Rockefeller Center
New York, New York 10020-2302
Phone: (212) 332-1200
Fax: (212) 332-1212