Financial institutions may not love regulators, but they get really steamed up when they discuss the labyrinthine capital adequacy standards external examiners want to afflict them with. Banks maintain that their in-house systems for measuring and covering risk are every bit as good as those devised by banking bureaucrats.

Last year the New York Fed showed it had been listening to these arguments by proposing its so-called precommitment approach to capital adequacy, whereby a bank would define its own probable risk exposure and pledge an appropriate amount of capital against it. If this capital proved to be inadequate, banking regulators would impose all sorts of dire but as yet undefined penalties.

Last month precommitment won the strong endorsement of Karen Shaw Petrou, president of the Washington-based financial industry consultancy ISD Shaw. She says precommitment is an "improvement of market risk rules currently considered by Basel and in the U.S." Petrou is a widely recognized consultant and analyst who has worked closely with senior bankers at major U.S. and overseas institutions. Petrou also serves as director of the $4 billion Rochester (New York) Community Savings Bank.

She made the remarks in April while on a panel of experts at the Jerome Levy Economics Institute at Bard College in upstate New York. Also on the panel were Allen Spillenkothen, director of the banking and regulatory division at the Fed in Washington, and Mark Brickell, a managing director of JP Morgan and board member of ISDA.

Petrou is not unequivocal in her support of precommitment. "It is a good idea about which I have many questions," she says. These questions include the type of punishment that would be imposed should the institution exceed the capital it has precommitted. "What kind of punishment should be meted out, and how can you mete out punishment against an institution which has so misjudged its capital as to be out of business?" she asks.

Moreover, the nature of the risk exposure to be disclosed has not yet been determined, she feels. Petrou wants to know whether this would be an average expectation of loss, or a worst-case expectation of loss. And though the blanket approach to capital adequacy currently in use is crude and often inaccurate, it has the advantage that bank examiners understand it. Precommitment would be more subjective, and consequently some examiners are worried about how they would implement it, "and I think correctly so," says Petrou.

BIS buster

Despite these caveats, the current risk-based capital rules, including the BIS proposals on market and credit risk that were announced last year, are full of holes, says Petrou. The BIS guidelines allow the use of internal models in the calculation of risk, a development which earned the approval of many bankers, but this aspect is mitigated by the fact that the BIS must approve the models to be used and will continue to use assessments of capital adequacy based on its own market criteria, stresses Petrou.

These BIS rules are also "very, very complicated," notes Petrou, and because they seek to measure risks that are in themselves extremely complex, no one is quite sure how they will be applied on a cross-border, cross-institution, cross-accounting-standards and cross-regulatory- regime basis. To address some of these complexities, the BIS assumes standard regulatory practices, and yet when these models are applied to the U.S., one ends up with results that "are, at best, perverse," says Petrou.

Consequently risk may in fact be undercalculated rather than overcalculated. Petrou acerbically points to the phenomenon that despite "billions and billions and billions of recognized and unrecognized loan losses," Japanese banks always managed to stay above the Basel minimum capital standards!

Of course, the adoption of the precommitment approach is a very long way off in the U.S., let alone the rest of the world. Petrou is encouraged that a large group of U.S. banks recently have begun a pilot program to test the proposal.

Precommitment may need a lot stronger sponsorship, judging from thoughts expressed a day earlier at the Bard conference by Federal Reserve Governor Janet Yellen. She complained that it was increasingly hard to assess the risks bankers are undertaking with derivatives. Said Yellen, "I fear we may be reaching the point that, for our largest, most complicated institutions, a bank's formal, regulatory 'risk-based' capital ratio is not as useful a signal of financial soundness as we would like."

By Karen Spinner

While shorts and sundresses are not likely to be de rigueur in the financial community anytime soon, summer dress-down days are fast becoming popular at even the most conservative financial institutions. One New York broker-dealer cynically theorizes that "casual Fridays came into existence because some top level execs wanted to be able to drive straight from the office to their summer houses in the Hamptons without having to go home to change first."

But that's not quite true. About 60 percent of the Fortune 500 companies tolerate some form of casual dress, either on specific days of the week, seasonally or year-round, the latter being a steadily growing pattern. Financial institutions are, predictably, in the rearguard of this trend.

At Bankers Trust, for example, "dress-down" or "casual dress" Fridays were in effect last year from May 26 to September 1. According to a company memo, "The intent in creating this policy is to accommodate casual dress on Fridays during the summer months without compromising a businesslike appearance." The memo also spelled out BT's official interpretation of casual: "No shorts. No T-shirts. No sandals. No bare-shouldered dresses. No torn jeans." Similar policies are in effect at Merrill Lynch and elsewhere.

Relative to similar institutions, BT's definition of casual is actually a touch on the liberal side. At Morgan Stanley, which also has summer "dress-down" Fridays, business casual-known to employees as "smart casual"-means "khaki pants or other slacks, collared shirts, lace-up shoes or loafers." Morgan Stanley "don'ts" include jeans, T-shirts, tank tops, abbreviated tops, sneakers and sandals.

Some financial firms have gone so far as to allow casual Fridays year-round. At Paribas Capital Markets, every Friday is dress-down day, though jeans are prohibited and collared shirts and khakis are still the norm. Some firms, like Credit Suisse Financial Products and Gen Re Financial Products, allow employees to dress in business casual every day of the week, although the suits are likely to magically reappear when a client plans a visit.

Then there are the radicals. Once a bastion of sartorial probity, the Swiss Bank Corp. now permits casual every day. It began revising its rather prissy image shortly after it bought O'Connor Associates in 1992. As the O'Connor people subsequently rose in the company, they spread the relaxed style they liked. Ditto the effect of Chicago Research and Trading's purchase by NationsBank.

There are still some holdouts-JP Morgan, for example. And in many other places summer casual is not likely to creep into the rest of the year. At Société Générale, which has casual Fridays, come Labor Day the ties come back out and the polo shirts go back in the drawer. Says Ellen Fischer-Taylor, a spokesperson for the French bank: "It's very over when it's over."

http://www.sbcm.com

Last month Sumitomo Bank Capital Markets launched a dedicated derivatives Web page, the first ever devoted to the swap market. After the opening page of standard corporate puffery, the site gets down to serious business. A department called "Up the Learning Curve" has sound tutorial materials on interest rate swaps, options, currency swaps, key rate duration and elements of pricing. From here there are hyperlinks to some on-line derivatives bookstores, lists of conferences and a mini encyclopedia of 36 commercially available derivatives front office systems. "Hot Topics This Month" features an erudite essay by the firm's Ravi E. Dattatreya on modeling yield curve risk via risk points. Claimed advantages for the risk point method: 1) it can highlight yield curve risk in an asset/liability context, 2) while in a portfolio context it can improve analysis of bond swaps. There is also a weekly commentary on the U.S. currency and swap markets supported with attractive charts.

Sumitomo believes the site has had some 1,000 visitors in the first two weeks, about half of these from outside the U.S. One of the drawbacks to any Web site is that very few financial professionals have access to the Internet during work hours. But Sumitomo was pretty surprised at the number of people giving up personal evening and weekend time to access the new site from their home computers.

After the staff managing the $40 billion pension portfolio of the State of Wisconsin lost $95 million in 1995 in derivatives trades, an angry state legislature put a freeze on bonuses. Now it appears the legislature has done an about-face and decided against reprisals. The 13 staffers will soon collect their checks despite their failings.

What's more, there are even Wisconsiners who believe these investment managers deserve a big pay hike. Separately the Wisconsin Legislative Audit Bureau recommended that the bonus pool be increased to improve the state investment board's effectiveness. The present bonus formulae are, in truth, pretty bizarre. The pool is fixed at 10 percent of the department's payroll. Then managers are awarded their share according to performance. If one manager receives more than 10 percent of payroll, another must receive less. Ergo, an individual manager is better off if his colleagues do badly. One can only imagine the level of cooperation in the department.

However, a joint committee of the state legislature nixed the suggestion that the pool to be enlarged to avoid this so-called "perverse incentive."