Derivatives must be carefully managed and supervised. We should be especially careful, however, not to discourage innovations or be close minded about change. Banking is not intended to be a risk-free activity. Risk-taking is a necessary condition of economic progress and rising standards of living.
Our use of derivatives is just one more step in the evolution of banking.
Don't focus on derivatives. One of the most dangerous activities of banking is lending.
Why in the world more banks don't look at interest rate swaps . . . I don't know. It's not an esoteric phenomenon anymore.
Financial innovations have not changed the substance of banking. The core functions of banking remain the measurement, acceptance and management of risk.
Let's put your relationship with your derivatives dealer on the proper footing. Before you hire the next one, investigate him as you would anyone you don't trust but desperately need, such as, oh, the nanny. Xerox the dealer's driver's license as the first item in the background file. Knowing his home address will be comforting to you and worrying to him. Then run a felony check. Hey, his boss did it when she hired him. Verify every achievement on his resumé including how many semesters he made Dean's list. Discuss any discrepancies.
I once had to explain to my father that a bank didn't really make its money taking deposits and lending out money to poor folk so they could build houses. I explained that the bank actually traded for a living.
Banks have used quantitative methods since the Medicis, but their ability today to aggregate risk information meaningfully across a variety of activities is unprecedented.
Derivatives are part of the vital machinery of the bank. We have put it at the heart of the business.
Last updated: January 9, 2011