This document discusses derivative activity at troubled banks and regulatory oversight. It finds that while derivatives are important for hedging risks, troubled banks engage in higher levels of derivative activity which could enable speculative "second bets." However, the analysis found no evidence that derivative activity alone leads to regulatory actions, which instead focus on problems like poor lending. The document calls for regulators to more closely monitor derivative use at troubled banks to limit speculative behavior.

1. Derivative activity at troubled banks
by
Joe Peek and Eric S. Rosengren
Prashant Ranjan
4113004004

2. Introduction
• Derivatives are essential element of financial activity,
enabling intermediaries to hedge market risks.
• They also entail risk to bank and banking system.
• Derivatives products are difficult to monitor and few
individual traders generate substantial losses. As
example: barings, daiwa, and sumitomo.
• A significant percentage of large banks engaged in
derivatives activity in the first half of this decade
have received a formal regulatory action.

3. Introduction
• There is no any evidence that derivatives activity has
been a factor in formal regulatory intervention or
even in downgrades of supervisory rating of banks.
• Derivatives activity is hardly mentioned in formal
regulator action, while lending activity, loan
monitoring, and reserves from problem loans.
• Banks call report data are not sufficiently detailed to
reveal the extent to which bank derivatives activity
affects the overall risk of the bank portfolios.

4. Content
• This paper discuss about derivative activity and
supervisory oversight.
• This paper also discuss about derivatives activity at
troubled institutions.

7. Methodology
• Bank's financial health and the nature and degree of
risks in both on-balance sheet and its off-balance
sheet should be important factor in supervisory
decisions to change the bank’s rating.
• They use the logistic model to determine in
derivatives activity contribute to triggering a CAMEL
downgrade or the imposition of a formal action
• Ii,t=b0+B1+X1i,t+B2X2i,t+Vi,t

8. Conclusion
• The set of large banks activity in derivatives market
includes a relatively high percentage of troubled
institution.
• troubled banks have the motive to place second bets
and that derivatives provides the means, it is
important that such banks not be given the
opportunity to do so.
• Derivatives positions can be altered quickly to reduce
risk exposure.

9. • No evidence that derivatives activity is a significant
factor in CAMEL downgrades or in regulatory
decisions to impose a formal action.
• Derivative activity is critical at many banks for the
effective hedging of risks.
• It is important that bank regulators limit the moral
hazard to use derivatives for speculation.
• Derivatives activity should have a more prominent
role in formal regulatory action at troubled banks.