tailieunhanh - INTEREST RATE SWAPS: RISK AND REGULATION

Thinking about the zero bound this way suggests that variable interest on reserves could be utilized routinely and productively as an instrument of monetary policy. The Fed could replace its current operating procedures with a new interest-on-reserves regime. For heuristic purposes, I describe the implementation of the new regime in two steps, although the steps would take place simultaneously in practice. First, the Fed would purchase additional securities in the open market, adding enough reserves to satiate the market and drive the federal funds rate to zero. The Bank of Japan actually implemented this step recently with its zero interest. | Interest Rate Swaps Risk and Regulation By J. Gregg Whittaker The rapid growth of off-balance sheet activities by banks in recent years has given rise to a number of concerns. These activities create commitments for banks that are not reflected on their balance sheets as either assets or liabilities. As a result it is often difficult for investors regulators and even bank managers to determine the risk exposure of banks engaging in such activities. One of the most rapidly growing of these activities is the interest rate swap. While enhancing financial market efficiency in many respects interest rate swaps give rise to new risks for banks. Bank regulators are concerned that the role played by banks in the swap market may lead banks to incur too much risk or risk for which they are not adequately compensated. Current regulatory capital requirements for banks apply only to risks arising from a bank s assets. And since swaps are not considered an asset and J. Gregg Whittaker IS an assistant economist at the Federal Reserve Bank of Kansas City. Bryon Higgins a vice president and economist at the bank supervised the preparation of the article do not affect the balance sheet they can lead to increased risk exposure without requiring the bank to hold additional amounts of capital. Therefore the potential may exist for excessive risk-taking and underpricing of this highly leveraged instrument. Bank regulators have recently proposed revising capital guidelines to help control these risks. The first section of the article explains how interest rate swaps work and documents the recent growth of the swap market. The second section explores the risks of swaps and risk management techniques. The third section discusses proposed regulatory changes and other possible improvements for limiting the risks for banks involved in interest rate swaps. What are interest rate swaps An interest rate swap is a financial transaction in which fixed interest is exchanged for floating interest of