Fitch Twitchy on EU banks and Derivatives

I can hardly believe it, but for once I seem to find myself on the same side of the ball park as Warren Buffet, and on the opposite side to Alan Greenspan. Buffet is worried about financial derivatives, Greenspan says that the use of derivatives, obligations derived from debt and equity securities, commodities and currencies, is a positive factor which has "significantly improved the flexibility of economies," Just to put the issue in perspective, the market for derivatives traded outside exchanges ( measured by the value of underlying assets) grew 15 percent, to a record 128 trillion dollars in the first half of 2002 according to the latest figures from the Bank for International Settlements. That is more than 10 times the value of the United States gross domestic product. So we are not talking small beer here. The big preoccupation is the way the value of derivatives can fluctuate more than the value of the underlying asset to which they are attached. Buffet, as is his way, is theatrical with his 'financail weapons of mass destructions' comment. Still, I think one this one needs watching just in case something does happen, and so do Fitch.

European regional banks have taken on a lot more risk than their public accounts show because of heavy exposure to credit derivatives, according to new research. Three-quarters of the European banks surveyed in a report by Fitch, the credit rating agency, have sold about €50bn of credit protection to other parties.Half of these banks were German, with the state-owned Landesbanken being particularly active. They have increased their exposure to high-yielding derivatives to offset flagging profits in traditional lending businesses. Fitch says it may cut the credit rating on banks with large exposures to credit derivatives. The Fitch report follows last week's warning from Warren Buffett, the influential US investor, that derivatives represented "financial weapons of mass destruction" and are "potentially lethal" to the economic system. Fitch said the European banks' exposure to credit derivatives was surprising because banks typically buy credit protection to reduce risk. Institutions that sell protection on a bond or loan using a credit derivative assume the underlying credit risk of the security. Although European banks are net buyers of protection, with about €65bn purchased, the bulk of the buying has been undertaken by a few large institutions. Only 30 per cent of European banks active in the credit derivatives market are protection buyers. Fitch has spent three months trying to quantify financial institutions' exposure to credit derivatives but has been only partially successful. Some institutions have refused to disclose information about their derivative activities."We need more financial transparency," said Roger Merritt, Fitch analyst and co-author of the report, to be released today.
Source: Financial Times
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