THE RISE in the use of derivatives by companies and financial institutions has been hailed as creating a brave new world of reduced financial risk and revenue generating opportunities.
Banks are making lots of money by acting as intermediaries in derivatives deals. But some critics wonder if regulators and bank chiefs have paid enough attention to the mushrooming activities of their derivatives 'rocket scientists', who are creating increasingly complex financial instruments.
For a start, analysts say most of the derivatives contracts are kept off the banks' balance sheets. That is good for the banks, as it means revenues from the deals can be a short-cut method to boosting return on equity. It also means capital-adequacy ratios are left intact.
The downside is that investors - and even bank bosses - may not be aware of the risks banks are exposing themselves to.
With minimal capital behind the derivatives positions, the banks are effectively turning themselves into highly leveraged hedge funds.
The near-collapse of giant hedge fund Long Term Capital Management (LTCM) in 1998 threw the arcane world of derivatives markets into the limelight.
One largely unintended offshoot of the huge growth in interest-rate swaps was that banks' financial statements became 'increasingly obscure', author Roger Lowenstein wrote in his book on LTCM, When Genius Failed.
