During the last days of december the attention of some financial newspapers was about the derivative products whose outstanding was such that Europe would be threatened again by a “banking Fukushima”.
Some figures were indeed quite impresive.
The notional value of derivatives in the world has returned to unseen levels since the crisis to the point of peaking above USD 700,000 billion,10 time the world global gross domestic product.
Some banks seem to have committed up to the equivalent of 1000 time their equity in the “notional” value of derivative contracts to which they are party.
In times of financial instability, an economic agent has every reason to want to hedge its risk. A variable-rate borrower would act as a “père de famille” if it choses to swap its variable rate against a fixed rate. In doing so it contributes to inflate the notional amount of derivatives up to the amount of its loan .
The counterparty that agrees to enter in such a swap will want to cover itself in turn which will cause the doubling of the notional amount at stake even if the underlying loan remains the same.
In such a game, it is easy to understand that a transaction can trigger a series of derivative contracts without major impact on the ultimate risk.
A good reason not to to panic.
But also a strong incentive to double check the calculations.
Never has it been so much talked about operational risk and execution risk in the bank industry.
With reason.
Dominique F. Pasquier