Advice from the Comptroller: 15 bucks
By Robert Hunter
Publishing companies typically release updated editions of books only
after a shrewd analysis of the marketplace, making sure that they have sucked
every last cent from the previous edition. The Office of the Comptroller
of the Currency plays by different rules. Though the skeletal 1994 first
edition of the Comptroller's Handbook for National Bank Examiners was a
big hit in its narrow demographic, and a steal at $15, it quickly became
a quaint anachronism that failed to cover quickly evolving topics in the
In January, the OCC released a new, radically revised edition that logs
in at 190 pages-more than twice the size of the original-and covers eight
new areas of interest to risk managers. The most conspicuous addition is
a drastically expanded section on internal control procedures, offering
more questions (59 in all, with sub-bullets) for the examiner checklist.
"We have quite a bit more detail," says Michael Brosnan, director
of the treasury and market risk division at OCC and principal author of
the new edition.
Another important-and somewhat controversial-addition is a section on
employee compensation. The handbook argues that derivatives personnel should
be paid based on five factors-individual overall performance, performance
relative to the bank's stated goals, risk-adjusted return, compliance with
bank policies and the compensation packages of competitors. Banks that pay
personnel based only on the profits they earn "encourage excessive
risk-taking," according to the handbook. The book also recommends that
certain key staff members be required to take their two-week vacations consecutively,
with no ability to make transactions, to help detect concealed trading activity.
Other areas of interest include an expanded section on risk measurement
that supports the use of Value-at-Risk as a common denominator; an improved
section on early termination agreements that is "improved to reflect
business practices," according to Brosnan; a section on undisclosed
counterparties; an evaluation of dealer books; a more thorough description
of price risk-management models, which supports Brosnan's claim that "the
document is educational as well"; and a section on stress testing which
argues that "good stress testing involves finding things that make
bank management uncomfortable and then making probability analyses,"
To order a copy of the handbook, send a check for $15 to the Comptroller of the Currency, P.O. Box 70004, Chicago, IL 60673-0004.
Revising Hedging Theory
Classical risk management theory argues that companies facing large exposures to changing rates can increase their market values by using derivatives
to reduce the variability of corporate cash flows and the costs associated
with financial distress. In practice, most corporates practice selective
rather than "full-cover" hedging and allow views of future rates
to influence their hedging ratios. Large companies, moreover, make far more
use of derivatives than smaller companies, even though smaller companies
have more volatile cash flows and more to lose if they get in financial
Does this mean that selective hedging is misguided and that "variance minimization" is an inappropriate goal? Not necessarily, argues Rene
Stulz, a professor at Ohio State University, in "Rethinking Risk Management,"
an article in the recently published Fall 1996 issue of the Journal of Applied
She concludes that some companies "have a comparative advantage
in bearing certain financial risks (while other companies mistakenly think
and act as if they do)." She then proposes a new goal: "elimination
of costly lower-tail outcomes that is designed to reduce the expected costs
of financial trouble while preserving a company's ability to exploit any
comparative advantage in risk bearing it may have." In trader talk,
that means corporates prefer to buy well out-of-the-money put options that
eliminate downside risk, while preserving as much of their upside as they
feel is justified.