Abstract

Financial Futures: New Risks for the Banks?

Futures trading in finance paper with standardized contracts (financial futures) has undergone an extremely dynamic development since its introduction in 1972 - first of allinthe USA. The opening of the London International Financial Futures Exchange (LIFFE) in autumn 1982 gave grounds to expect that German banks, too, would take increased interest in the new business possibilities. It was therefore necessary to inquire into whether banks undertaking direct futures commitments might be faced with new and possibly unjustifiable risks. Asarule, financial futures do not involve settlement by delivery on the appointed day, but rather realization of expected, but uncertain interest or exchange rate differences. Since financial futures contracts require only a small capital investment, their leverage with respect to possible profits and losses is considerable. Here lies the enticement but also the risk of financial futures. Because also bank supervision regulations currently do not bar expansion of financial futures trading, a loss potential may be built up, the magnitude of which is not oriented to the risk absorption capability of the banks. And even the institutional arrangements on the futures markets to limit losses do not, in the final analysis, preclude the loss risk. However, it would not be reconcilable with due and proper bank management to conclude futures contracts solely with an eye on hoped-for interest and exchange rate changes, that is to say, for speculative purposes. The limiting criteria as between speculative and non-speculative contracts (hedges) are derived. A financial futures contract is non-speculative only when the banking business shown in the balance sheet embodies an interest or exchange rate risk which offsets the financial futures risk. It is thus evident that the conclusion of non-speculative contracts on the financial futures market for German banks’ own account can be considered only to a limited extent. Even when good opportunities for such transactions present themselves, certain residual risks remain. Moreover, hedges involve the same risk of loss as speculative items with respect to the impact on the balance sheet. Furthermore, the handling of futures transactions demands in any case adherence to bank supervision regulations concerning notification and reporting and observance of certain minimum requirements for trading, settlement and control