In the arcane world of derivatives trading, banking has become a branch of applied mathematics. How do the managers cope? Rudi Bogni, of Swiss Bank Corporation, explains why he is going back to universityby Rudi Bogni / October 20, 1995 / Leave a comment
Published in October 1995 issue of Prospect Magazine
I am a 47-year-old banker-chief executive of Swiss Bank Corporation in London, to be precise-and I have just decided that I need to go back to university for two years to study mathematics. Some of my friends think I am mad, and perhaps they are right. But perhaps something strange has happened to banking too.
It is hard to imagine that there is anything really new in banking. The tools of the trade have been around and in use, pretty much unchanged, for hundreds of years. Yet within the span of my own career, the world of international finance has enjoyed a renaissance-a spurt of creativity in the 1970s and 1980s, when new techniques emerged which have transformed the conduct of many banks and bankers. These techniques-collectively known as derivatives-have spawned a new jargon (would you know what to do with a Jellyroll, or an Alligator Spread?), huge new sources of profit, and mystifying new types of risk. They have even crept into the popular consciousness as a kind of sorcerer’s apprentice-an all-purpose bogey for mythologising the modern City. Was it the power of these strange new instruments which allowed a 28-year-old trader in Singapore to bring down a 200-year-old banking dynasty?
Derivatives-so called because their pricing is derived from the underlying “cash” markets for loans, equities and foreign exchange-were originally designed to provide users with a way of reducing financial risk. The user might be any kind of organisation-corporations, governments and investment funds are all exposed to financial risks of one kind or another: the risk, say, that their cost of borrowing will rise if interest rates go up, or that the value of their foreign assets will fall if the exchange rate moves the wrong way. Swaps, options and futures are simply contracts which allow the parties concerned to exchange one form of payment for another. Even housebuyers keen to lock in fixed rates are unwittingly using swaps and options.
Now the tail has come to wag the dog. The efficiency and effectiveness of these instruments has meant that the derivative markets are so large and so liquid that they now drive the real markets, rather than the other way around. Some economists even fear that derivatives threaten the stability of the financial system. They have certainly made the financial condition of companies more opaque, as accounting conventions have not kept pace with invention. Whereas 15 years ago the bulk of a bank’s business would be accounted for in the traditional way, today much of the important business is in derivatives which do not show up on the balance sheet at all, but are recorded in contingent accounts.