. yet large losses on over - the - counter derivatives have been few. derivatives possibly intensified the losses in underlying markets in the liquidity crisis during the third quarter of 1998, but they were scarcely the major players. credit losses on derivatives spiked but remained well below those experienced on banks ’ loan portfolios in that episode. derivatives credit exposures, as you all know, are quite small relative to credit exposures in traditional assets, such as banks ’ loans. in the fourth quarter of last year, for example, banks charged off $ 141 million of credit losses from derivatives - including options, swaps, futures and forwards - or only 0. 04 % of their total credit exposure from derivatives. this in part reflects the fact that in some derivative contracts, most notably in interest rate swaps, there is no principal to be exchanged and thus no principal at risk. in comparison, net charge - offs relative to loans were 0. 58 % in that quarter - also small but, nonetheless, almost 15 times as much. in the third quarter of 1998, at the height of the recent financial turmoil, the loan charge - off rate at us banks was four and a half times that of derivatives. in a similar vein, concerns of highly leveraged positions caused by derivatives have led to fears of “ excessive leverage ”. but leverage, at least as traditionally measured, is not a particularly useful concept for gauging risk from derivatives. a firm might acquire an interest rate cap, for example, to hedge future interest rate uncertainty and hence to reduce its risk profile. yet if the cap is financed through debt, measured leverage increases. thus, although one may harbor concerns about the overall capital adequacy of banks and other participants in derivatives markets and their degree of leverage, the advent of derivatives appears to make measures of leverage more difficult to interpret but not necessarily more risky. to be sure, the unfamiliar complexity of some new financial instruments and new activities, or the extent to which they facilitate other kinds of risk - taking, cannot be readily dismissed even by those of us who view the remarkable expansion of finance in recent years as a significant net benefit. what i suspect gives particular comfort to those of us most involved with the heightened complexity of modern finance is the impressive role private market discipline plays in these markets. importantly, derivatives dealers have found that they must maintain strong credit ratings to participate in the market. participants are simply unwilling to accept counterparty credit exposures to those with low ratings. besides requiring a strong

readily available, we might be able to demonstrate the same pattern at institutions significantly involved in the private equity market and perhaps even in derivatives trading. any earnings stream that shows variability has been appropriately discounted. that is not to say that real economic value is not being created for banking organizations, their shareholders and the economy from what appears to be a greater - and perhaps expanding - flow of venture and other equity capital from banking organizations. but despite the very good record to date in both the derivatives and private equity activities of banking organizations, we all would be remiss if we did not note that there are risks in these activities that, during some periods in the future, will create reduced returns, if not significant overall losses, for individual organizations. however, the same might be said about portfolios of loans - the traditional historical major asset of banks - and one that will continue to dominate the business of most banks for the foreseeable future. conclusion i have noted many times over the years that the purpose of banks and banking organizations is to take risk in order to contribute to, and facilitate the growth, and other needs, of an economy. we must be cautious, however, that we understand the nature of the new risks that have evolved with information innovation technologies and be certain that they are managed in ways that do not undermine this economic role. balancing these objectives is no easy task. we need to ensure that strong risk - management systems are in place and that the management of banking organizations use these systems both to enhance their awareness and understanding of the risks knowingly taken and to manage those risks accordingly. but systems are never perfect, mistakes will be made and tails in loss distributions do represent a reality that sooner or later occurs. individual foreign and domestic banking organizations in the past have, from time to time, suffered large losses in the derivatives and private equity markets. we will not be immune from such events in the future. but so long as we recognize the risks and insist on good risk - management system, and so long as supervision moves - as it has - from balance sheet analysis to a review, evaluation and criticism of risk management systems, economic growth is, i suggest, enhanced by the kinds of financial innovation that technology and deregulation are now producing.