Derivatives regulation: Implications for central banks

We review aspects of derivatives markets that affect central bank operations. We focus on how derivatives affect monetary policy and bank supervision, and argue that derivatives have no material adverse impact on the conduct of monetary policy. Our analysis suggests that both derivatives users and dealers face relatively small default risks from derivatives. Systemic risk, the risk of widespread default, has been largely exaggerated. Policy debates have neglected incentives of employees; the nature of this agency risk suggests that internal controls are more likely to reduce these problems than derivatives regulation.