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Wednesday, January 5, 2011

What's Wrong With Risk Management in Financial Institutions?

A recent article about financial institutions what is wrong with risk stimulated me to think broadly about what is truly busted with these banks, what is the crux of the problem?

I fair the industry misses several points in general; one of the most disappointing responses from regulators and governments around the world for the credit crisis was to punish the traders and sales teams of financial institutions by cutting their bonuses. In reality all these people were doing was their jobs, too well perhaps. The risk departments seemed to dodge the spotlight of attention to some degree and it is these control functions which should manage the depth of risk taking.

Risk People
On the point of risk people in general, of which I have met quite a few now, there are two kinds: Academically applied individuals that have insight into the dynamics of how markets work and general plebs who may have incredible qualifications but haven't read a book since they left university. This latter group generally lack expertise across the various disciplines in a bank to be of much use and too often focus on political campaigns to further their careers, they are an unpleasant morbosity for the bank and there are too many of them.

Being a risk manager should be a vocation not a job and interviews should start with the first question "what paper have you written or conference have you spoken at during the last twelve months?"
 
Risk Systems
On risk systems in these banks, there is a lot of rubbish out there when there shouldn't really be. There are some great tools out in the market place now, such as the Algo suite or FRS Global Risk Pro toolset or Sungard and so many others yet, I have seen so little of the profound in many of these banks. Most financial institutions can't measure wrong way risk, they have a silo approach to monitoring risk, the risk systems can't aggregate offsetting exposure on structured deals, historical VaR is still being used when even the janitor knows it is backward looking, risk information isn't presented in a context that can drive decision which is tracked and risk categories such as liquidity, crowded markets, concentration risk are fanciful futuristic notions without to much reality.
 
Too big to fail
This too big to fail concept (which is another debate) in my opinion is a bit of a farce. As banks broaden the revenue lines and differentiate their balance sheets, they become more resilient however as they become useful to a large populous they are deemed hazards. What goes wrong in the too big to fail is they turn into bureaucracy houses full of the type two risk management teams with numerous sometime hundreds of systems that don't interconnect. There is nothing wrong with mixing retail markets with securitisation functions and it will fly but only on the proviso that it is operated as a well governed autocracy. As it stands most to big organisations can't join the dots.

What is the solution for all of this, well I am not sure there is but that is what I see as broken in general.

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