Comments on: “Sub-prime” - is this the last great risk management failure? http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/ Risk Management in Australia Tue, 02 Dec 2008 02:38:21 +0000 http://wordpress.org/?v=MU hourly 1 By: Steve Edney http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/#comment-23254 Steve Edney Wed, 15 Aug 2007 01:00:53 +0000 http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/#comment-23254 Andrew, I think you are overly optimistic. While Basel II may well shut the gate on these particular practices inevitably the industry will find new structures instruments and investments that it won't cover well and there will be yet another such crisis. I think its just part and parcel of doing business. I don't think any codified system of regulation is going to stop that, only active individuals in Risk management actually engaging with trading practices and critically examining what is going on can keep it in check in a timely fashion. Those without it will get caught up eventually. Not that I think Basel II is worthless, but its hardly a panacea for risk management. Andrew,

I think you are overly optimistic. While Basel II may well shut the gate on these particular practices inevitably the industry will find new structures instruments and investments that it won’t cover well and there will be yet another such crisis. I think its just part and parcel of doing business. I don’t think any codified system of regulation is going to stop that, only active individuals in Risk management actually engaging with trading practices and critically examining what is going on can keep it in check in a timely fashion. Those without it will get caught up eventually.

Not that I think Basel II is worthless, but its hardly a panacea for risk management.

]]> By: Andrew http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/#comment-23196 Andrew Mon, 13 Aug 2007 11:35:22 +0000 http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/#comment-23196 Penguin, This is at least a little bit of stirring. In this instance, though, and unusually, I think that it is mostly credit or market risk. Ops risk will bring down one small to medium institution - as you noted. It is wide-spread credit and market risk that will cause this sort of wave. That's why I think the disclosures have to be improved. Institutions still try to get away with the regulatory minimum - to me, beating that minimum by a wide margin is behavior to be encouraged. Penguin,
This is at least a little bit of stirring. In this instance, though, and unusually, I think that it is mostly credit or market risk. Ops risk will bring down one small to medium institution - as you noted. It is wide-spread credit and market risk that will cause this sort of wave.
That’s why I think the disclosures have to be improved. Institutions still try to get away with the regulatory minimum - to me, beating that minimum by a wide margin is behavior to be encouraged.

]]> By: Penguin http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/#comment-23193 Penguin Mon, 13 Aug 2007 10:50:52 +0000 http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/#comment-23193 My contrary view (at least to your headline): many if not most major financial services risk management failures (eg HIH, Barings, NAB's FX scandal, etc) seem to be operational risk. While holding capital against op risk under AMA will hopefully encourage better risk management behaviour (not cutting costs in a way that increase op risk, for example), the calculations are manipulatable enough that I'm reserving judgement until I've seen the behaviour in action. Last great credit risk management failure - possibly. I'm not sure that I know enough about it, yet. My contrary view (at least to your headline): many if not most major financial services risk management failures (eg HIH, Barings, NAB’s FX scandal, etc) seem to be operational risk. While holding capital against op risk under AMA will hopefully encourage better risk management behaviour (not cutting costs in a way that increase op risk, for example), the calculations are manipulatable enough that I’m reserving judgement until I’ve seen the behaviour in action.

Last great credit risk management failure - possibly. I’m not sure that I know enough about it, yet.

]]> By: Saso http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/#comment-23185 Saso Mon, 13 Aug 2007 06:13:47 +0000 http://ozrisk.net/2007/08/13/sub-prime-is-this-the-last-great-risk-management-failure/#comment-23185 I've been wondering the same myself, and the more I think about it, the more I get the feeling that this may just be the signs of things to come. I have a feeling that the 'sub-prime' market fallout is a result of risk management techniques becoming too sophisticated for us to keep a track of. After all, 'sub-prime' bottom fell off a few months before first hedge funds reported problems, and we're still unsure of the total exposure to it. I think with all the smart risk exposure 'slicing and dicing' that is going on right now, we have lost track of who is actually exposed to the risk, and how much of it. Banks have created smart risk management tools to - supposedly - minimise their exposure, but have forgotten that all this sophistication inevitably brings complexity. And complexity is hard to manage. As you already said, what Basel II brings is clarity of vision. Banks have been too busy devising new financial tools and risk management approaches with similarly sophisticated tools to miss the most basic of all risks - what you don't see coming is what is going to bite you in the end. I’ve been wondering the same myself, and the more I think about it, the more I get the feeling that this may just be the signs of things to come. I have a feeling that the ’sub-prime’ market fallout is a result of risk management techniques becoming too sophisticated for us to keep a track of.

After all, ’sub-prime’ bottom fell off a few months before first hedge funds reported problems, and we’re still unsure of the total exposure to it. I think with all the smart risk exposure ’slicing and dicing’ that is going on right now, we have lost track of who is actually exposed to the risk, and how much of it. Banks have created smart risk management tools to - supposedly - minimise their exposure, but have forgotten that all this sophistication inevitably brings complexity. And complexity is hard to manage.

As you already said, what Basel II brings is clarity of vision. Banks have been too busy devising new financial tools and risk management approaches with similarly sophisticated tools to miss the most basic of all risks - what you don’t see coming is what is going to bite you in the end.

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