Warned, but didn't take heed
by Rob Russell

It was Pearl Harbour all over again. The early warning systems – in this case the quantitative models – correctly predicted the impending disaster at the banks. But the generals at banks across America just didn’t pay attention or react quickly enough.

Enterprise risk management would have helped banks prevent the sub-prime meltdown. Many banks’ quantitative models accurately illustrated the threat of sub-prime mortgages before rising delinquencies precipitated the market meltdown. If only bankers had paid attention to them.

In the wake of sub-prime mess, banks are looking at Enterprise Risk Management (ERM) with greater seriousness. It is not too far-fetched to say that ERM in its essence does not exist in many or most banks today. ERM necessarily entails a comprehensive, proactive and most importantly, an integrated view to risk.

The banks that got it right

In fact, according to a report issued by the Senior Supervisors Group, an organisation of American and European regulatory authorities, “firms that avoided such problems demonstrated a comprehensive approach to viewing firm-wide exposures and risk, sharing quantitative and qualitative information more effectively across the firm and engaging in more effective dialogue across the management team.”
“Firms that avoided such problems had more adaptive (rather than static) risk measurement processes and systems that could rapidly alter underlying assumptions to reflect current circumstances.”

The report adds: “They had more adaptive (rather than static) risk measurement processes and systems that could rapidly alter underlying assumptions to reflect current circumstances.”

The fundamental problem is that many organisations today simply do not have a good appreciation for the interdependencies within their organisation, resulting in risk control measures that are too narrowly focused and with risk managers in charge of those systems having a propensity to over react. When these risk managers exaggerate the dangers, product innovation, entrepreneurship and business opportunities are the casualties. This unbalanced approach to Risk Management is a fundamental problem that masked inadequacies when one looks at this from an Enterprise Risk Management vantage point.

ERM necessarily entails the coordination of risk management between disparate but vital areas of finance, including operations, credit, interest rates and markets.

Taking the proper approach can also pay dividends in the form of more effective cross-selling, higher transparency of information that leads to better decisions and possibilities for relationship pricing.

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