Senior financial supervisors from five countries today issued a report that assesses the risk management practices of a sample of major global financial services organizations in an effort to find out what worked, and what didn’t during the recent period of market turmoil.
The report, “Observations on Risk Management Practices during the Recent Market Turbulence”, finds that the predominant source of losses for firms in the survey was concentrated exposure to securitizations of U.S. subprime mortgage-related credit.
“In particular, some firms made strategic decisions to retain large exposures to super-senior tranches of collateralized debt obligations that far exceeded the firms’ understanding of the risks inherent in such instruments, and failed to take appropriate steps to control or mitigate those risks.”
It also says that another risk management challenge concerned firms’ understanding and control over their potential balance sheet growth and liquidity needs. Some firms failed to price properly the risk that exposures to off-balance-sheet vehicles might need to be funded on the balance sheet; and some firms found that they could not syndicate their holdings of leveraged loans nor could they cancel their commitments to fund those loans.
The firms that largely averted big losses took a broader approach to assessing, and managing their risks, the regulators found. “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,” it observes. “Senior managers in such firms also exercised critical judgment and discipline in how they valued its holdings of complex or potentially illiquid securities both before and after the onset of the market turmoil.”
These firms also had more dynamic risk measurement processes that could rapidly alter underlying assumptions to reflect changing circumstances; and, management relied on a wide range of risk measures to gather more information and different perspectives on the same risk exposures and employed more effective stress testing with more use of scenario analysis, they found.
In addition, the review found that management of better performing firms typically enforced more active controls over the consolidated organization’s balance sheet, liquidity, and capital, often aligning treasury functions more closely with risk management processes, incorporating information from all businesses into global liquidity planning, including actual and contingent liquidity risk.
Based on these findings, supervisors are critically evaluating the efforts of the individual firms they supervise, and ensuring that its firms are making appropriate changes to risk management practices. They will also help to define an agenda for strengthening supervisory oversight, they note.
“We will use the results of our review to support the efforts of the Basel Committee on Banking Supervision to strengthen the efficacy and robustness of the Basel II capital framework,” they say, adding that their observations also support the need to strengthen the management of liquidity risk, and they will continue to work directly through various international forums on this issue; and, individual national supervisors will review, and revise, existing guidance on risk management practices, valuation practices, and the controls over both. Finally, they will support efforts to address issues such as whether disclosure practices need to be improved, whether the accounting and disclosure treatments of exposures to off-balance-sheet vehicles are appropriate, and how to manage the incentive problems created by compensation practices.
The report reflects a joint review that supervisors initiated this past autumn. The seven supervisory agencies participating in this project are the French Banking Commission, the German Federal Financial Supervisory Authority, the Swiss Federal Banking Commission, the U.K. Financial Services Authority, and, in the U.S., the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Federal Reserve. The report also reflects the results of a roundtable discussion that participating supervisory agencies held with industry representatives on February 19, at the Federal Reserve Bank of New York.
Regulators issue report on risk management practices of global banks
Firms failed to control risks of concentrated exposure to securitizations of U.S. subprime mortgage-related credit
- By: James Langton
- March 6, 2008 March 6, 2008
- 13:20