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Stress based risk management has emerged as one of the foremost priorities for the financial services industry. Having consulted a number of financial institutions, the vast majority cited stress testing as the pivotal objective around which future initiatives will evolve. To this end, banks are heavily focused on implementing more robust and comprehensive infrastructure to facilitate more timely and meaningful results. To meet this objective, institutions must overcome significant challenges owing to the monumental volumes of data involved, varying portfolios across businesses and multiple data sources.
Since the turn of the millennium, the financial sector has attempted to mimic other industries by exhibiting remarkable degrees of innovation. Under the guise of spreading risk, the era spawned a deluge of derivative instruments that led to both the industry’s prosperity and eventually spectacular implosion. As a consequence, financial institutions are seeking to benefit from increased diversification into commodities.
The subsiding turmoil in financial markets heralds an era with vast revisions of risk management conventions and regulatory action to forestall another crisis of such severity. While excessive risk taking by financial institutions is summarily consigned the greatest blame, one must be mindful that even the most meticulously planned preventive measures for loss control buckle when assets cannot be sold within a foreseen range of prices.
Ascertaining the gravity of operational risk as opposed to other types is handicapped by the relative difficulty of defining and quantifying it. Fortunately, enshrined within Basel II is an attempt to provide guidance in this direction. The Advanced Measurement Approach to gauge losses arising from operational risk and allocating sufficient capital is the most analytical and flexible method.
Deconstructing the traditionally entrenched silos in risk management is an affair that has gained immense currency in recent months. Even the most benign risk exposures for each specific risk type may prove collective precursors to quite grave issues. To mitigate these concerns, it is imperative to collect, collate and convey all risk metrics that track potential hazards to senior management in a format that is easy to discern.
Wrong way risk is a key area of interest at the moment. In the past, banks were perhaps more focused on default rates, considering them in isolation, but this has certainly changed of late. Measuring credit exposure has gradually evolved and become more sophisticated.
Although the regulatory climate over monitoring frequency of market risk has been marked by relative ambiguity in recent years, the evolution, complexity and effervescence of financial markets renders intraday reports a sensible approach. However, several issues may yet inhibit its feasibility.
It has become increasingly important that risk management, and risk in general, is recognised right across the bank, along all business lines and from the boardroom to the trading floor. Previously solely the remit of risk managers, it has now become essential that everyone at a financial institution becomes well versed regarding the inherent risks faced.