Post the 2008 Global Financial Crisis, there has been a serious attempt to learn from the banking crisis that threatened to envelop the world and push it into a seemingly never ending recession. The anemic growth following the reduction of interest rates to almost zero in most emerging economies, with the Federal Reserve Quantitative Easing policy has many, including us a Gnostam asking whether anything has been learned from this latest crisis.
We contend that to those who want to observe the experience of the last 5 years, there are lessons of value, which we summarize below:
- Treat your balance sheet funding and asset requirements separate in terms of risk, even though this runs counter to much of received wisdom. What do we mean by this? That if you are a bank, or a financial institution, your business is managing the risk on the asset side of the business, which fundamentally includes financial assets of all types, loans, interbank exposure, real estate and equities. There is this common sense caveat, if you do not understand the assets on the right hand side of the balance sheet, what-ever is left on the left side wont be right, if you pardon the pun. Most business have asset exposures, which they have to fund some-how, whether as a bank through “bank” deposits which depend on trust, or by long term loans. We contend that the responsibility for management is to ensue that the integrity of the asset values is not compromised, by gaming the system, by misrepresenting the quality of assets, [as was done with CDO’s in 2007-2008], and by having a management system that maps the quality of these assets with a system of verification which takes account of “human” incentives and decisions.
- If you are in the risk business like insurers, then your business is the mirror image of most “normal” business in that you are managing liabilities, for profit, therefore you have to segregate your assets into pools of “safe” assets that can be accessed in the event of a claim, [see for example the operation of the London Lloyds insurance market, where there are “agreed” risk acquisition procedures, and asset management procedures which are quite seprate].
In an engagement for a client we will review the operations risk of the business and determine with management, an outside economic overall risk assessment and an internal risk assessment. We will map the organizations capability to respond to these risks, through a series of scenario based audits, which take account not only of economic risk, but of “human” responses.