What do you think are the most important lessons learnt on Managing Risks in Banking Industry from the Economic crisis in Europe?

I think there are number of important lessons. First of all, some observers tend to highlight the wrong behavior of bank managers and general financial institutions. I think a more important point is related to the macro-economy. One of the main underlining factors of the financial crisis was the significant macroeconomic imbalance whereby we have a major country like the US that in some way was running a significant twin deficit and in some way the issue of the subprime mortgages was just a reflection of the American dream, so you can fund everyone that people can buy houses from. I think this means that Risk Management which has always been based on technical statistical analysis of market factor returns and volatility on one side and credit risk on the other side, should be more macro economic driven.

Second lesson is – what is my personal view – I have the impression that more than the failure of risk management and measurement models, which are generally quite flawed since these are tools like testing volatility or calculating estimates, there is not much focus on real governance issues. I saw cases where models were clearly showing that ‘volatility were shooting up’ and therefore risks were shooting up and the typical management responses had been – “Well this is temporary, and we won’t dismantle our positions”. Clearly when things go well, everyone is after profit and within committee meetings which I sometimes saw, the Risk manager has an over-gaining power the reason being that there is presence of asymmetric payoffs.

Risk Management has no upside potential and just face the downside. When things go well in the market you typically have an asymmetric bargaining power. So more than the technicalities it’s about governance issues. And finally a third lesson is – within banking boards, there is a strong need to improve technical knowledge and expertise of board members. Already some guidelines by regulators have been provided to this effect.

A lot of MBA grads look forward to Finance roles in major Banks. How would you guide them (for example at Bocconi University Milan) in these uncertain times?

I tend to resist the temptation that because things have gone wrong, you have to change everything. Now everyone wants more regulations, and everyone is against the markets and people also think that we would need to address more ethical issues. I still believe that a strong rigorous academic education on the technical skills is crucial. By Technical skills I mean – how financial markets work, math, financial statement analysis, accounting, etc. Indeed the Bocconi University curriculum is very much focussed on that. It’s important to highlight practical examples, so “What does properly addressing compliance mean?” or “When can some profitable transaction be figured out to circumvent regulation in real time?” etc. So you really need to go through case studies.

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