Creating a New Foundation for Risk Management

By Tannenbaum, Carl R.; Chmielewski, Rebecca et al. | Chicago Fed Letter, July 2011 | Go to article overview

Creating a New Foundation for Risk Management


Tannenbaum, Carl R., Chmielewski, Rebecca, Jordan, Paul, Chicago Fed Letter


The Chicago Fed's Supervision and Regulation Department, in conjunction with DePaul University's Center for Financial Services, sponsored its fourth annual Financial Institution Risk Management Conference on April 11-12, 2011. In addition to discussions about risk management, this year's conference focused on the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

Conference discussions also centered on the new face of mortgage finance and the management of incentive compensation and the associated regulatory guidance, along with the impact of new capital rules, which are expected to be influenced by the Basel Committee on Banking Supervision guidelines for strengthening the banking sector's resilience (known as Basel III). This Chicago Fed Letter provides a summary of the presentations and discussions of the regulators, academics, risk-management professionals, and business leaders who participated.

Ali Fatemi, alumni professor and chair, DePaul University, and Carl R. Tannenbaum, senior vice president, Federal Reserve Bank of Chicago, opened the conference. Fatemi noted that, as in the past, this year's meeting would provide for timely, illuminating, and informative discussions. Tannenbaum pointed out that we are in the "middle stages" of improving risk management, including the supervision of bank hold ? ing companies. Many lessons have been learned from the recent financial crisis. The Dodd-Frank Act was legislated in an attempt to address some deficiencies that became evident during the crisis, including certain nonbanks not being subject to regulations and loan under ? writers not retaining sufficient "skin in the game." However, not all observers agree that such efforts will have the desired effect of making the financial system more resilient to financial shocks and crises. Although improved gover ? nance and increased levels of capital may assist in strengthening financial institu ? tions, much of the architecture of the current banking system still needs to be reviewed and evaluated-and perhaps improved upon. There is an expectation that a stronger banking system will emerge in the "later stages" of improving risk management, said Tannenbaum.

Views on the recession and the banking sector

Charles L. Evans, president and CEO, Federal Reserve Bank of Chicago, noted that recent data suggest growth has picked up, indicating a moderate eco ? nomic expansion, despite factors such as residential and commercial real estate markets not growing, unemployment still remaining high, and state spending levels being down. At the January Federal Open Market Committee meeting, gross domestic product (GDP) growth in the range of 3.5% to 4% was forecasted for 2011. Although any growth is welcomed, such growth, by historical standards, constitutes a moderate recovery, said Evans, and unemployment remains at 8.8%. Certain market segments are still depressed, such as residential investment and single-family housing starts; and new home sales are at historic lows. Many distressed and foreclosed properties still have not been put on the market. Evans noted that mortgage reform may be a lengthy process. Sales of new mortgage-backed securities issues have been ane ? mic, and many questions remain as to what role government will play in the mortgage market in the future.

Shifting to the health of the banking sector, Evans stated that many banks have completed balance sheet repairs and, although earnings have not fully recovered, recent capital analysis shows bank health has improved. Still, bank managers remain cautious while ques ? tions-such as what is the appropriate level of capital for systemically important financial institutions (SIFIs) and what should be the form of that capital-continue to be debated.

In conclusion, Evans noted that as we slowly emerge from the worst financial crisis since the 1930s, government and regulators are heavily involved in making changes through the Dodd-Frank Act and the potential implementation of Basel III.

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