Academic journal article Chicago Fed Letter

Risks and Resolutions: The 'Day After' for Financial Institutions-A Conference Summary

Academic journal article Chicago Fed Letter

Risks and Resolutions: The 'Day After' for Financial Institutions-A Conference Summary

Article excerpt

The Chicago Fed's Supervision and Regulation Department, in conjunction with DePaul University's Center for Financial Services, sponsored its second annual Financial Institutions Risk Management Conference on April 14-15, 2009. The conference focused on risk management, headline issues, and recent financial innovations.

This year's risk conference focused on how the rapidly shifting financial and economic environment is changing the way risk is being managed. This Chicago Fed letter provides a summary of the relevant research presented and discussions held by the bankers, supervisors, and academics in attendance.

Opening the conference, Ali Fatemi, De Paul University, described how rapid growth in the U.S. financial sector in recent decades led to deregulation, increased leverage,1 and overconfidence in the industry's ability to manage risks. As we enter a new period of stricter regulation, he said, there is concern that the best and brightest workers will depart the industry in significant numbers.

Carl R. Tannenbaum, Federal Reserve Bank of Chicago, noted that the U.S. financial landscape has changed dramatically in just the past six months. The U.S. Department of the Treasury and the Federal Reserve have been exceptionally active over this period. He said that we will be identifying and debating the lessons learned for years to come. These include lessons about the assumptions and applications of financial risk-management models, as well as lessons about linkages between credit risk and liquidity risk.

Amplifying Tannenbaum' s assessment, Charles L. Evans, president and CEO, Federal Reserve Bank of Chicago, outlined how an abrupt swing from extreme risk tolerance to extreme risk aversion had brought the financial system to its current state. Financial stress is also taking a toll on the "real" economy during this business cycle; i.e., the turmoil on Wall Street is affecting what's happening on Main Street. This has not always been the case historically. Gross domestic product continues to contract, and unemployment is likely to continue to rise until 2010.

Evans predicted that a number of reforms could figure into the resolution of this crisis. These include identifying systemically important institutions, rethinking how to price the safety net, and requiring higher capital - whether "exogenously" through higher regulatory minimums for capital balances or "endogenously" through putting debt holders at risk and exerting market discipline.

CEO and chief risk officer perspectives

William Downe, CEO, Bank of Montreal (BMO), argued that BMO has benefited from the diversity of its businesses, the strength of its risk infrastructure, the sound judgment of its staff, and its conservative risk culture (especially regarding credit risk) . BMO 's most important lessons learned concerned liquidity and interdependencies among products and markets, especially the vulnerabilities of asset securitization.

Under BMO's risk-management program, business lines own the risks, but additional lines of defense are provided by the corporate risk-management and audit functions. BMO has historically had strong risk functions for individual risks, but has been working recently to strengthen communication across these functions.

Richard Cahill, Federal Reserve Bank of New York, moderated a panel of three chief risk officers: Joyce M. St. Clair, Northern Trust Corporation; Dominic Monastiere, Chemical Bank; and Kevin Van Solkema, The Private Bank. The panelists discussed their organizations' riskmanagement structure and how they are responding to the global financial crisis.

St. Clair said that at Northern Trust, risk policies, tolerances, and reporting flow through an extensive committee structure at the business-line and executive levels to the board of directors. In the current economic and political climate, the bank has institutionalized and globalized its incident management process, is focusing more on emerging risks, and is paying more attention to scenario analysis and stress testing to determine capital adequacy. …

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