Academic journal article Chicago Fed Letter

Searching for the New Normal: The Rebuilding Process for Risk Management-A Conference Summary

Academic journal article Chicago Fed Letter

Searching for the New Normal: The Rebuilding Process for Risk Management-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 third annual Financial Institution Risk Management Conference on April 6-7, 2010. The conference concentrated on comprehensive risk management, lessons learned, and headline issues.

In addition to overviews ofthe risk-management landscape, this year's conference focused on commercial real estate (CRE) , financial modeling, capital planning, and risk and compensation. This Chicago Fed Letterpvovides a summary of the relevant research presented and discussions held by the bankers, academics, and supervisors in attendance.

Opening the conference, Ali Fatemi, DePaul University, described how risk aversion on the part of both bankers and regulators had reduced the availability and increased the cost of credit. Establishing the "new normal" requires efficient allocation of credit at the lowest cost; therefore, he called for the proper balance of private and regulatory incentives to achieve this goal. Carl R. Tannenbaum, Federal Reserve Bank of Chicago, continued by contrasting the turbulent circumstances of the previous conference (held in the immediate aftermath of the worst of the financial crisis) with the relative calm surrounding the current conference, reflecting improvements in the economy and financial system.

Policymaker perspectives

Charles L. Evans, president and CEO, Federal Reserve Bank of Chicago, offered his thoughts on some of the challenges banks and regulators are likely to face. For example, enhancements to microprudential regulations, which focus on individual institutions, need to be supplemented by macroprudential supervision, which considers risks to the financial system as a whole. However, such macroprudential approaches also face obstacles, such as knowing exactly when to intervene in a potential asset bubble. Evans advocated a multipronged approach featuring strengthened capital requirements, a comprehensive approach to risk management, a macroprudential supervisor, and a process for effectively resolving insolvencies at large institutions.

According to Evans, central banks should play a key role in financial stability and in the supervision and regulation of financial institutions. For one thing, a central bank without supervisory responsibilities would have to confront any financial crisis using only monetary policy. In such a case, the central bank might have to act against exuberance in financial markets by tightening monetary policy more than would be indicated by macroeconomic considerations alone.

A former Governor ofthe Federal Reserve System, Randall S. Kroszner, currently of the University of Chicago, surveyed some ofthe lessons about risk management learned from the global financial crisis. He first provided an overview of some of the fragilities of the current financial system. Then he listed "seven deadly sins of risk management" that risk managers should strive to avoid. These included allowing accounting values to obscure economic realities, failing to fully capture risk concentrations, ignoring risks faced by funding counterparties, being overconfident during periods of high market liquidity, and failing to adequately model and manage tail risk.1

Kroszner concluded by suggesting reforms for risk managers and policy-makers to consider. Risk-management functions should be independent, have sufficient stature in the organization, and consider the full range of risks. Central clearing of derivatives should be encouraged to enhance market resiliency and mitigate interconnectedness problems. The resolution regime for large financial institutions should also be improved. Finally, regulators should improve the monitoring of liquidity risks and reform capital requirements.

CEO and chief risk officer perspectives

The conference featured perspectives on risk management from a bank CEO and a panel of bank chief risk officers. …

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