Risk Magazine Articles

2015

November:  And so farewell
After more than 16 years, I have decided to stop down from my role as the monthly Risk Analysis columnist at Risk magazine. My final column takes a personal look back at the issues and events that have shaped risk management during this period.

October:  Expected Shortfalls Silver Lining
Despite continuing to insist that replacing value-at-risk with expected shortfall in the Basel capital rules is wrongheaded and potentially dangerous, I argue that the shift may have an important silver lining.

September:  An Optimistic Note
Economists in general, and risk specialists in particular, are often viewed as a gloomy lot. Nevertheless, I offer a contrarian and basically upbeat view on two often discussed long-term concerns.

August:  Let the Dice Fly
A painfully negotiated agreement may have staved off the immediate threat of Grexit, but I argue that the structural inconsistencies of the eurozone will be a source of uncertainty for years or even decades to come.

July:  Agility versus Transparency
For the past thirty years, banks have faced a difficult trade-off between agility and transparency. I argue that this trade-off was an unavoidable consequence of 20th century technology that now can be overcome. Unfortunately regulators seem as stuck in the 20th century as the banks are.

June:  Geeks at the Gates
Hampered by increasingly complex regulations, as well as the cost and inertia of inefficient legacy systems, banks are facing growing competition from innovative non-bank organisations. Unless they start to confront the mission-critical importance of transforming their technology, they could face death by a thousand cuts.

May:  Still in Denial
Despite banks’ ongoing struggle to improve the agility and transparency of their information systems, I argue that they are still ignoring the need for a fundamental change in architecture.

April:  Its Seismology Not Roulette
The Swiss franc surge on January 15, when the central bank abandoned its peg to the euro, revealed continuing confusion about the role, the value and the limitations of models. I argue that too many analysts still carry around a misleading analogy that hampers their understanding such events.

March:  Greece: a new drachma unfolds
The electoral triumph of Syriza in Greece has awakened the sleeping ogre of the eurozone crisis. I argue that no plausible outcome of the confrontation between Greece and its creditors will ultimately resolve the inconsistency of a monetary union unsupported by political union. Nevertheless, a temporary fudge might work for awhile, leading the unwary into complacency.

February:  An Idea Whose Time Has Come?
The merits of breaking up JP Morgan were widely discussed in early January, marking the topic’s shift to the mainstream of public discourse. It is an open question whether the global mega-banks can resist an idea whose time may have come.

January:  The Era of Computational Abundance - and its risks
The advent of the internet of things and the explosion of computational power it portends will transform banking information systems. Unfortunately, many institutions will fail to capitalize on this because they are constrained by a reluctance to surrender decades-old assumptions.

2014

December:  The Complexity Conundrum
Complexity is an inherent aspect of almost all human progress, but it also can be a source of danger. In light of the global financial crisis, countering this danger understandably remains high on the policy agenda. Important as this is, I continue to argue that regulating new derivatives like new drugs would be a step too far.

November:  Poisoning the Well
Billions of dollars in fines have recently been imposed on US companies for activities that occurred before the offending business units were acquired, often under government pressure and/or with government support. I argue that the way these fines were imposed not only undermines the rule of law but it will make future crises harder to manage and more severe.

October:  The Limits of Ambiguity
The UK has a remarkably successful record of living with ambiguity but it may have reached the limits of its ability to do so. Whether it can resolve regional differences in an equitable way poses a source of fundamental uncertainty.

September:  Cyber Fears - Go Modular
Cyber security has become an increasingly important concern over the past year. I argue that embracing radically modular computer architecture is essential if we are to make real progress in meeting the challenge.

August:  Prudent Valuation versus Confidence Accounting
As the financial crisis demonstrated, markets sometimes do not know what something is worth. I argue that explicit estimates of value uncertainty would be a better way of addressing this than so-called prudent valuation.

July:  Europes Leaders are Playing with Fire
After the proposed European Constitution was rejected by French and Dutch voters in 2005, I wrote that Europe’s leaders needed to rethink the pace of integration. After the latest European parliamentary election, I argue that such a change of direction is even more urgent - but still far from certain.

June:  Optimal Currency Areas and the Euro
A classic paper on the economics of currency areas illuminates the dilemma facing the eurozone. The recent calm in financial markets does not alter the fundamental problem.

May:  Underestimating the Risk Data Challenge
The Basel Committee on Banking Supervision is pressing banks to clean up their act when it comes to risk data. This is a commendable and long overdue initiative but supervisors may well be underestimating the full magnitude of the task

April:  Fair-value Accounting's Blind Spot
In recent years, the preference for market-determined prices as the correct basis for valuation has become deeply ingrained. While agreeing with this view in principle, I argue it is not applicable in all circumstances and can, in fact, magnify the impact of negative feedback loops.

March:  Unwilling or Unable?
Regulators recently published the findings of a study of counterparty risk data at the world’s largest banks. I note that it makes for depressing reading but also is symptomatic of deeper problems hampering the practice of enterprise risk management.

February:  Beyond Relational Databases
Data and analytical fragmentation have been obstacles to effective risk management for decades. I argue that the intractability of this problem is rooted in dependence on relational databases and that moving beyond this framework holds the key to success.

January:  An Impractical White Elephant
The Basel Committee’s Fundamental review of the trading book raises some serious issues but I argue its central proposed revision to the market risk capital regime is little more than a costly distraction that should be abandoned.

2013

December:  Yellen Faces a Logistical Nightmare
The impending transition from Ben Bernanke to Janet Yellen at the US Federal Reserve is taking place at a particularly sensitive time. I argue that the new chair faces a logistical nightmare in unwinding a massive increase in the central bank’s balance sheet.

November:  Beyond the Comfort Zone
Institutional inertia is one of the abiding forces in human experience, especially in governmental institutions. Sadly, such inertia is likely to hinder much-needed revisions in the practice of financial risk management.

October:  Ignorance in Action
Many of the proposed reforms in derivatives market regulation were driven by politics rather than economics. I argue that this could lead to an additional source of systemic risk and less effective risk management among end-users.

September:  Focus on Fundamentals
For too long, regulators have issued complex rules while remaining seemingly oblivious to the fact that banks will struggle to comply. A new Basel initiative around effective risk data aggregation and reporting represents an overdue focus on the fundamentals.

August:  Consent and Chaos
In many different guises, an ancient question still haunts human society: “What is the source of government legitimacy?” While this is a largely settled issue in the Western industrial countries, it is likely to disrupt parts of the Islamic world for generations.

July:  Wishing Won't Make It So
François Hollande’s claim that “the crisis in the eurozone is over” says more about the wishful thinking of many European leaders than it does about economic and social reality.

June:  Tipping Point?
Electoral advances by anti-European parties and vocal criticism by influential voices represent the most serious challenge to the European project in a generation. While a rapid restructuring of the eurozone, or of the union itself, may seem unlikely, I argue that risk managers ignore the possibility at their peril.

May:  From Greek Tragedy to Cypriot Farce
The crisis in Cyprus may come to be seen as a turning point towards reduced moral hazard and a viable future for the euro but I argue that many pitfalls remain.

April:  China's Challenge
If China is to continue its remarkable economic success of the past 30 years, it needs to tolerate and even encourage disruptive figures such as Steve Jobs. I argue that it is unclear whether the existing power structure is prepared to do so.

March:  The Case for Dynamic Efficiency
The shift from vacuum tubes to transistors revolutionized the optimum approach to software design. Banks’ risk technology strategy should be formulated with this lesson in mind.

February:  Regulators' High-Wire Act
The recent easing of the Basel III liquidity coverage ratio is welcome, but it highlights the difficult – perhaps impossible – regulatory challenge of striking the right balance in a world of too-big-to-fail banks.

January:  Forgotten Pillars
As well as doubling down on complexity, I argue that Basel III represents the triumph of elaborate Pillar I capital rules and the total neglect of Pillars II and III.

2012

December:  Basel Faulty
Having been broadly supportive of the effort to establish global bank capital standards over the past 25 years, I explain why I believe Basel III has gone badly astray.

November:  The False Promise of Expected Shortfall
The Basel Committee on Banking Supervision has proposed using expected shortfall instead of value-at-risk as the central metric for regulatory market risk capital. I argue that this will be both ineffective and dangerous.

October:  Personal Criminal Liability Works, like it or not
If the banking industry is to be cleaned up, rules alone will not cut it. I argue that bankers should face personal criminal liability as well.

September:  Debt Mutualization: Lessons from the U.S.
Some argue that debt mutualization across the Eurozone is the answer to the current crisis, pointing to an almost 200 year old experience in the U.S. for support. I argue that this represents a very selective reading of history.

August:  How to Mend the Libor Process
Barclays’ settlement of Libor-rigging claims has sparked a full-scale financial scandal and exposed the conflicts inherent in the rate-setting process. I argue there is a better way to organise it.

July:  The Eurozone Crisis is a Buyers' Strike
Commentators portray the markets as aggressively attacking European government bonds. I argue that what is really happening is a buyers’ strike motivated by fear. Failure to recognize this can lead to bad policy.

June:  Too-Big-to-Fail: The Next Chapter
The threat to society of institutions that are too big to be allowed to fail should be solved through a predictable legal framework rather than punitive regulation. I commend a group of academics formulating the details of such an approach.

May:  A Crisis of Identity, part two
It has taken a long time to build broad international support for a system of legal entity identifiers. Now that progress is being made, I argue it is important to achieve a responsive system that will last.

April:  Beware of Data Leverage
The inadequacy of available data resources for effective decision-making is a widely recognized problem. I argue that some rough and ready means of quantifying this shortcoming is important to keeping it under control.

March:  Not All Hedges Are Created Equal
The Global Financial Crisis has taught many hard lessons. One lesson risk managers should take especially seriously is that not all hedges are created equal. Furthermore, a hedge that is effective for one type of risk may be ineffective or even counterproductive for another.

February:  Foundations of Sand
Despite the remarkable advances made over the past 25 years, I argue the existing financial risk models are not fit for purpose when it comes to stress testing and analysis of tail risk.

January:  2012: Another Year of Living Dangerously
It is always possible to envisage threats to economic and political stability, but I argue that 2012 presents an especially abundant source of potentially unhappy surprises.

2011

December:  CDSs: Lubricant or Landmine?
Credit default swaps have allowed banks and investors to improve the management of their credit risk, but I argue that they may represent a lurking source of contagion in a crisis.

November:  The Democracy Deficit
The Eurozone is grappling with a fiscal crisis but I argue that its ability to cope is being hampered by a more fundamental problem, namely a democracy deficit.

October:  Dangerous Adaptation: the evolution of risk
Adaptation is a powerful force that helps ensure the survival of species. Nevertheless, I argue it also has a dark side that risk managers should keep in mind.

September:  Quo vadis, CVA?
I argue that hedges of derivatives counterparty credit exposure based on credit default swap spreads are unreliable and may lull banks into ignoring tail risks.

August:  Europe in Wonderland
European politicians are still blaming rating agencies for the continent’s debt crisis. I argue that this is obscuring some of the real problems posed by ratings.

July:  Mission Impossible for Ratings
The U.S. Securities and Exchange Commission is soliciting views on how to reform the credit rating process to minimise conflicts of interest and assure higher quality ratings. I argue that this exercise is based on an erroneous view of the possible.

June:  Stress Testing Culture
Many financial institutions are putting greater focus on stress testing, but I argue that most will require a cultural adjustment for it to become an effective part of the risk management process.

May:  Darkest Before the Dawn?
Tragic upheavals sometimes shock a society out of patterns of behavior that have endured for decades or even centuries. In my Risk Analysis column for May I ask whether the triple disaster that has befallen Japan may be a case in point?

April:  Jeopardy and the Future of Risk Management
Computers may triumph playing Jeopardy, but that represents mastery of only one dimension of what we call human intelligence. Nevertheless, the computational advances in natural language processing and information filtering have implications for the practice of risk management.

March:  Market-driven Transparency
Much of the legislation written in response to the financial crisis is intended to force greater disclosure and increase transparency for both market participants and regulators. I think we should consider whether there may be a better way to achieve this badly needed objective.

February:  Withholding Versus Withdrawing
The political difficulty of withdrawing privileges, especially those long expected by the public, will create fundamental uncertainty for years to come.

January:  The Power of Defunct Economists
Economists’ concepts have informed much of the debate around fiscal policy, but the crisis in the eurozone goes well beyond basic text book theories.

2010

December:  Regulators Double Down
I have reluctantly concluded that trying to formulate a reliable quantitative estimate of extreme, low-probability tail risk for banks is futile. If true, this raises serious questions about the wisdom of developing a more complex Basel III capital framework.

November:  Whither the Office of Financial Research?
The new US Office of Financial Research can make a real contribution to financial stability, but only if it develops goals that are both ambitious and realistic.

October:  Analysing Correlations Under Stress
A structural assessment of co-variability during periods of stress can improve crisis management and contribute to better strategic planning.

September:  BP: Lessons Learned
The BP oil disaster in the Gulf of Mexico offers some hard lessons for risk managers. It also shows the essential importance of the rule of law and how easily it can be threatened by the court of public opinion.

August:  Organizational Aspects of Risk Management
In this last of a four-part series, I consider organizational issues and argue that the chief executive and board must accept responsibility for strategic risk management decisions.

July:  Beyond Distributional Analysis
Risk management must move beyond distributional analysis to weigh more qualitative considerations.

June:  Taking Flight
In the second of a four-part series on the development of risk management, I consider the phenomenon of high-impact events, or Black Swans.

May:  Don't Distort the Message
Looking back on the development of financial risk management over the past 25 years, this paper notes how easily risk assessments can be misinterpreted by nonspecialists and the necessity for risk managers to guard against this as best we can.

April:  The Problem is Severity
Financial reformers talk endlessly about the too-big-to-fail problem, but they often fail to address the heart of the issue.

March:  Crossing the Chasm
Existing risk management information systems proved too fragmented and cumbersome to meet decision-makers’ requirements in the crisis. A major reappraisal is required.

February:  Hammers and Nails
Excess regard for the techniques we know can lead to these methods being misapplied. Risk managers too often fall into this trap.

January:  Revenge of the Economists
Business economists are poised for a resurgence if they will apply their skills to the problem of diagnosing structural stresses and dark risk.

2009

December:  Twenty-first Century Supervision
Much of the regulation governing banks was developed in the last century. It is time to stop trying to supervise twenty-first century financial institutions with twentieth century oversight tools.

November:  Let Small Fires Burn
The remarkable stability of the past two decades sowed the seeds of the current crisis. In future, monetary authorities will have to be more aggressive about removing the punch bowl when the party gets interesting.

October:  Beyond Comparative Statics
It is time to extend stress testing to include more than just analyzing the immediate impact of selected extreme events.

September:  Financial Network Risk
Both macroeconomics and financial theory have failed to deal adequately with systemic risk. Other disciplines have much to teach us about the stability and fragility of complex dynamic systems.

August:  Flying Blind
Despite including some useful proposals, the Obama administration’s regulatory reform initiative ignores a crucial issue.

July:  Fostering Opacity
"Too-big-to-fail" is not just a moral hazard problem, it positively fosters dangerous opacity.

June:  Markets Are Not Magic
Despite their pervasive contributions to economic growth and efficiency, it is important to remember that markets are not magic when transparency fails.

May:  Can the Center Hold?
Despite the inevitability of tighter and more intrusive regulation, this alone will not prevent future financial crises as long as ‘too big to fail’ remains an issue.

April:  Second Order Uncertainty
The financial crisis has drummed home the dangers of basing analysis on unreliable data. Despite its amorphous character, risk managers must begin to increase their focus on second order uncertainty.

March:  Systemic Risk Capital
We have seen what can happen when the size of financial institutions rivals – or even surpasses – that of their home countries. It may be time to limit the size of institutions through imposition of systemic risk capital requirements.

February:  The Danger of Two Cultures
A 50-year-old essay on the failure of communication between scientists and literary intellectuals might offer lessons for the future of modern finance.

January:  Corrosive Feedback
Innovations create their own feedback loops and many of these are dangerous. Risk managers need to pay greater attention to such effects in the future.

2008

December:  Dangerous Momentum
All too often, we extrapolate tomorrow based on the momentum of today’s trends. We would do well to adopt our primitive fear of physical momentum when assessing the prospects for financial markets.

November:  Macrofinancial Risk
A valuable synthesis of financial theory and macroeconomics appears to be emerging. This could enrich both areas.

October:  Time for Action
Back-office processing has long been the neglected stepchild of the derivatives business. Improved technology and growing systemic risk mean the time is ripe for supervisors to demand T+0 reconciliation.

September:  Towards T+0 Reconciliation
The Counterparty Risk Management Policy Group’s third major policy statement appeared in early August – and it presents surprisingly radical demands.

August:  Truth and Responsibility
The meltdown in subprime collateralized debt obligations will affect financial markets for years. One likely result will be a renewed market willingness to reward sound credit underwriting – and therein lies a valuable business opportunity.

July:  Required Reading
Over the past year, we have witnessed a unique experiment in what makes ¬ financial risk management effective. A succinct supervisory summary of what we have learned should be required reading for all interested parties.

June:  A Second Means of Valuation
In the same way credit risk managers used to question how a loan would be repaid if the primary means of payment were to fail, so banks ought to ask if there is another way to value structured credit investments if market liquidity were to dry up.

May:  Really Too Big to Fail?
Are bulge-bracket investment banks really too big to be allowed to fail? Despite the upheavals such a failure would cause, the consequences may have been overblown.

April:  Self-Referential Risk
Even good models and successful product innovations can cause problems when their very success exposes them to the paradox of self-referential risk. It is important to analyze such feedback effects in our risk assessments.

March:  Whither Originate & Distribute?
Some argue that the crisis in structured credit markets signals the demise of the originate-and-distribute model of banking, but this fails to take into account the pattern of all revolutions.

February:  Legal Lethargy
Constraining buy-side institutions to hold only investment-grade securities uses a nearly century-old metric with limited contemporary relevance. One modest reform proposal would help.

January:  Where the Buck Stops
Risk management units alone cannot avoid the damage from periodic bouts of irrational exuberance. Ultimately that responsibility lies with the chief executive and the board.

2007

December:  CCDS Unchained
An earlier column argued that contingent credit default swaps offered only limited potential for active counterparty credit risk management. The convergence of several factors could change that.

November:  Cutting the Gordian Knot
Basel II remains wedded to incremental extensions to the market risk rules. It is time for a bolder approach in this area.

October:  No Silver Bullet
The emergence of contingent credit default swaps has presented banks with a new way to manage their counterparty credit exposures, but they have important limitations.

September:  Lagging Risk Management
The rate of growth in the complexity of new derivatives products is causing a worrisome lag in risk management’s ability to keep pace. As credit derivatives markets endure a period of stress, this lag could have serious consequences.

August:  Is It Really Alpha?
Hedge funds often characterize their mission as the pursuit of pure alpha. A growing body of research, however, argues that a significant proportion of observed hedge fund returns are really alternative beta. This column considers the implications for the hedge fund industry and for investors.

July:  A Supervisory Landmark
Allowing the use of internal market risk models for calculation of associated regulatory capital was a landmark change in financial supervision. This can give regulators a powerful tool to force continuing improvement in risk practices if they will use it.

July:  Risk Milestones
The 20th anniversary of Risk Magazine was an inevitable inspiration to reminisce. Herewith are several important public milestones and one personal milestone in the development of financial risk management.

June:  Unthinkably Favorable?
Imagination in stress testing demands unorthodox thinking, since even seemingly favorable events can have negative consequences. In the case of the oil markets, this means stress testing for a fall, as well as a rise, in oil prices.

May:  A Dangerous Idea
Encouraging and supporting sound internal risk management has become an important aspect of effective financial regulation. Imposing a regulatory capital charge for stress-test losses would undermine this important objective.

April:  A Yen for Financing
Yen-denominated mortgages have proven an attractive source of low-cost housing funding over the past 10 years. Are these products an accident waiting to happen?

March:  The Stress Testing Trident
While stress testing is a much discussed topic, an accepted definition of best practice remains elusive. A three-pronged approach may be a start.

March:  The Stress Testing Trident (in Chinese)
While stress testing is a much discussed topic, an accepted definition of best practice remains elusive. A three-pronged approach may be a start.

February:  A Gathering Storm
U.S. default rates for high-yield bonds have remained surprisingly low over the past three years. Some argue this indicates that the world has changed, but we have heard this story before.

January:  Prescription vs Principles
Over the past decade, the shift of supervisory practice from prescription towards a principles-based approach has been dramatic. This was a valuable and necessary change, but it also has greatly complicated retaining qualified supervisory staff.

2006

December:  From VaR to Stress Testing
Implementation of enterprise-wide VAR models in the 1990s was an important risk management advance, but it’s time to rethink some fundamental aspects of how they were designed.

November:  Validating EPE
Empirical validation of trading credit exposure simulation models is clearly essential. The process must differ significantly, however, from traditional back-tests of VaR models.

October:  Arrogance of Hindsight
Some governments are reportedly becoming more active in using derivatives to manage their debt and funding costs. While arguably quite sensible, public distrust and sensationalist journalism present special dangers.

September:  Awakening Giant?
Some circumstances endure long enough to become embedded in the unexamined assumptions of a generation. In the case of the Japanese economy, these assumptions could prove costly.

August:  Home Host Conflict
Despite structural attempts at supervisory co-ordination, international banking groups need to foster bilateral understanding with their subsidiaries’ host regulators.

July:  Dangerous Perfection
An obsessive insistence on academic perfection could limit the benefits of allowing simulation-based counterparty credit exposure methods in Basel II.

June:  Who Benefits?
The accounting scandal at Fannie Mae has been an unfolding story for the past two years. Events from the early 1990s should have provided an early warning of future trouble.

May:  Protect and Survive
Internet banking has soared in popularity over the past few years, but the banking industry must improve security or risk a major loss of public confidence.

April:  An Echo from the Past
Derivatives offer excellent potential for spreading insurance risks across a wide base of investors. Legal uncertainty, however, represents a potential obstacle to traditional insurance companies’ efforts to realize these benefits.

March:  Regulatory Arbitrage - Back to Basics
The increasing tradability of credit risk is creating complications for the Basel Capital Accord that were never envisioned when the market risk amendment was first formulated. The problem is a basic inconsistency between Basel’s assumptions regarding the treatment of risk in the banking and trading books.

February:  China - Covering the Angles
The spectacular growth of the Chinese economy over the past 20–25 years is historically unprecedented in its scope and speed. While there is little sign of this process stalling or even slowing, a note of caution is still advisable.

January:  Building Pessimised Scenarios
Isolating events that could produce significant losses has long been a part of risk assessment. Pressure is building, however, to make such insights a standard component of regular risk analysis and reporting.

2005

December:  Basel 1.5
In October, US banking supervisors released an advance notice of proposed rule-making regarding regulatory capital requirements. While it continues to demonstrate an insistence by the US on going its own way, some aspects of Basel 1.5 would be thoughtful improvements to the standardized approach of Basel II.

November:  The end of an era for the world
George Bush has made his choice to replace Alan Greenspan. Despite initial praise, Ben Bernanke faces months of close scrutiny and the markets face a period of increased uncertainty. Demonstrating his independence will be key to Bernanke’s success.

October:  Whither Stress Testing?
In light of the Basel Committee’s renewed emphasis on stress testing, an industry dialogue is overdue on how this oft-cited technique should be applied. Herewith are some preliminary thoughts on the issue.

September:  The New Market Risk Challenge
Since the late 1990s, the issue of market risk assessment has been viewed as largely settled. A recent statement from the Basel Committee, however, is likely to change this comfortable presumption.

August:  Beware Creative Destruction
A previous column discussed the importance of resisting unnecessary change. This month's column cautions against the tendency to avoid confronting fundamental threats to an organization’s established position.

July:  History Will Not Be Rushed
In the aftermath of the ‘double no’ vote on the draft European constitution, much has been written about the crisis in Europe. While much of this is overblown, trying to rush history can be a risky undertaking.

June:  At long last
After more than a decade of active deployment at major institutions, simulation-based estimation of counterparty credit exposure is on track to become part of the Basel II regulatory capital regime. Its impact on regulatory capital is not the most important benefit of this change.

May:  The Risk of Inertia...and of Change
"Embrace change or die," we are told. Clearly slavish resistance to change will end badly. Nevertheless, embracing change for its own sake can be equally disastrous.

April:  The Dangers of Complexity
The dramatic financial market changes of the past twenty years have introduced daunting complexity into the system. Much of this complexity is the necessary consequence of valuable innovations but complexity for its own sake is dangerous.

March:  Is Risk Management Dangerous?
Risk management has experienced such a remarkable rise in the past 15 years that some have begun to decry its influence. Often these are just the complaints of those who bristle under its constraints. A recent more thoughtful critique, however, raises issues that should be taken seriously.

February:  Dynamic Benchmarks
One of the biggest challenges in effective risk reporting is avoiding the trap of mind-numbing routine. Dynamic benchmarks and exception highlighting are ways of keeping such reports relevant and useful, thereby maintaining management’s attention.

2004

December:  Risk Information - Balancing Priorities
Reliable generation and timely distribution of relevant information is essential for effective risk management. A senior executive with working knowledge of all aspects of the problem and authority to make the necessary compromises among competing priorities is essential for success.

November:  Risk Management: Overhead or Value Added
Many argue that risk management professionals must break out of the role of being the ‘risk police’ and become value-added contributors. This idea is commendable but it still is important to distinguish the nature of a risk manager’s role from that of traditional line managers.

October:  With a Bang or a Whimper?
Inconsistent pricing across traditionally segmented markets has been greatly reduced in recent years. Much of this improved market efficiency is due to the efforts of hedge funds, but the very success of these funds may be laying the foundation for a major shake-out, with potentially serious consequences.

September:  Operational Risk and Black Swans
Scarce data is a well recognized problem for the assessment of operational risk. In such circumstances, it is necessary to blend professional judgment with the available data. In doing so, however, it is crucial to counter some well documented psychological biases in our subjective estimates of probability – and a healthy dose of humility is also advisable.

August:  Basel II: The Time for Action
Despite some lingering issues, the main points of contention around the revised Basel II capital Accord have been resolved, and implementation seems more certain than it has for several years. It is time to stop hoping it will go away and get on with the inevitable effort required to comply.

July:  The Risk of Generational Change
Most industrial countries are in the midst of a transition away from socially mandated to individually managed retirement planning. This holds potentially huge strategic risks for buy-side firms that fail to meet the highest standards of fiduciary care while offering real opportunities to the most innovative among them.

June:  A Difference in Kind
Tracking key risk indicators is emerging as a central aspect of best practice for operational risk management. Defining these indicators and establishing benchmarks for them is a complex task. There is an industry initiative that can help.

May:  Commensurable vs Appropriate Risk Measures
Integrated measurement has become something of a mantra in the risk management field. Unfortunately, this means different things to different people. It does not mean that a uniform measure is suitable for detailed monitoring of risk at all levels of an organization.

April:  What Are Loan Loss Reserves?
Few things are more frustrating to businesses than to be subjected to contradictory requirements by multiple authorities. While modest inconsistencies can be glossed over with little or no harm, conflicting definitions of loan loss reserves are creating real problems and need to be resolved.

March:  Net Asset Value and Risk
In light of the growth of hedge funds and the recent mutual fund market-timing scandal, valuation has become a hot topic. A clear definition of what published valuations represent is essential and such valuations need to be supplemented with consistent risk information.

February:  Accounting for Revenue Uncertainty
The past 20 years have seen an increasing focus on mark-to-market accounting when determining corporate profits. This has been accompanied by a dramatic growth in contracts where multiple complex contingencies interact to affect valuation. Recent proposal to partition revenue into three components would bring added transparency to financial statements.

January:  Mutual Self-Awareness and Fat Tails
Mutual self-awareness among market participants is an important distinction between physical and social systems. This is a fundamental cause of the well documented characteristic of fat tails in the distribution of changes in market data, and should be a key focus of all market risk managers.

2003

December:  Credit Risk Catches Up
When Basel II was first proposed in 1999, credit risk models lagged way behind market risk models. But that’s changed, which means we need less prescriptive rules for determining credit risk capital.

November:  When is Best Practice Good Enough
The most dramatic change in banking regulation in decades has been the move from highly prescriptive procedures towards demanding "best practice" risk management methods. Differences over how quickly the new approach can be applied to credit risk management is at the heart of the controversy over revising the Basel capital Accord.

October:  Statistical Process Control
Too often, finance professionals manifest a smug sense of superiority towards their peers in manufacturing. When it comes to operational risk management, the manufacturing sector has much to teach financial institutions. Statistical process control is a good case in point.

September:  Reason for Hope
One disappointing aspect of the Basel II deliberations has been the lack of any proposed change in the treatment of counterparty credit exposures. Recent dialogue between the Basel Committee and industry representatives offers hope for an important improvement in this area.

August:  The Operational Risk Pyramid
The extremely heterogeneous character of operational risk often makes discussion of it appear fragmented and unstructured. This column proposes a possible paradigm for organizing our thinking on various aspects of this increasingly important topic.

July:  The Point of Operational Risk Management
The inclusion of an explicit operational risk component in the proposed Basel II Capital Accord has caused widespread controversy. Much of this has surrounded the feasibility of accurately measuring, or even defining, such risk. A more important goal should be to improve the consistency of banks’ internal process execution.

June:  Accounting for Stock Options
Social problems often grow to uncomfortable proportions before democratic societies can muster the consensus needed to deal with them. Then the steps taken are often sudden and ill-considered. This common pattern is playing itself out relative to accounting for stock options. This column suggests an alternative to the proposed "expensing" approach.

May:  Is 8% for All Seasons?
Considering the potential pro-cyclical impact of Basel II and the limited effectiveness of countervailing influences, making the 8% ratio of capital-to-risk-adjusted-assets a discretionary policy variable should be part of the new capital Accord.

April:  A Buffetting for Derivatives
Warren Buffett’s outspoken condemnation of derivatives received wide press coverage in early March. Everyone recognizes Buffett as a shrewd and experienced observer of the business world. Neverhtheless, while his remarks contain some important hard truths, his extreme conclusions reflect the fact that a little knowledge is a dangerous thing.

March:  No Cure Through the Cycle
Some have argued that the antidote for pro-cyclicality in the Basel II capital requirements is the use of ‘through-the-cycle’ estimates of default and recovery rates. While this might mitigate the pro-cyclical impact of the Accord, it would also introduce unacceptable vagueness into the estimates and seriously undermine the basis for back-testing and verification.

February:  Don't Count on Buffers
One possible mitigator of the pro-cyclical impact of risk-sensitive capital requirements would be counter-cyclical changes in capital buffers. Empirical evidence on this issue is scarce and a new regulatory capital regime could well induce a behavioral change. Nevertheless, relying on counter-cyclical capital buffers to neutralize the impact of pro-cyclical capital requirements is risky at best.

January:  The Role of Correlation
A review of recent research on the role of correlation between probability of default and recovery rates, as well as among default probabilities.

2002

November:  Basel II and Procyclicality
The main argument for making regulatory capital requirements more risk-sensitive is to improve allocational efficiency. Unfortunately this may lead to intensified business cycles if regulators fail to take measures to prevent such an impact. This essay reviews the rationale for risk-sensitive rules and how they could magnify business cycles.

October:  Factoring In Stock Options
In the wake of recent corporate scandals, support has spread rapidly for including the cost of employee stock options as an expense item in corporate income statements. While some reform is appropriate, present trends could end up doing more harm than good.

September:  Correlation and Credit Risk
Active development of full credit portfolio modeling continues apace, even though it is not recognized in the proposed Basel II framework. An important issue is the relationship between probability of default and loss-given default. Caution is needed in interpreting apparent correlation between the two.

August:  From Strategy to Tactics
Effective tactical use of risk management information has long been an aspiration of many organizations, but multiple technical obstacles have stood in the way. Advances in technology and analytics mean this reality may finally be within reach.

July:  A Crisis of Identity
Disputes over identification of the specific reference entities in certain credit derivatives contracts is troubling. It reflects a more pervasive lack of discipline among financial institutions. Improved quality control of legal information is vital for the success of integrated credit risk management.

June:  Integrated Credit Risk Management - Are You Ready?
Consolidating data across fragmented systems is crucial for integrated credit risk management - but it's not the whole story. Organizational readiness is a more amorphous, but equally important, requirement.

May:  The Future of Basel II
Basel I is the best argument for persevering with Basel II, but any revisions must address regulatory arbitrage problems and take greater account of the full range of credit risk mitigation techniques.

April:  Hedge Fund Risk and VaR Uncertainty
External transparency of the risk of hedge funds continues to be a difficult issue. Even internally, traditional risk measures can fail to portray the full implication of highly leveraged positions. The parameter sensitivity of value-at-risk estimates can help.

March:  Tracking Wrong-Way Exposure SunGard web only


January:  Enron and Systemic Risk
Regulators worry that concentrating derivatives market-making in a few major dealers poses severe systemic risk issues. Could one big player’s failure break the whole system? Enron is an ideal test case, with some encouraging indications.

2001

December:  A Major Improvement
The Operational Risk working paper the Basel Committee published in late September outlines a major and valuable improvement in the proposal.

November:  Rethinking International Law
International terrorism now appears to pose risks of previously unthinkable magnitude. While civilized nations must resist resorting to lawlessness, the accepted rules of engagement, as reflected in international law, need to change.

October:  Organizational Balance
Excessive risk can destroy a company - but a company that takes no risk will fail. Balancing risk and return is the key to long-term success.

September:  The Age of Collateral
Even collateralised trading relationships can give rise to potential unsecured credit exposure. Portfolio aging is an important and often neglected source of such exposure.

August:  Cracking the covariation code
A relative rank-based representation of covariance is more useful than one based on actual values.

July:  FSI: Stable and Able
While the Basel Committee on Banking Supervision remains in the limelight, the quiet efforts of its related entity, the Financial Stability Institute, should not be overlooked.

June:  Strength Through Diversity
Recognition of the impact of diversification effects is imperative for good portfolio management. Regulatory capital rules should pay greater attention to this aspect of credit risk measurement.

May:  Could Do Better
The Basel Committee can provide better incentives for improved operational risk management than those implicit in the draft revision to the capital accord.

April:  Frozen in Time
The Basel Committee of the Bank for International Settlements appears stuck in the distant past with regard to counterparty credit risk analysis.

March:  Basel's Flawed Paradigm
The proposed new Basel Capital Accord is a major improvement on the existing framework. Nevertheless, it reflects an obsolete definition of capital adequacy. Here is a proposed alternative paradigm for consideration.

February:  Is Risk Constant?
An exploration of Gerald Wilde’s idea that risk homeostasis is relevant to risk management.

January:  Presidents and Risk Precidents
The probability of a hung US presidential election now falls into the category of an uninsurable risk.

2000

December:  Science and Sentience
A caution for those tempted to follow a purely scientific approach to risk estimation.

November:  Counterparty Credit Risk - Let's Get Serious
A call for the introduction of simulation-based methods to quantify counterparty credit exposure.

October:  Down With Add-ons
There are historical and cultural reasons why many banks miscalculate counterparty credit risk exposures. What’s needed is consistency across counterparties and over time.

September:  In Defense of Exotics
Exotics options remain a mistrusted and misunderstood entity, but a sensible approach to exotics can provide unique protection benefits for end-users.

August:  VaR Is Not Everything
Why I disagree with those who assert the benefits of multi-step Monte Carlo simulation versus scaling one-day VAR in estimating market risk over a longer period.

July:  The Flaw of Averages
Statistical intuition is an essential skill for risk managers but don’t assume that other business professionals share such intuition ... and beware of overconfidence in your own.

June:  The New Encryption
Public key encryption is a vital enabling technology for Internet commerce that risk managers should understand.

May:  VaR Over More Than One Day
The simplest option - scaling by the square root of time - is the best, Dynamic simulation with portfolio rebalancing is a dangerous diversion.

April:  Consistency and Credit Risk Models
If banking supervisors are to allow use of credit risk models to calculate regulatory capital requirements, how can they be sure the figures they are receiving are accurate?

March:  Two Cheers for the Regulators
Allowing internal models for market risk capital was a big, bold step by the regulators. The downside was a reduction in comparability between internal model and standard model users.

February:  Operational Risk - Keep It Simple
Many seek perfection in a system for calculating risk exposures. This is understandable, but we shouldn’t forget that sometimes the most workable solutions lie in the simple things.

January:  XML and the Future of Risk Management
Risk managers need to know the potential value of eXtensible Mark-up Language (XML). Without it, they will be stuck in an era of rigidly inflexible data formats.

1999

December:  Risk and Uncertainty
Some risk managers' confidence in science leads them to ignore the uncertainty of markets. In times of crisis. Forewarned is forearmed.

November:  When Price Changes are Not Normal
If investor decisions are statistically independent, price changes tend to be normally distributed.. But on some days this independence flies out the window. What can you do at times like these?

October:  How to Right Wrong-way Exposure
How can banks track derivative exposures that tend to increase as the counterparty's credit status weakens? In the first of a new series, David Rowe offers a simple approach to the thorny issue of wrong-way exposure.