Institutions are expected to adopt safer strategies
With the world financial markets going into a tailspin, banks are re-examining their risk management.
Many are expected to embrace a corporate-wide risk culture - one where bankers are actively encouraged to question portfolio irregularities while quantitative tools are deployed across the board to monitor inconsistencies and take heed of early warning signs.
'Though not every bank has fared poorly in the financial crisis, the ones that had strong risk-management practices at an enterprise-wide level really thrived, but for the majority of financial institutions, there was a massive breakdown in risk management,' said Alan Laubsch, head of RiskMetrics Labs Asia, which specialises in helping banks assess and manage risk.
He added: 'We believe that this will be the golden era of risk management. People will now begin to pay more attention to risk and understand that if you manage risk only on a short-term basis, it will only be a matter of time before it blows up in your face.'
Banks can adopt a gamut of forward-looking tools that enable them to make decisions about the risks they see today. For example, private banks can use tools that look not only at sector allocation, but examine each client's securities details. The use of more statistical measures, such as standard deviation and downside statistics that study expected shortfalls, should also feature high on the agenda.
Rigorous stress testing of portfolios is also useful, as is the regular monitoring of portfolios.
Most important of all, however, is the need for these tools to be deployed at an enterprise level, allowing every individual in the organisation to be monitoring risk at the same time, in the same way.
'Many banks are not using enterprise-wide tools. Some of the existing tools are still based on Excel spreadsheets, which means the information is not reaching people in a timely manner, departments are not communicating with each other properly and people, as a result, are unable to react rapidly to market conditions,' Mr Laubsch said. Ultimately, it is the culture of private banks and financial institutions that must change in order for risk-management practices to undergo an improvement.
'Most firms still operate on the brokerage model in the sense that it is all about generating sales and short-term commission, but the best firms take an advisory approach rather than focus on pushing products on their clients,' Mr Laubsch explained.
Financial institutions, which have shifted away from deal making, tend to provide these high-calibre advisory services only to ultra-high-net-worth clients. Very few have taken this down to affluent clients or retail customers.
Fostering a sound culture of risk-management practices requires the right organisational structure. These should include, for example, the formation of an independent corporate-wide risk-management team that reported directly to the corporate office, proactive senior management involvement, a common language of communication about risk, and active and continuous dialogue that examined risk from different perspectives, Mr Laubsch said.