Risk in the financial sector – have we learned any lessons?

As part of his pre-Budget report in December, the UK chancellor, Alistair Darling, announced a one-off super-tax on bankers’ bonuses. This followed ongoing threats by bankers that they will leave the UK if their (bonus) earning potential is curtailed.

Unsurprisingly, this angered the British tax-payer who, thanks to the excessive risks taken by the banks, is now the proud owner of several formerly publicly-owned national banks.  As a result of this and the severe recession that followed, for a while it seemed as though the financial sector would have to change.  However, the current headlines suggest that, whilst the financial crisis was certainly a sharp shock, it may have been too short to ensure that measures were put in place to ensure it never happened again.

The key factor to understand is the grasp that money has over financial institutions.  In fairness this is as it should be – after all their raison d’etre is to make money.  However, this has developed into a culture of ‘profit-at-any-cost’ that is inherent throughout almost all financial organisations.  One outcome is inappropriate incentive structures that reward short-term income-generation over and above any other activity.  Another repercussion, particularly over the past few boom years, has been an increased tolerance of risk.

Over the past two years or so, many risk departments will have flagged up levels of uncertainty that, in previous times, would have been unacceptable.  For various reasons, much of this advice has been ignored.  Frustrating at the time, in light of events of the past few months, this must now seem inexcusable to risk managers, both within and outside the financial sector.  Many of these people will know that sophisticated risk analysis tools are available to enable them to ‘measure’ the likelihood of an event occurring and the severity of its effects.

The accuracy of the results depends on the quality of the data input.  It also hinges on the ability of the financial sector to adopt a realistic attitude to risk.  And, to quote City minister Lord Myners, this means that bankers must ‘live in the real world‘.

Craig Ferri
EMEA Managing Director of Risk & Decision Analysis

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