“I think we’re too comfortable in our assumption that it has been mended Rather, I think the conditions are setting us up for another very real crisis somewhere.” Richard Meddings “Arguments are even being made that banks should be allowed to regulate themselves Imagine.” Adrian Blundell-Wignall “Look, being a … risk compliance guy means you are sitting there and you are watching all the kids in the pool and you know somebody is doing something they shouldn’t be doing in the pool but you don’t know who the hell it is.” Michael Hintze “For me it was more about who’s making money, and why is he is making money, and can he explain to me in an intuitive way how he is making it?” John Breit “But whether we really need a regulatory rulebook with more than 10,000 pages (Dodd-Frank), I wonder. Hugo Băanziger I dont know how many pages of forms would give you the information that you get from meeting somebody face to face and asking some pertinent questions.” Paul Bostok CRISIS WASTED? Leading Risk Managers on Risk Culture Frances Cowell Matthew Levins This edition first published 2016 © 2016 John Wiley & Sons, Ltd Registered office John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom For details of our global editorial offices, for customer services and for information about how to apply for permission to reuse the copyright material in this book please see our website at www.wiley.com All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Designations used by companies to distinguish their products are often claimed as trademarks All brand names and product names used in this book are trade names, service marks, trademarks or registered trademarks of their respective owners The publisher is not associated with any product or vendor mentioned in this book Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose It is sold on the understanding that the publisher is not engaged in rendering professional services and neither the publisher nor the author shall be liable for damages arising herefrom If professional advice or other expert assistance is required, the services of a competent professional should be sought Library of Congress Cataloging-in-Publication Data Cowell, Frances, author Crisis wasted? : leading risk managers on risk culture / Frances Cowell, Matthew Levins pages cm Includes bibliographical references and index ISBN 978-1-119-11585-4 (cloth) Financial services industry–Risk management Financial institutions–Risk management Financial risk Investment advisors I Levins, Matthew, author II Title HG173.C69 2016 2015025690 332.1068′ 1dc23 A catalogue record for this book is available from the British Library ISBN 978-1-119-11585-4 (hardback) ISBN 978-1-119-11587-8 (ebk) ISBN 978-1-119-11586-1 (ebk) ISBN 978-1-119-11588-5 (obk) Cover design: Wiley Cover image: (c) andrey_l/Shutterstock Set in 13.5/15pt BemboLtStd by Aptara, New Delhi, India Printed in Great Britain by TJ International Ltd, Padstow, Cornwall, UK Frances dedicates the work to Josie Matthew dedicates the work to Sonia Contents Preface ix Acknowledgements xvii About the Authors xix Chapter Setting the Scene Chapter Background Chapter Sir Michael Hintze 37 Chapter John Breit 59 Chapter Bill Muysken 85 Chapter Hugo Băanziger 103 Chapter Carol Alexander 119 Chapter Mark Lawrence 141 Chapter Paul Bostok 181 Chapter 10 Todd Groome 205 Chapter 11 Richard Meddings 227 vii viii Contents Chapter 12 Adrian Blundell-Wignall 259 Chapter 13 Innovations 279 Chapter 14 Interpretation 295 Appendix A Risk Silos 309 Appendix B The Mechanics of Selected Financial Products 313 Appendix C Basel I, II and III – Risk Weightings 321 Glossary of Terms 323 Glossary of People 347 Further Reading 353 Bibliography 361 Index 367 Preface In a Paris caf´e in April 2013, the conversation turned to how the financial services industry was shaping up following the global financial crisis We – Frances and Matthew – shared an uneasy intuition that some developments, especially in regulations – despite the best intentions to the contrary – could have the result of actually making the financial system more fragile Risk management and governance failures, such as the 2012 London Whale, where JP Morgan incurred massive losses in CDS contracts, and similarly massive losses in 2008 at Soci´et´e G´en´erale caused by a rogue trader in stock index derivatives, continue to happen, suggesting that the professional risk management put in place by large, sophisticated organisations was not working as it should There was a sense that an opportunity was being wasted and the debate about what was needed to reinforce financial stability was somehow being hijacked by a combination of popular mis-information, political short-sightedness and special interests But was this merely a perception stemming from our common perspective? What did others think? From casual conversations, it was evident that many friends and colleagues shared our views, prompting questions about how widely they were shared outside our circles In particular, what other factors were operating that we were perhaps unaware of? What extra insights could be had from the best informed market participants and observers? Matthew proposed a formal exercise: to ask those who were most caught up in it as it all happened The transcripts of the conversations would result in a readable and substantial book to make available to decision-makers, in the financial services industry and elsewhere, insights from the inside point of view, thereby leading to a more ix x Preface constructive and informed debate and perhaps even influencing decisions in favour of sensible regulation that would reinforce stability not undermine it Both having been risk takers turned risk managers, in banking and investment management respectively, since the early 1980s, we had therefore lived through a number of financial crises This experience allowed us to select and engage an interesting and impressive faculty of interviewees, and to pose good, pointy questions that would fuel debate We reasoned that, like us, our readers would want to know why some developments since the crisis have been so disappointing Like us, they would like better to understand the sub-agendas that operate on decision-making in financial organisations, their regulators and supervisors; to leverage the perspectives and insights of insiders and to understand what is really going on Constructive debate necessarily entails a forward-looking orientation That said, given that the aim is to mitigate the effects of a future financial crisis, reflection on past events is inevitable and can be instructive But the past must be kept in perspective, since the conditions that prevailed then will not be repeated exactly in the future To paraphrase the ubiquitous risk warnings in prospectuses, the past is not necessarily a guide to what will happen in the future Learn from the past, but don’t extrapolate from it Our first steps were to gather initial feedback and ideas – for practical execution as well as to crystallise our thinking about issues we should address and that would emerge during our inquiry In doing this, we were struck by the general enthusiasm for the project (only one person was not whole-heartedly supportive) This was of course due partly to its likely commercial appeal, but more important was that so many people saw it as a project that needed to happen It seemed that even more people than we had imagined agreed that a new level of debate was called for Themes and questions The next challenge was to decide how structured or otherwise the conversations should be Certainly, readers would benefit from some Preface xi comparability between the views of each interviewee, which suggests some structure; but interviews that are too constrained or structured would risk limiting the potential for unique insights What people choose to talk about is as important as what they say This led to the idea of common themes, or threads, which would connect the conversations while allowing scope for each interviewee to address the issue closest to his or her heart The themes were thus conceived as parameters rather than boundaries In developing the themes, we were keen to leap-frog arguments that are already well aired, such as conflicts inherent in the way many investment bankers are rewarded But where we found that we could add a new perspective to an existing debate, we have done so, and so we include themes such as the complexity of models for valuation and risk, contradictions in regulatory regimes and possible unintended consequences Lots of “brainstorming” and plenty of war stories later, about 20 somewhat inter-connected themes emerged These in turn boiled down to three macro themes: behaviour, models and regulation Within each theme, the challenge in framing the questions was to be specific enough to give the interviewees something to get their teeth into, but open enough to be relevant to more general issues Behaviour, the first theme, covers organisations and the people who work in them – what is increasingly referred to as organisations’ risk culture: how it regards risk A good indication of an organisation’s attitude to risk is the status it accords risk management This seemed to us a good place to start our questions too Our experience of working in different organisations told us that this is about more than the organisational hierarchy, it is also about the relationship between the risk manager and risk takers – at all levels of the organisation, from the dealer and the risk analyst to the CEO and the CRO For example, how equal are they in the event of a dispute? How equal can they be? What mix of personalities works best? What organisational structure works best? Which day-to-day practices work best? The next bloc of questions is about how well equipped the risk manager is How much has the organisation invested in the tools, and the skills needed to deploy them effectively, both to measure and report risk, and also to manage it? Aware that many readers are unfamiliar with how risk models work, we have done our best to present these xii Preface questions in a way that does not demand any technical knowledge (Technical explanations, for those interested, can be found in the appendices.) We have therefore aimed for questions that steer clear of the arcane details of risk measurement and focus instead on what their users think of them How useful are the risk reports that inform supervisors, regulators and investors? The world is complex, should the models be too? Should everyone use the same one, or does this lead to herding that exacerbates systemic risk? The last and most extensive theme concerns regulations What is likely to work and what is not likely to work? Why? What might be the unintended consequences? Might there be a better way of doing it? Another challenge was to avoid imposing our views on the interviews This is easier said than done, since we draw heavily on our own experience to formulate questions We therefore were at pains to couch questions in as even handed a way as possible, to avoid leading the witnesses Nevertheless, we acknowledge that the very choice of questions can affect the course of conversations Even so, as each conversation developed, our views are sometimes, unavoidably, drawn out Research Reading around our themes and talking with friendly experts was an adventure in itself It uncovered a number of rich veins of research, including valuable early and ongoing work on the theory of regulation, original approaches to understanding and estimating risk appetite and of calibrating market instability, as well as very thoughtful pieces on the pros and cons of analytical versus behavioural ways of managing risk: detailed VaR reports versus an hour in the pub with some traders Perhaps the most rewarding was that we learned about a number of innovations that promise to address some tricky problems that came up during our conversations Because these innovations are concrete evidence that some good has indeed come from the crisis, they seem valuable enough to merit their own chapter They are a stimulating challenge to the book’s title For a selection of other books and articles that stood out, interested readers are directed to the Further Reading section Further Reading r r r r 355 been ignored or improperly dealt with in our regulation so far” Cochrane, J.H., Toward a Run-Free Financial System, University of Chicago Booth School of Business, NBER, Cater Institute, April 2014 John Cochrane argues that the riskiness of bank assets is not the problem, but their liabilities He argues that this is where efforts to ensure the future stability of the financial system should be directed Danielsson, J et al., Pro-cyclical Leverage and Endogenous Risk, LSE, October 2012 Jon Danielsson, Hyun Song Shin and Jean-Pierre Zigrand give a detailed account of how bank leverage is inherently procyclical, affects economic activity and, by implication, aggravates crises when they happen DiBartolomeo, D., Madoff Mayhem, Presentation to the London Quant Group, Cambridge, 2009 This is a modern-day version of The Emperor’s New Clothes that H.C Andersen would surely approve of It chronicles the lead-up to the exposure of the massive fraud that bears the name of its perpetrators Not only was the fraud easy to spot, it was both spotted and reported – repeatedly – to the Securities and Exchange Commission (SEC) as early as 10 years before Mr Madoff presented himself to the FBI The SEC and others did not – or would not – believe what they were told because they were either blinded by the status and esteem in which Madoff was held in US financial markets, or they were fearful of being made to look silly, or some combination of the two It reminds us how even the most thorough regulations and oversight can still fail in the face of human perception and vanity Greenspan, A., Remarks to the Federal Reserve of Chicago’s Forty-first Annual Conference on Bank Structure, May 2005 Mr Greenspan observes that the combination of more complex and varied financial instruments, together with increased sophistication of risk measurement technology to complement them, has contributed greatly to the stability of the world’s financial system 356 Further Reading But he also notes that concentrations of derivatives-related risk in non-financial organisations are generally not recorded, and cites a study that finds that the scale of such risks is small relative to that within financial organisations The same study found no evidence of “hidden concentrations” of credit risk in non-banks Mr Greenspan sees some issues stemming from the CDO market, namely that simple credit ratings cannot reflect the risks stemming from default correlations across tranches He also observes that many organisations’ back offices are struggling to accommodate increasing volumes and complexity of financial instruments With respect to exposures to hedge funds, he notes: “Banks’ due diligence procedures and hedge funds’ disclosures have improved sufficiently that banks now can qualitatively assess the risk-management capabilities and overall risk profiles of the funds.” r Kane, E., Good Intentions and Unintended Evil, Journal of Money, Credit and Banking (1977) 9: 55–69 Edward Kane examines the history of US Federal Reserve (Fed) market interventions and its decision-making processes to argue his case that, through its role in influencing interest rates, the Fed is “a policy scapegoat for incumbent politicians”, which he believes explains “the perennial incompleteness of Fed control strategies and the Fed’s bureaucratic features” r MacKenzie, D and Spears, T., The Formula that Killed Wall Street? The Gaussian Copula and the Material Cultures of Modelling (University of Edinburgh, 2012) Picking up on the theme of financial models as black boxes, MacKenzie and Spears explore the fortunes of a particular model for pricing credit derivatives In what unfolds, something akin to a game of Chinese whispers, they show clearly how a sensible, but computationally complex model can be misused with very unfortunate results This happens because a computational simplification introduced for one legitimate use of the model becomes generalised for subsequent applications Because few analysts understood the model well enough to spot the potentially corrupting effect of the early simplification, it became embedded Further Reading 357 so that the model was no longer fit for the purposes for which it is put r Mikes, A., From Counting Risk to Making Risk Count – Boundary Work in Risk Management, Accounting, Organizations and Society (2011) 36: 226–245 Mikes investigates the behavioural aspects of risk management in seven large banks, including two detailed case studies She identifies two patterns of risk management The first stresses the quantitative aspect of risk measurement and the second the importance of judgement in risk management The first approach relies on extensive risk measurement, and the implied assumption that if you measure enough things, all risks will be accounted for – including hard to quantify risks such as operations risk This method reduces risk to a measure of Economic Capital, which has the advantage that it can be aggregated to the level of the organisation – and beyond Mikes notes that the validity of the resulting risk management is heavily dependent on the veracity of the risk measurements The risk manager’s job therefore is concerned largely with ensuring that this is not open to question, which can, at the limit, encourage a “black box” view of the risk models The second approach demands a broad understanding of the organisation and its processes by the risk manager It therefore suffers a number of practical limitations, not the least of which is that individuals with the necessary accumulated knowledge can be hard to find Risk assessment based on judgement and experience are also hard to aggregate, and can be tricky even to report to senior management and external parties, such as regulators Mikes also shows how risk managers erect “boundaries” to their domains of responsibility These serve two purposes: to establish their zone of influence and to limit the responsibility they bear in the case of things going wrong She notes the highly political nature of risk management in other aspects too: many organisations reward their staff on the basis of risk-adjusted performance, so the risk associated with their achievements has a direct bearing on how much they are paid This provides the incentive for each individual to deflect 358 Further Reading risk from themselves rather than to seek to mitigate risk for the organisation r Shin, H.S., Risk and Liquidity (New York: Oxford University Press, 2010) This book devotes a number of chapters to explaining some of the implications for systemic risk of widespread use of Value at Risk (VaR) as a primary measure of risk for banks and longshort hedge funds – regardless of the actual model used to estimate VaR In clear prose that is supported by some simple maths and intuitive diagrams, he identifies at least three mechanisms whereby VaR can exacerbate systemic risk The first is that the combination of the test for a binary state of solvent-or-non-solvent and the tendency of VaR to ignore the possible costs of insolvency exacerbates the “agency” problem, whereby the interests of managers are at odds with those who bear the true costs of failure, which, in the case of banks, are borne by creditors and other stakeholders such as taxpayers The second mechanism is that risk appetite is pro-cyclical because VaR, on which it is based, is calculated as a function of the bank’s capital, which is in a sense fixed This ensures that risk appetite increases as the prices of risky assets increase, causing the bank – and other market participants – to chase return by buying more and pushing up prices Mr Shin shows that this positive feedback loop works also in reverse: assets are sold as prices decline, which, when many participants are doing the same thing, results in a market rout Reliance on VaR as an effective capital floor thus has a similar effect on incentives to take risk as leverage does This pattern is redolent of Hyman Minsky’s Market Instability Hypothesis Mr Shin’s contribution is to show that VaR can exaggerate the effect The third mechanism applies to long-short hedge funds, where VaR is often used in conjunction with variancecovariance modelling to estimate risk Mr Shin describes how the assumption of known covariances between assets more often than not causes risk to be underestimated, because in times of market turbulence, covariances tend to be higher than in stable markets, when the covariance readings tend to be taken This means that, in unstable markets, the fund’s estimate of risk turns Further Reading 359 out to be too low, exaggerating the leverage effect of VaR and accelerating the fund’s need to de-risk r Wall, L., Basel III and Stress Tests, www.frbatlanta.org, December 2013 Mr Wall observes that the effectiveness of stress tests depends entirely on their design, which is necessarily subjective and informed by the recent past He points out that because of the subjectivity of risk measurement design, it can become hostage to the financial incentives of the individuals responsible for design and choice of parameters in risk measurement – and hence the measures actually generated r Wall, L., Simple Concept, Complex Regulation, www frbatlanta.org, January 2014 In this blog, Mr Wall builds a strong case for addressing the causes of financial imbalances rather than simplistically attacking the symptoms by devising ever 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John Wiley & Sons, Ltd Index 1987 Market crash, 17, 87–88, 143, 182 ABS, see Structured products Absorption ratio, 290–291, see also Interconnectedness Agency problem, 199 AIFMD, 23, 24 AIG, 265 Algorithmic trading, 167, 239–240, 274–275, 276 Arbitrage, ratings, 24, 42, 71, 73 Arbitrage, regulatory, 24, 243, 261–262 Asset capacity of banks, 247–249 Asset valuations, 4, see also Mark-to-market Asset-liability management, 24–25, 70–73, 187, 190–191 Assets versus liabilities, 200–201, 210–211, 217, 305–306, see also Liabilities Bagehot, Walter, 30 Bank business models, 262–263 Bank lending, 68, 162, 167, 210, 217, 231–232, 247–249, 302 Bank of England, 27, 53, 111, 196 Bank rescue, 229–230 Barnier, Michel, 47 Barrier to entry, 23, 47, 96–97, 197, 208, 301 Basel, 26, 42, 51, 106–107, 109, 115–116, 161, 163–164, 167, 174–179, 218, 235–237, 242, 263, 269, 271–272, 302 Behaviour, 39, 42, 43–44, 48–49, 51, 53, 63, 69–70, 93, 98–99, 184–186, 199, 202, 207, 242–243, 251, see also Risk culture Behavioural finance, 93, 122, 126, 128 Big data, 127–128 Black box, 190 Boards of directors, 152–154, 168, 219, 238, 273, 295 Box-ticking, 23, 52, 62–64, 196, see also Compliance Capital adequacy, 3, 27, 29, 31, 41, 42, 68, 76, 107, 113–114, 162, 163–164, 165, 177–178, 245–246, 247–249, see also Capital requirements, Economic capital Capital buffers, 27 Capital buffers, counter-cyclical, 167, 245 Capital requirements, 153, 233, 236, 254, 263 269, 271–272, 321, see also Capital adequacy, Economic capital Capitalisation, 4–5 Caveat Emptor, 25, 214–215, 244–245, 247 CDO, 1–3, 40–41, 70–71, see also Structured products Central Banks, 32, 43, 45, 50–51, 115, 220–221 Central clearing, 233, 254, 266, 314, 317 Central counterparty, 114, 115, 167 Collateral requirements, 4–5 Commonsense, 48, 77, 87, 94, 95, 187, 202, 220 Communication, 47 367 368 Index Complexity, 202 Complexity, banks, 146–147, 154 Complexity, regulation, see Regulation, complexity Complexity, risk models, see Risk models, complexity Complexity, systemic, 20, 274, 296 Compliance, 18, 23, 43, 48, 54, 75, 114, 197, 252, see also Box-ticking Compliance, burden of, 23–24, 301–302 Conduct risk, 171 Connectedness, see Interconnectedness Contagion, 4, 8, 14, 25, 27, 29, 160, 265, 282–283, see also Interconnectedness Copula, 15, 40, 50, 65, 128–129, 310 Correlations, 24, 40, 50–51, 94, 112, 121, 122–123, 164, 187, 189, 245, 250, 283–284, 287, 288–289, 291–292, 298, 316, 318, 319 Counterparty risk, 112–113, 315, 317 CPI, 252 CPPI, 88–89, 319 Credit committee, 250 Criminal penalties, 131, 132 Crisis Management, 14, 46–47, 75–76, 91–92, 126, 195–196, 242–243 CRO, see Risk manager Crowded trades, 88, 117, 166, 221–222 CTA, see CPPI Currency union, 240, 275–276 CVaR, 310 Dark pools, 239–240 Data management, 104–105 Data sampling, 14, 15–16, 17–18, 24, 52, 71–72, 87–88, 93–94, 105, 116, 128, 147–148, 168, 178, 189–190, 283–285, 287, see also Risk models, calibration Default rates, Derivatives netting, see Risk netting Diamond, Jamie, 43 Disaster Recovery Plan, 196 Diversification, 27 Diversity, 221–222 Dodd-Frank, 42, 43, 53, 114, 166, 266, 301, see also Regulation Economic Capital, 130–131, 163–164, see also Capital adequacy, Capital requirements Equity markets, 61 ETL, 310 European Council, 53 European Parliament, 53 Exchange traded, 112, 114, 115, 133, 135–136, 233 Fair value, see Mark-to-market FCA, 130 Federal Deposit Insurance Corporation, 27, 174 Federal Reserve Bank, 62, 68 Financial Conduct Authority, 49, 196 Financial Policy Committee, 130 Financial repression, 261, 262 Financial Services Authority, see Financial Conduct Authority Financial Stability Board, 27, 50–51, 115, 261–262, 290 First passage probabilities, 281 Fragility, systemic, see Systemic Stability Fragmentation, 27–28, 230, see also Subsidiarisation Front running, 135 FSA, 113 Full-scale optimisation, 280–281 Fund benchmarks, 195 Fund turnover, 193–195 G7, 218 Gaussian Copula, see Copula GFC, see Global financial crisis Glass-Steagall, 130, 246, 263, 264, see also Regulation Global financial crisis, 42, 44, 47, 61, 87, 91, 92, 94, 105, 106, 107, 108, 111, 112, 114, 116, 134, 147, 161, 196, 229–232, 238, 239, 243, 251, 253, 260–261, 265–266, 274, 279, 290, 296, 297 Global financial crisis, cause, 264 Globalisation, 4, 27, 115, 117–118 Governance, 63, 99, 107, 108–109, 152–154, 168, 171, 219, 273 Government guarantee, 29, 31–32, 76–77 Index Government rescue, 4–5 Greenspan, Alan, 25, 220–221 GSIB, see Systemically Important Bank Haldane, Andy, 176 Hedge funds, 208–209, 218, 261 Illiquidity, see Liquidity Incentives, 43–44, 63, 67, 71, 93, 113, 124, 129–130, 159, 200, 211, 234 Institute of International Finance, 33, 34 Insurance, 221–222 Insurance captives, 272–273 Interconnectedness, 27, 29, 233, 263, 266, 289–292, see also Contagion Investment objectives, 192–193 Investment returns, 241 Judgemental biases, 98–99, 100 Leadership, 47, 54–55 Leverage, 116, 162, 232, 266, 322 Liabilities, 19, 31–32, 76, see also Assets versus liabilities Liabilities, long-term, 8, 31 Liabilities, short-term, 8, 31, 106, 115, see also Margin calls LIBOR, 60, 69–70, 251 Liquidity, 2, 4–5, 14, 41, 42, 45, 46, 61, 68, 88, 105, 108, 149–150, 166, 167, 210, 212, 214, 217, 232–233, 240, 247–249, 250, 264–265, 266, 285–286, 287, 295, 310–311, 314–315, 317, 321 Liquidity management, 106–107 Liquidity risk, see Risk, liquidity Liquidity squeeze, 2, 4–5 Liquidity trap, 45 Liquidity, 19 Look-back period, see Data sampling Louisiana Bubble, 43, 45 Margin calls, 4–5, 26, 116, 167, 246, 265–266, 314, 315, see also Liabilities, short-term Market manipulation, 70, 251 Mark-to-market, 18, 46, 115–116, 130, 211, 246–247, 272, 314 369 Maturity, 247–249 Mis-selling, 43, 49, 70–71, 215–216, 231–232, 244–245, 297–298 Monte Carlo simulation, 105, see also Risk models Moral Hazard, 29–30, 43, 93, 131, 199–200, 274 Mortgage-backed security, 142 Nodes, 290 NSFR, 248 Off balance sheet, 213, 232, 238, 317 Operations risk, 39, 149, 321 Over-the-Counter, see Exchange traded P&L, 63–64, 67, 105–106, 109 Pension funds, 241, 267–268 Personality tests, 89–90 Politicians, 32, 47, 52–53, 113–114, 153, 214, 243–244, 252, 266–267, 299, 304 Portfolio insurance, 182 Portfolio invariance, 271–272 PPI, 244–245 Prince, Chuck, 43 Principal Components Analysis, 291–292 Private information, 263–264 Probity, see Behaviour Pro-cyclicality, 26, 40, 50–51, 115–116, 166–168, 220, 245, 269, 304, 318–319 Proprietary trading, 161 Quantitative easing, 45, 239, 265–266, 297 Real economy, 247–249, 253–254, 268, 270 Reasonableness checks, 86–87 Recovery rates, 41 Regulation, 123, 128, 161 Regulation, burden of, 96–97, 101, 111, 114, 154–155, 196–197, 209, 215, 220, 230, 252, 301 Regulation, complexity, 21–22, 114, 131, 174–176, 177–178, 230, 243, 245, 252 Regulation, failure, 20, 196–197 Regulation, harmonisation, 244, 261–262, see also Regulation, inconsistent 370 Regulation, inconsistent, 230, 246, 303, see also Regulation, harmonisation Regulation, “light touch”, 148 Regulation, rules versus principles, 21, 49, 131–132, 244, 301 Regulation, theory of, 303–304, 305 Regulation, unintended consequences, 114, 130, 161, 301–302, 304 Regulators, blocs, 261–262 Regulators, role, 153 Regulatory capture, 273–274 Regulatory reporting, 209, 214, 215, 217–219 Remuneration, 9–11, 30, 253, 254 Rent seeking, 270–271 Repo market, Retail banks, see Bank lending Retail investors, 49 Ring-fencing, 27–28, 231–232, 243, 254 Risk appetite, 32, 33, 89–90, 97–99, 106, 108, 148, 150, 151, 154, 159, 163, 164–166, 187–188, 208, 280–281, 282–283 Risk concentrations, 164, 199, 250, 271–272, 288, 302, 321 Risk culture, 9, 24, 33–34, 53, 89–90, 93, 107, 108, 144–145, 148, 151–152, 156–157, 158–160, 169–170, 171–173, 183–186, 193, 200, 234–235, 250, 255, 297–298, 302–303, see also Behaviour Risk distribution, 122–123, 129 Risk horizon, 97, 113, 129–130, 187–188, 192, 210, 216–217, 246–247, 264–265, 272, 281, 284 Risk limits, 63, 65–66, 94, 95, 118, 142, 162, 167, 243 Risk management committee, 24, 152, 154 Risk management, enterprise-level, 13, 14, 111, 128 Risk management, failure, 107, 111, 279, 299 Risk management, independence, 11–12, 89–90, 101, 107, 125–126 Risk management, infrastructure, 48, 66, 104–105, 106, 107, 108, 109, 110–111, 128, 143–144, 183 Index Risk management, process, 155–157, 170–171, 185 Risk management, qualitative, 12–13, 48, 52, 62–64, 65, 67, 74–75, 77, 78–79, 86, 121–123, 144, 146, 148–149, 157, 169–170, 188, 197, 202, 207, 214, 219, 229, 242, 300, 301 Risk management, quantitative, 12–13, 48, 93–94, 121–123 Risk management, versus risk control, 12 Risk manager, 9–12 Risk manager, asymmetry versus risk taker, 10, 65, 77–78, 107–108, 109, 168–170, 300 Risk manager, influence, 9–11, 62, 74–75, 79, 89–90, 124, 142–143, 169–170 Risk manager, professional, 11 Risk manager, qualifications, 110–111, 120–121, 123, 125 Risk manager, role, 9–12, 77–78, 124, 89–90, 109, 150, 120–121, 155, 250, 299–300 Risk manager, skill, 9–11, 77–78, 91, 107, 110, 120–121, 125, 165, 173–174, 182–183, 190, 235, 299–300 Risk measurement, 121–122, see also Risk reporting Risk models, 15–18, 48, 64, 65, 66–67, 72–73, 104–105, 112, 121–122, 147–148, 168, 178, 189, 234, 235, 237, 269, 283–285, 287–288, 300 Risk models, calibration, 15, 16, 18, 40, 71–72, 190–191, see also Data sampling Risk models, complexity, 16, 49–50, 93, 112, 122–123, 128–129, 190, 235, 300 Risk models, diversity, 17–18 Risk models, harmonisation, see Risk models, standardisation Risk models, internal, 161–162, 177–178, 241, 269 Risk models, mis-use, see Risk models, calibration Risk models, standardisation, 28–29, 117, 17, 79, see also Risk models, harmonisation Risk models, subjectivity, 15 Risk netting, 123, 271–272, 296 Index Risk premium, 283 Risk pricing, 43–44, 264–265, 266, 270 Risk reporting, 13, 48, 62, 77, 105–106, 295, see also Risk measurement Risk silos, 13, 110–111, 124, 128, 241–242 Risk tolerance, 32, 33, 89–97, 106, 126–127, 188, 192–193, 235–236, 241, 280–281, 282–283 Risk tools, see Risk models Risk transfer, 25, 222, 247, 267–268 Risk warehousing, 66 Risk weights, 235–237, 242, 249, see also Capital adequacy, capital requirement Risk, liquidity, 171 Risk, systemic, 132 Risk-Weighted Assets, 176–177, see also Capital adequacy, capital requirement RPI, 252 Scenario analysis, 14, 48, 51–52, 92, 123–124, 132, 133, 202, see also Stress tests Securities and Exchange Commission, 53, 80 Securitisation, 1–2 Shadow banking, 32–33, 116, 160–161, 207–208, 247, 267–268 Shareholders, 153, 303 Short selling, 44, 167 Smart beta, 195 Socially useless activities, 239 Solvency, 41, 42, 45, 61, 132 Solvency II, 50 South Sea Bubble, 43, 45 Stress tests, 26, 48, 51–52, 68, 95–96, 105–106, 132, 162, 241–242, 245, 250, see also Scenario analysis Structured Investment Vehicles, 49, see also Structured products Structured Products, 24–25, 112, 198, 239, 254–255, 261, 263–264, 297–298, 315–317 Sub-prime mortgages, 1–3, 40, 61, 72, 231, 232–233 Subsidiarisation, 230–231, 302 Swaps Push-Out Rule, 266–267, 301 371 Systemic risk, see Risk, systemic Systemic stability, 8, 28, 31, 220–221, 230, 232, 251–252, 286–289, 289–290, 302 Systemically Important Bank, 25, 29–30, 270–271 Systems Theory, 288 Tail risk, 50, see also Risk measurement, risk reporting TARP, 4–5, see also Regulation Tarullo, Dan, 27, 176 Theory of regulation, see Regulation, theory of Too big to fail, 30–31, 33, 45, 68–69, 114–115, 199–200, 212–213, 264, see also Systemically Important Bank Trading, 49 Tranches, 72–73 Tranching, 1, 40, 317 Transaction taxes, 276 Transaction, volume, 19, 46, 104, 149 Transparency, 22–23, 29, 42, 107, 116–117, 133, 155–156, 157, 215, 218–219, 220, 237, 300, 321 Trust, 274–275 UCITS, 18 Uncertainty, 15, 122–123, 282 Universal banking, 263 Use test, 177, 234, 237, 242 Utility banks, 200–201, 254–255, 263, 305 Valuation, 18–19, 46 VaR, 48, 52, 62, 64, 66, 79–80, 105, 129, 214, 269, 285, 310, see also Risk measurement, risk reporting Volatility, 1, 19, 184, 189, 191–193, 220–221, 283–284, 288–289, 310, 318 Volatility trading, 133–136 Volker Rule, 166, see also Regulation Walker Report, 33 Wheatley, Martin, 49 Yield, demand for, 43, 70–71, 73, 112, 131, 239–241, 255, 267–268, 272–273, 298–299, 303 .. .CRISIS WASTED? Leading Risk Managers on Risk Culture Frances Cowell Matthew Levins This edition first published 2016 © 2016 John Wiley & Sons, Ltd Registered office John Wiley & Sons Ltd,... of a competent professional should be sought Library of Congress Cataloging-in-Publication Data Cowell, Frances, author Crisis wasted? : leading risk managers on risk culture / Frances Cowell,... current hedging and risk control in modern banking xix Crisis Wasted? : Leading Risk Managers on Risk Culture By Frances Cowell Matthew Levins Copyright © 2016 John Wiley & Sons, Ltd Setting the