Practical Risk Management

Practical Risk Management......Page 4
Contents......Page 8
Acknowledgments......Page 12
Biographies......Page 14
Introduction: Financial Risks and Avalanches......Page 16
PART I DEFINING AND MEASURING RISKS......Page 18
1 Losses: One-Hundred-Year Floods that Happen Every Three Years......Page 20
1.1 Barings: Flawed controls......Page 21
1.2 Long Term Capital Management: Too much leverage, too little liquidity......Page 22
1.3 Merrill Lynch: Too much risk, not enough governance......Page 25
1.4 Failures in the risk process......Page 27
2.1 Market risk......Page 30
2.2 Credit risk......Page 34
2.3 Liquidity risk......Page 36
2.6 Process risk......Page 37
2.7 Legal risk......Page 38
3.1 Asset liquidity risk......Page 40
3.2 Funding liquidity risk......Page 41
3.3 Asset and funding liquidity risk......Page 42
3.4 Leverage arbitrage......Page 44
3.5 Monitoring liquidity risk......Page 45
3.6.2 Concentration limits......Page 48
3.6.4 Adequate haircuts......Page 49
3.7 Ten useful liquidity risk questions......Page 50
4 Suitability: Coping with Customers......Page 52
4.1.2 Procter and Gamble......Page 53
4.1.3 Sumitomo Corporation......Page 54
4.1.4 Prudential Securities......Page 55
4.2 Knowing your customer......Page 56
4.2.1 Funds......Page 57
4.2.2 Governments and charities......Page 58
4.2.3 Other corporations and financial intermediaries......Page 59
4.4 Dealing with client suitability......Page 60
4.5 Toward better disclosure......Page 61
4.6 Ten useful suitability risk questions......Page 63
5.2 Categorizing process risk......Page 66
5.3 Disaster recovery risk......Page 67
5.4 Business recovery risk......Page 70
5.6 Front-office error risk......Page 71
5.8 Software error risk......Page 72
5.10 Structured product risk......Page 73
5.13 Training and regulatory compliance risk......Page 74
5.15 Ten useful process risk questions......Page 75
6.1 Mathematical measures......Page 76
6.2 Subjective measures......Page 78
6.3 Measuring different risks......Page 79
6.3.1 Market risks......Page 80
6.3.2 Credit risks......Page 81
6.3.3 Liquidity risks......Page 83
6.3.5 Legal, suitability and reputational risks......Page 84
PART II DEVELOPING A HOLISTIC APPROACH TO RISK MANAGEMENT......Page 86
7 The Risk Management Process: Building the Foundation......Page 88
8.1 Risk philosophy......Page 92
8.1.2 Focus of “balance sheet” risk activities......Page 93
8.1.3 Stakeholder expectations......Page 94
8.2.2 What resources are available?......Page 95
8.2.3 Is the firm getting paid to take risk?......Page 96
9.3 Principle 3: Efficient and independent control functions......Page 100
9.4 Principle 4: Thorough business reviews......Page 101
9.6 Principle 6: Solid risk infrastructure......Page 102
9.8 Principle 8: No surprises!......Page 103
10.2 Roles and responsibilities......Page 104
11.1.1 Computing maximum losses......Page 112
11.1.2 Aggregating losses......Page 114
11.1.3 Credit risk......Page 116
11.1.4 Liquidity risk......Page 120
11.1.5 Setting limits at different levels......Page 124
11.3 Monitoring, adjusting and dealing with exceptions......Page 125
12.2 Rule 2: Escalate all exceptions......Page 130
12.3 Rule 3: Organize all risk taking......Page 131
12.4 Rule 4: Allocate capital efficiently......Page 132
12.6 Rule 6: Be able to explain risk earnings in detail......Page 133
12.8 Rule 8: Understand the worst-case scenarios......Page 134
13.2.1 Skills......Page 136
13.3 Manual control 2: Effective human resource management......Page 137
13.4.1 Incentive compensation......Page 138
13.6 Manual control 5: Spot checks......Page 139
14.1 Policies......Page 142
14.2 Reporting mechanisms......Page 143
14.3.1 Data......Page 145
14.3.2 Technology......Page 146
15.2 An ideal world......Page 148
15.3.1 Governance......Page 149
15.3.2 Identification......Page 151
15.3.4 Reporting/monitoring......Page 152
15.3.5 Ongoing management......Page 153
15.3.6 Infrastructure......Page 156
15.4 Toward greater transparency......Page 157
15.6 Ten questions the CFO ought to be able to answer......Page 158
15.8 Ten questions the head internal auditor ought to be able to answer......Page 159
15.10 Ten questions the head external auditor ought to be able to answer......Page 160
Conclusion: Can there be Heroes?......Page 162
Glossary......Page 164
References......Page 174
Index......Page 176