Lessons from past financial crises

Here are some useful lessons as captured by Derivatives Guru, John Hull.

Companies and banks must define clearly the limits to the financial risks that can be assumed.
Violations of risk limits must be sternly dealt with.
Even successful traders must be monitored carefully. Luck rather than superior trading skills often explain the success of traders. “Star” traders should not enjoy immunity from audit checks by risk managers.
Diversification benefits should not be over estimated. Concentration risk must be managed carefully.
Scenario analyses and stress testing must back risk measures such as value-at-risk. It is important to think outside the box and consider extreme situations. As Nicholas Nassem Taleb would say, just because we have never seen a black swan, it does not imply that one does not exist.
Models should not be blindly trusted. If large profits result from relatively simple trading strategies, risk managers should become suspicious. Maybe, the profits are being measured in the wrong way.
Getting too much trading business of one type, warrants as much critical examination as getting too little of these businesses.
Traders should not be allowed to book inception profits , i.e., profits at the start of a trade, by marking-to-model. By recognizing inception profits slowly, a longer term, more mature orientation can be inculcated among traders.
Banks must sell clients products that are appropriate for them. Before the sub prime crisis, many wealth management clients seem to have been been sold complex products whose risks they did not fully appreciate.
The possibility of liquidity black holes must not be underestimated. Liquidity problems can crop up more frequently than what models would seem to suggest. Less actively traded instruments will not always sell at close to the theoretical price, as predicted by models. When many market participants are following the same strategy, there might be big market moves leading to a liquidity crisis. So liquidity and market risks should be examined together.
Top management should not approve a trading strategy that they do not fully understand. Otherwise, traders are quite likely to take advantage of the situation.
Caution should be exercised before turning the treasury department of a company into a profit centre. The treasury can become a profit centre only by taking more risk. This implies that hedging will inevitably move towards speculation.