Instead of considering liquidity risk separately, it often makes sense to integrate it with market and credit risk. In simple terms, adverse market movements can lead to liquidity problems in terms of funding. If this triggers off asset sales, it leads to asset liquidity problems. Similarly, a lowering of the credit rating may result in the need to deposit more collateral or margin. This in turn may lead to liquidity problems. So liquidity risk must be integrated into VAR models so that risk measures pay sufficient attention to liquidity. A simple way to do this is by looking at a bid-ask spreads.
Bid – ask spreads are driven by:
Order processing costs, which tend to decrease with volumes
Asymmetric information costs
Inventory carrying costs.
High spreads often mean the markets are shallow and liquidity is lacking.
Liquidity adjusted VAR can be calculated by adding sa/2 for each position in the book, where a is the dollar value of the position and s is defined as (offer price – bid price) / mid-price.
Liquidity risk can also be factored into VAR measures by ensuring that the horizon is at least greater than an orderly liquidation period. Generally, the same horizon is applied to all asset classes, even though some assets may be less liquid than others. Alternatively, by increasing the time horizon, the capital requirement can be enhanced. Thanks to more capital, a financial institution will be better placed to deal with a severe liquidity crisis. Sometimes, longer liquidation periods for some assets are taken into account by artificially increasing the volatility. This again leads to a higher capital buffer.
Saturday, 2 January 2010
Containing liquidity risks: Recommendations of the UK Financial Services Authority
The UK Financial Services Authority has recently come out with detailed guidelines for managing liquidity risk. Measuring and managing bank liquidity risk must receive as much attention as capital/solvency risk management. In the years running up to the recent financial crisis, this was not the case.
Key considerations in liquidity risk management.
§ Liquidity risk has inherently systemic characteristics. The simultaneous attempt by multiple banks to improve their liquidity position can contribute to a generalised collapse of liquidity.
§ Liquidity management has become increasingly complex over time. There is increased reliance on ‘liquidity through marketability’ alongside traditional liquidity through funding access. This makes it difficult to base good liquidity regulation primarily on one or a few standard ratios.
§ There is a tradeoff to be struck. Increased maturity transformation delivers benefits to the non bank sectors of the economy and is favourable to long-term investment. But the greater the aggregate degree of maturity transformation, the more the systemic risks and the more difficult for central banks to address liquidity crises.
Recommendations to deal with liquidity risk:
• There is a need for greater disclosures. For example, firms must be required to provide, for example, detailed maturity ladders, analysis of the assumed liquidity of trading assets, and analysis of off-balance sheet positions with liquidity implications.
• Individual Liquidity Adequacy Assessments (ILAAs) must be carried out for different assets.
• A liquid assets buffer must be maintained, whose minimum value (defined relative to balance sheet size) will be determined for each bank in Individual Liquidity Guidance.
• Firms must quantify and reflect in internal costing systems the liquidity risk created by participation in different categories of activity.
• Regulators must specify some stress tests, rather than leave it entirely to bank internal decisions. Stress tests must consider market-wide events as well as firm specific events.
• There must be a strong focus on the analysis of cross-system liquidity trends, with the publication of a periodic system-wide report.
A new regime
There can be considerable risk both for individual banks and for the system as a whole, if rapid asset growth is funded through increased reliance on potentially unstable funding sources. In the UK, between 2002 and 2007, growth of bank balance sheets was significantly correlated with the % of funding derived from short-term wholesale deposits. The new liquidity regime, should ideally result in:
• less reliance on short term wholesale funding,
• greater emphasis on retail time deposits;
• a higher amount and quality of stocks of liquid assets, including a greater proportion of those assets held in the form of government debt;
• a check on the unsustainable expansion of banking lending during favourable economic times.
These measures will naturally involve a trade off between a cost to the economy during ‘normal times’ and the benefits of the reduced probability of extreme adverse events. Given the scale of the economic fallout from the financial crisis, such a trade-off is justified in order to safeguard future financial stability.
A ‘core funding ratio’ as a prudential and macro-prudential tool.
The FSA has proposed a core funding ratio. Most developed countries have not used standard funding ratios (e.g. loans to deposit ratios) as regulatory tools for many years: but several emerging countries (e.g. Hong Kong and Singapore) have continued to apply regulatory constraints of this nature.
Key considerations in liquidity risk management.
§ Liquidity risk has inherently systemic characteristics. The simultaneous attempt by multiple banks to improve their liquidity position can contribute to a generalised collapse of liquidity.
§ Liquidity management has become increasingly complex over time. There is increased reliance on ‘liquidity through marketability’ alongside traditional liquidity through funding access. This makes it difficult to base good liquidity regulation primarily on one or a few standard ratios.
§ There is a tradeoff to be struck. Increased maturity transformation delivers benefits to the non bank sectors of the economy and is favourable to long-term investment. But the greater the aggregate degree of maturity transformation, the more the systemic risks and the more difficult for central banks to address liquidity crises.
Recommendations to deal with liquidity risk:
• There is a need for greater disclosures. For example, firms must be required to provide, for example, detailed maturity ladders, analysis of the assumed liquidity of trading assets, and analysis of off-balance sheet positions with liquidity implications.
• Individual Liquidity Adequacy Assessments (ILAAs) must be carried out for different assets.
• A liquid assets buffer must be maintained, whose minimum value (defined relative to balance sheet size) will be determined for each bank in Individual Liquidity Guidance.
• Firms must quantify and reflect in internal costing systems the liquidity risk created by participation in different categories of activity.
• Regulators must specify some stress tests, rather than leave it entirely to bank internal decisions. Stress tests must consider market-wide events as well as firm specific events.
• There must be a strong focus on the analysis of cross-system liquidity trends, with the publication of a periodic system-wide report.
A new regime
There can be considerable risk both for individual banks and for the system as a whole, if rapid asset growth is funded through increased reliance on potentially unstable funding sources. In the UK, between 2002 and 2007, growth of bank balance sheets was significantly correlated with the % of funding derived from short-term wholesale deposits. The new liquidity regime, should ideally result in:
• less reliance on short term wholesale funding,
• greater emphasis on retail time deposits;
• a higher amount and quality of stocks of liquid assets, including a greater proportion of those assets held in the form of government debt;
• a check on the unsustainable expansion of banking lending during favourable economic times.
These measures will naturally involve a trade off between a cost to the economy during ‘normal times’ and the benefits of the reduced probability of extreme adverse events. Given the scale of the economic fallout from the financial crisis, such a trade-off is justified in order to safeguard future financial stability.
A ‘core funding ratio’ as a prudential and macro-prudential tool.
The FSA has proposed a core funding ratio. Most developed countries have not used standard funding ratios (e.g. loans to deposit ratios) as regulatory tools for many years: but several emerging countries (e.g. Hong Kong and Singapore) have continued to apply regulatory constraints of this nature.
Types of liquidity risk
There are two types of liquidity risk :
a) Asset Liquidity Risk
b) Funding liquidity risk
Asset liquidity risk is the risk that the liquidation value of the assets may differ significantly from the current mark-to-market values. When unwinding a large position or when the market circumstances are adverse, the liquidation value may fall well below the fair or intrinsic value.
Asset liquidity is low when it is difficult to raise money by selling the asset. This typically happens when selling the asset depresses the sale price. Asset liquidity depends on the relative ease of finding somebody who takes on the other side of the trade. When it is difficult to find such counterparties, liquidity is low. There are three forms of asset liquidity:
v the bid–ask spread, which measures how much traders lose if they sell one unit of an asset and then buy it back right away;
v market depth, which shows how many units traders can sell or buy at the current bid or ask price without moving the price;
v market resiliency, which tells us how long it will take for prices that have temporarily fallen to bounce back. While a single trader might move the price a bit, large price swings occur when “crowded trades” are unwound—that is, when a number of traders attempt to exit from identical positions together.
Funding liquidity risk refers to the inability to meet payment obligations to creditors or investors. Funding liquidity risk can thus take three forms:
v margin/haircut funding risk, or the risk that margins and haircuts will change;
v rollover risk, or the risk that it will be more costly or impossible to roll over short-term borrowing;
v redemption risk.
Most financial institutions fund long term assets with short term sources of funds. This maturity mismatch can lead to problems if depositors/investors start withdrawing their money simultaneously.
Funding liquidity problems also arise because most trading positions are leveraged. Traders post collateral in exchange for cash from a broker. The value of the collateral is constantly marked to market. If this value falls, the market participant may be asked to deposit some additional payment called the variation margin to keep the total amount held above the loan value. Without adequate liquidity to make these margin payments, market participants can find themselves in trouble.
Typically, when a trader, purchases an asset, the trader uses the purchased asset as collateral and borrows (short term) against it. However, the trader cannot borrow the entire price. The difference between the security’s price and its value as collateral is called the margin or haircut. The haircut must be financed by the trader’s own equity capital. Haircuts are adjusted to market conditions on a daily basis. Since traders are leveraged and carry little capital in relation to their assets, increasing the haircut may force them to sell part of their assets when liquidity dries up in the market.
Financial institutions that rely substantially on short-term (commercial) paper or repo contracts have to roll over their debt. An inability to roll over this debt is equivalent to margins increasing to 100 percent, because the firm becomes unable to use the asset as a basis for raising funds. Similarly, withdrawals of demand deposits from an investment fund have the same effect as an increase in margins. When the time is due for redemption or if investors want to make premature withdrawals, banks can find themselves in serious trouble if they do not have adequate liquidity.
a) Asset Liquidity Risk
b) Funding liquidity risk
Asset liquidity risk is the risk that the liquidation value of the assets may differ significantly from the current mark-to-market values. When unwinding a large position or when the market circumstances are adverse, the liquidation value may fall well below the fair or intrinsic value.
Asset liquidity is low when it is difficult to raise money by selling the asset. This typically happens when selling the asset depresses the sale price. Asset liquidity depends on the relative ease of finding somebody who takes on the other side of the trade. When it is difficult to find such counterparties, liquidity is low. There are three forms of asset liquidity:
v the bid–ask spread, which measures how much traders lose if they sell one unit of an asset and then buy it back right away;
v market depth, which shows how many units traders can sell or buy at the current bid or ask price without moving the price;
v market resiliency, which tells us how long it will take for prices that have temporarily fallen to bounce back. While a single trader might move the price a bit, large price swings occur when “crowded trades” are unwound—that is, when a number of traders attempt to exit from identical positions together.
Funding liquidity risk refers to the inability to meet payment obligations to creditors or investors. Funding liquidity risk can thus take three forms:
v margin/haircut funding risk, or the risk that margins and haircuts will change;
v rollover risk, or the risk that it will be more costly or impossible to roll over short-term borrowing;
v redemption risk.
Most financial institutions fund long term assets with short term sources of funds. This maturity mismatch can lead to problems if depositors/investors start withdrawing their money simultaneously.
Funding liquidity problems also arise because most trading positions are leveraged. Traders post collateral in exchange for cash from a broker. The value of the collateral is constantly marked to market. If this value falls, the market participant may be asked to deposit some additional payment called the variation margin to keep the total amount held above the loan value. Without adequate liquidity to make these margin payments, market participants can find themselves in trouble.
Typically, when a trader, purchases an asset, the trader uses the purchased asset as collateral and borrows (short term) against it. However, the trader cannot borrow the entire price. The difference between the security’s price and its value as collateral is called the margin or haircut. The haircut must be financed by the trader’s own equity capital. Haircuts are adjusted to market conditions on a daily basis. Since traders are leveraged and carry little capital in relation to their assets, increasing the haircut may force them to sell part of their assets when liquidity dries up in the market.
Financial institutions that rely substantially on short-term (commercial) paper or repo contracts have to roll over their debt. An inability to roll over this debt is equivalent to margins increasing to 100 percent, because the firm becomes unable to use the asset as a basis for raising funds. Similarly, withdrawals of demand deposits from an investment fund have the same effect as an increase in margins. When the time is due for redemption or if investors want to make premature withdrawals, banks can find themselves in serious trouble if they do not have adequate liquidity.
Understanding liquidity risk
Liquidity risk and other financial risks go together. For example, market risk is the possibility of losses due to fluctuations in interest rates, commodities, stocks and currencies. Managing market risk calls for ongoing adjustments of the exposure depending on the performance of the portfolio. But this adjustment is possible only when a liquid market exists where assets can be bought and sold easily.
Liquidity risk emanates from the liability side when creditors or investors demand their money back. This usually happens after the institution has incurred or is thought to have incurred losses that could threaten its solvency. Problems arise on the asset side when the forced liquidation of assets at distress prices causes substantial losses.
Liquidity risk is more complex than we think. Understanding liquidity risk involves knowledge of market microstructure, which is the study of market clearing mechanisms; optimal trade execution (e.g., minimising trading costs) and asset liability management (matching the values of assets and liabilities on the balance sheet).
Liquidity is crucially dependent on the market conditions and the prevailing sentiments. As Paul McCulley of the CFA Institute ( CFA Institute Reading 53, “The Liquidity Conundrum.”) mentions, “Liquidity is the result of the appetite of investors to underwrite risk and the appetite of savers to provide leverage to investors who want to underwrite risk. The greater the risk appetite, the greater the liquidity and vice versa. Put another way, liquidity is the joining or separating of two states of mind – a leveraged investor who want to underwrite risk and an unleveraged saver who does not want to take risk and who is the source of liquidity to the leveraged investor. The alignment or misalignment of the two investors determines the abundance or shortage of liquidity.”
In his very insightful book, “The Partnership,” consultant Charles Ellis has given an excellent example of liquidity by quoting Bob Mnuchin, a senior leader of Goldman Sachs: “When you can get out a stock that you’re long at a small loss and buy back a stock you’re short at a small loss, that’s an easy decision. It is painful when there isn’t an apparent opportunity to unwind a position or the price moves farther and faster away. Then you hesitate. Then you pray.”
Liquidity risk emanates from the liability side when creditors or investors demand their money back. This usually happens after the institution has incurred or is thought to have incurred losses that could threaten its solvency. Problems arise on the asset side when the forced liquidation of assets at distress prices causes substantial losses.
Liquidity risk is more complex than we think. Understanding liquidity risk involves knowledge of market microstructure, which is the study of market clearing mechanisms; optimal trade execution (e.g., minimising trading costs) and asset liability management (matching the values of assets and liabilities on the balance sheet).
Liquidity is crucially dependent on the market conditions and the prevailing sentiments. As Paul McCulley of the CFA Institute ( CFA Institute Reading 53, “The Liquidity Conundrum.”) mentions, “Liquidity is the result of the appetite of investors to underwrite risk and the appetite of savers to provide leverage to investors who want to underwrite risk. The greater the risk appetite, the greater the liquidity and vice versa. Put another way, liquidity is the joining or separating of two states of mind – a leveraged investor who want to underwrite risk and an unleveraged saver who does not want to take risk and who is the source of liquidity to the leveraged investor. The alignment or misalignment of the two investors determines the abundance or shortage of liquidity.”
In his very insightful book, “The Partnership,” consultant Charles Ellis has given an excellent example of liquidity by quoting Bob Mnuchin, a senior leader of Goldman Sachs: “When you can get out a stock that you’re long at a small loss and buy back a stock you’re short at a small loss, that’s an easy decision. It is painful when there isn’t an apparent opportunity to unwind a position or the price moves farther and faster away. Then you hesitate. Then you pray.”
Understanding business risk
Business risks refer to the risks a company willingly assumes to create a competitive advantage and add value for shareholders. These are the risks which arise in the design, development, production and marketing of products. In other words, business risk refers to the uncertainty about the demand for a company’s products and services. Some of these risks may arise due to internal factors while others may be due to the environment.
Risks arising due to internal factors include:
§ Product development choices
§ Marketing strategies
§ Organizational structure
Risks emanating from external factors include:
§ Macro economic risk
§ Competition risk
§ Technological risk
Risks arising due to internal factors include:
§ Product development choices
§ Marketing strategies
§ Organizational structure
Risks emanating from external factors include:
§ Macro economic risk
§ Competition risk
§ Technological risk
Understanding integrated risk management
Integrated risk management also popularly called Enterprisewide Risk Management (ERM), looks at various kinds of risk - market risk, credit risk, liquidity risk, operational risk and business risk in a holistic fashion. An integrated view generates a better picture of the risk climate of the organization and also helps in making the risk management process more efficient. Considerable cost savings can be achieved by aggregating and netting out positions. A firmwide approach can reveal natural hedges and guide the firm’s strategy towards activities that are less risky when taken as a whole. ERM also acts as a check on risk migration, i.e., movement towards other types of risk that are less visible but may be more dangerous. Last but not the least, by providing an aggregate measure of risk, ERM helps companies to decide what is the optimal level of capital they must hold. Too little capital means the company is taking risks which it cannot afford to take. Too much capital means the company is being too conservative and may fail to generate adequate returns for shareholders.
While the integration of market and credit risk in banks has made impressive strides in recent years, the same cannot be said about the integration of business and financial risks in non banking corporations. Traditionally, the two kinds of risk have been handled in two different silos by two types of people, the business managers and the finance managers respectively. Business people bring in a strong intuitive dimension to risk management but often lack the tools to quantify risk. The finance people are data driven and swear by quantification. But often they do not understand the business adequately enough to bring in the necessary element of intuition and judgment. ERM can help bridge the silos by striking the right balance between intuition and quantification.
While the integration of market and credit risk in banks has made impressive strides in recent years, the same cannot be said about the integration of business and financial risks in non banking corporations. Traditionally, the two kinds of risk have been handled in two different silos by two types of people, the business managers and the finance managers respectively. Business people bring in a strong intuitive dimension to risk management but often lack the tools to quantify risk. The finance people are data driven and swear by quantification. But often they do not understand the business adequately enough to bring in the necessary element of intuition and judgment. ERM can help bridge the silos by striking the right balance between intuition and quantification.
Mitigating systemic risk
The Counter party Risk Management Policy Group (CRMPG) is an influential self regulatory authority that is concerned with the identification, measurement and control of counterparty risk. The group’s August 2008 report provides valuable inputs on dealing with risk in an increasingly complex global financial system. The following summary outlines the approach suggested by the CRMPG.
It is difficult for the senior management of large banks to fully grasp the scale and complexity of these control and risk management challenges. But there are certain relatively simple, core precepts that can facilitate the management and supervision of large integrated financial intermediaries and ensure that risk controls are both robust and flexible over business and credit cycles.
Precept I: The Basics of Corporate Governance
The culture of corporate governance at individual financial institutions can have a very large bearing on how individual institutions respond to unstable periods/crisis.
Risk monitoring and risk management must not be based totally on backward looking quantitative risk metrics. Instead risk management must rely heavily on judgment, communication and coordination, spanning the organization and reaching to the highest levels of management.
Sound corporate governance can help to break down the silo mentality and ensure that critical information on risk profiles, institution-wide exposure and potential channels of contagion are regularly monitored at all levels.
Critical control personnel in such areas as risk monitoring, credit, operations, internal audit, compliance and controllers must be truly independent from front-line business unit personnel. Support and control functions must be equipped and empowered to impose necessary checks and balances across all risk- taking business units. High-potential individuals must be rotated between business units and support/control functions. Incentives must be designed to discourage short-run excesses in risk taking.
Precept II: The Basics of Risk Monitoring
Risk management models and metrics will be effective only if individual institutions are able to monitor all positions and risk exposures on a timely basis. All large integrated financial intermediaries must have the capacity to monitor risk concentrations and exposures, to all institutional counterparties in a matter of hours. The operating staff must provide effective and coherent reports to senior management regarding such exposures to high-risk counterparties.
Precept III: The Basics of Estimating Risk Appetite
Estimating risk appetite and finding an adequate risk-reward balance must be a dynamic process that takes into account both qualitative and quantitative factors. Stress tests and other quantitative tools are necessary, but not sufficient, tools for making judgments about risk appetite. Stress tests can never anticipate how future events will unfold unless such tests are so extreme as to postulate outcomes that no level of capital or liquidity will provide protection against potential failure. Risk appetite must also consider inherently judgmental factors such as compensation systems and the quality of the control environment.
In other words, estimating acceptable thresholds of risk appetite is more an art than a science. The challenge for senior management, boards and prudential supervisors is to exercise the necessary judgments as to how factors such as incentives, the quality of the control environment, the point in the business cycle and other qualitative inputs will influence the appetite for risk. All large banks must periodically conduct comprehensive exercises aimed at estimating risk appetite. The results of such exercises should be shared with the highest level of management, the board of directors and the institution’s primary supervisor.
Precept IV: Focusing on Contagion
The basic forces that give rise to contagion are reasonably well known and recognized. These include:
· credit concentrations;
· broad-based maturity mismatches;
· excessive leverage
· the illusion of market liquidity.
All large financial institutions must regularly brainstorm to identify “hot spots” and analyze how such “hot spots” might play out in the future. Even if the “hot spots” do not materialize or even if unanticipated “hot spots” do materialize, the insights gained in the brainstorming exercise will be of considerable value in managing future sources of contagion risk.
Precept V: Enhanced Oversight
The board must provide an appropriate degree of oversight of the company consistent with the goal of maximizing shareholder value over time. It is difficult for outside independent directors to fully grasp all the risks associated with the day-today activities of large banks. But they can ask the right questions and insist on necessary information – properly presented so that they can exercise their oversight responsibilities.
The highest-level officials from primary supervisory bodies should meet at least annually with the boards of directors of large integrated financial intermediaries. The supervisory authorities must share with the board and top management their views on the underlying stability of the institution and its capacity to absorb periods of adversity. The spokesperson from the supervisory body should be a true policy level executive or, preferably, a principal of the supervisory body. These high level exchanges of views should minimize the use of quantitative metrics and maximize the use of discussion and informed judgment.
The core precepts mentioned above are interrelated. No one institution can, by itself, accomplish all that needs to be done in restoring the credibility of the industry and limiting future financial stocks. There must be collective and concerted industrywide initiatives supported by progressive and enlightened prudential supervision.
It is difficult for the senior management of large banks to fully grasp the scale and complexity of these control and risk management challenges. But there are certain relatively simple, core precepts that can facilitate the management and supervision of large integrated financial intermediaries and ensure that risk controls are both robust and flexible over business and credit cycles.
Precept I: The Basics of Corporate Governance
The culture of corporate governance at individual financial institutions can have a very large bearing on how individual institutions respond to unstable periods/crisis.
Risk monitoring and risk management must not be based totally on backward looking quantitative risk metrics. Instead risk management must rely heavily on judgment, communication and coordination, spanning the organization and reaching to the highest levels of management.
Sound corporate governance can help to break down the silo mentality and ensure that critical information on risk profiles, institution-wide exposure and potential channels of contagion are regularly monitored at all levels.
Critical control personnel in such areas as risk monitoring, credit, operations, internal audit, compliance and controllers must be truly independent from front-line business unit personnel. Support and control functions must be equipped and empowered to impose necessary checks and balances across all risk- taking business units. High-potential individuals must be rotated between business units and support/control functions. Incentives must be designed to discourage short-run excesses in risk taking.
Precept II: The Basics of Risk Monitoring
Risk management models and metrics will be effective only if individual institutions are able to monitor all positions and risk exposures on a timely basis. All large integrated financial intermediaries must have the capacity to monitor risk concentrations and exposures, to all institutional counterparties in a matter of hours. The operating staff must provide effective and coherent reports to senior management regarding such exposures to high-risk counterparties.
Precept III: The Basics of Estimating Risk Appetite
Estimating risk appetite and finding an adequate risk-reward balance must be a dynamic process that takes into account both qualitative and quantitative factors. Stress tests and other quantitative tools are necessary, but not sufficient, tools for making judgments about risk appetite. Stress tests can never anticipate how future events will unfold unless such tests are so extreme as to postulate outcomes that no level of capital or liquidity will provide protection against potential failure. Risk appetite must also consider inherently judgmental factors such as compensation systems and the quality of the control environment.
In other words, estimating acceptable thresholds of risk appetite is more an art than a science. The challenge for senior management, boards and prudential supervisors is to exercise the necessary judgments as to how factors such as incentives, the quality of the control environment, the point in the business cycle and other qualitative inputs will influence the appetite for risk. All large banks must periodically conduct comprehensive exercises aimed at estimating risk appetite. The results of such exercises should be shared with the highest level of management, the board of directors and the institution’s primary supervisor.
Precept IV: Focusing on Contagion
The basic forces that give rise to contagion are reasonably well known and recognized. These include:
· credit concentrations;
· broad-based maturity mismatches;
· excessive leverage
· the illusion of market liquidity.
All large financial institutions must regularly brainstorm to identify “hot spots” and analyze how such “hot spots” might play out in the future. Even if the “hot spots” do not materialize or even if unanticipated “hot spots” do materialize, the insights gained in the brainstorming exercise will be of considerable value in managing future sources of contagion risk.
Precept V: Enhanced Oversight
The board must provide an appropriate degree of oversight of the company consistent with the goal of maximizing shareholder value over time. It is difficult for outside independent directors to fully grasp all the risks associated with the day-today activities of large banks. But they can ask the right questions and insist on necessary information – properly presented so that they can exercise their oversight responsibilities.
The highest-level officials from primary supervisory bodies should meet at least annually with the boards of directors of large integrated financial intermediaries. The supervisory authorities must share with the board and top management their views on the underlying stability of the institution and its capacity to absorb periods of adversity. The spokesperson from the supervisory body should be a true policy level executive or, preferably, a principal of the supervisory body. These high level exchanges of views should minimize the use of quantitative metrics and maximize the use of discussion and informed judgment.
The core precepts mentioned above are interrelated. No one institution can, by itself, accomplish all that needs to be done in restoring the credibility of the industry and limiting future financial stocks. There must be collective and concerted industrywide initiatives supported by progressive and enlightened prudential supervision.
Subscribe to:
Posts (Atom)