Two things are certain in relation to the financial industry:
- Financial crises are a part of economic cycles and can’t be avoided.
- Tail risk is the bane of a financial institution’s revenue model
At the intersection of these two certainties lies a graveyard of the victims of excessive tail risk. Tombstones that read Franklin National Bank, Continental Illinois Bank, Wachovia, Washington Mutual, Bear Stearns, Lehman Brothers and MF Global to name a few, plus names of hundreds of savings and loans institutions, make clear the devastation tail risk is capable of causing.
What causes havoc at a financial institution in a crisis is not too much risk but too much tail risk (sudden extremely low-probability events with catastrophic exposure from unquantifiable uncertainty). The distinction is critical. How extreme-tail risk has been managed determines the fate of a financial institution in a sudden financial crisis. While a financial institution can’t do much to prevent a systemic financial crisis, the proactive management of its tail risk can make a life-and-death difference on its sustainability during the crisis.
The objective of this blog, sponsored by Strategic Exposure Group, is to enhance public debate about extreme-tail risk, and its implications on “sustainability management,” bank capital, regulations and systemic factors. We welcome your thoughts, comments, input and ideas.
Strategic Exposure Group is an advisory firm with client focus on proactively managing extreme-tail risk at financial institutions to ensure their sustainability during a future financial crisis. For more information about the firm’s capabilities, please visit StrategicExposureGroup.com or contact us at Info@StrategicExposureGroup.com.