By Karamjeet Paul
Recent proposals to increase the bank capital requirement to 15% amount to kicking the can down the road.
Why 15%? After all, if the solution is so simple then why not raise it to 50% to make banks super safe? The 15% requirement is just as arbitrary as any other subjective figure that can be brought to the table. Instead, regulators should address the fundamental issue that creates the need for capital in the first place, and help us truly postpone our next day of reckoning.
Capital serves a critical function. Managed properly, it supports growth by cushioning exposure from unexpected hits that may otherwise discourage prudent risk taking. Without this focus, stricter capital regulations not only avoid the real issue. They actually add three new risks.
(Click here to read more …)
Regulatory reforms always start out with well-meaning intentions. However, unless new regulations address the root cause of the problem requiring reform, and interests of all parties are aligned, they are not just less than effective. They can have unintended consequences resulting in greater complexities that actually end up increasing risk. Are we beginning to see some such effects with the recent regulatory reform? The following article from last Sunday’s (April 20, 2014) New York Times may be of interest along these lines.
“Banks Cling to Bundles Holding Risk” by Gretchen Morgenson http://www.nytimes.com/2014/04/20/business/banks-cling-to-bundles-holding-risk.html?ref=todayspaper
Improved understanding of extreme risks can mitigate bank-regulator conflicts
By Karamjeet Paul (Published by GARP Friday, March 14, 2014)
The relationship between regulators and financial institutions can be described in many ways, but one would not be to call them allies. While it is not totally antagonistic, it is also not like a partnership.
Regulators have an objective to protect the financial system and minimize taxpayer costs. A very large part of their efforts, other than to prevent fraud, constitutes protecting institutions from extreme tail risk and drawing regulatory boundaries and limits. Tail risk refers to exposure from uncertainty that is so high that — if it materializes — it can turn into catastrophic losses and overwhelm institutions.
Financial institutions view such boundaries and limits as overly restrictive, even though institutions also have a fiduciary objective to protect themselves from extreme tail risk. Despite this common objective of protection, there is an apparent divergence of interests because of how each side goes about achieving this objective. (Click here to read more …)
Published by GARP – NOVEMBER 19, 2013
A series of catastrophic events in recent years have sensitized corporations, governments and other institutions to the low-probability, high-impact threats known in the risk management profession as tail risks. These events have been occurring with increasing frequency in the form of both natural and human-caused disasters. The financial kind is the focus of veteran risk manager and adviser Karamjeet Paul in the recently published Managing Extreme Financial Risk: Strategies and Tactics for Going Concerns. He notes that the crisis of 2008-’09 was but the latest — and certainly the most costly and far-reaching — of a modern progression that included the stock market crash of 1987, the savings and loan failures of the early 1990s, Long Term Capital Management and the Asian debt collapse in the late 1990s, and the Internet bubble shortly thereafter. Given this established, albeit unpredictable, pattern of mounting costs and concerns, Paul explains how conventional modeling is ill-suited for tail risks and lays out a framework for managing them that he defines as “sustainability management,” taking into account the systemic and operational consequences of extreme events that threaten not only a firm’s profitability, but also its very existence. (Click here to read more …)
By Karamjeet Paul (Published by Agenda, a Financial Times publication, Feb, 10, 2014)
No director wants their company to experience the fate of MF Global, Enron or Lehman Brothers. For this reason, minimizing exposure to sudden catastrophic events — known academically as extreme tail risk — must be a top priority for boards because of their devastating financial impact.
Two macro-business trends make extreme risk a greater governance priority. (Click here to read more … )
By KARAMJEET PAUL (Published in American Banker Nov. 6, 2013)
The banking industry has a paradoxical problem. There is tremendous pressure to increase capital, but it can’t increase capital by adding capital. (Click here to read more…)
By KARAMJEET PAUL (Published in American Banker Nov. 8, 2013)
Five years ago, the Lehman bankruptcy triggered a crisis of greater scope than any other the modern financial world had seen. Not long ago, people assumed that extreme crises happened once every 100 years. Based upon their frequency over the last 30 years, another crisis may not be far away. Is the financial industry ready for it? (Click here to read more …)