Risk management is not Rocket Science

Financial pundits, especially those who failed to see the clear warning signals of the Global crisis, are trying to make Risk management look like Rocket Science. We industrialists, who manage projects big and small, and handle business risks of all type besides financial risks, think otherwise. In the world of engineering and science, extremely complex and crucial operational and dynamic risks are measured, managed and mitigated every day by application based approaches like predictive analytics instead of the classical theoretical quantitative analysis, which proves that successful Risk methods exist. http://tinyurl.com/lzokqy

NY Federal Reserve President Mr. Dudley is right and deserves Kudos for admitting that The Fed's view of having insufficient tools and data to manage systemic risk has been wrong. That it is erroneous to say that bubbles can be identified only in hindsight, and that all the Central Bank can do is prepare to clean up after they burst.

As a matter of fact adequate , if not excessive data was available during this credit crisis and the years proceeding it, to identify the derivative transactions as a potential risk. A lot of this data was even presented by Republican Member Jim Saxton in his May 2008 report to U.S. Congress, months before the September crash. The data during the period of 2002 to 2007 particularly a single tell tale Graph 1.7 on Page 16 – titled “Subprime Mortgage Loans Gains Marketshare from FHA-Insured Mortgage Loans after 2002” showed it all. As the Saxton report correctly identified, the situation was brought about by an overly aggressive credit policy during the days of the Bush regime and a total relaxation of lending norms by the banks to profit from the CDS mortgages. This data is in the Saxton report for all to see.
THE U.S. HOUSING BUBBLE AND THE GLOBAL FINANCIAL CRISIS ...

It was rather a lack of identification of right Risk data, esoteric and theoretical risk modelling practices and a wilful negligence by the Banks, the rating agencies and regulators that brought about this situation. Mr. Dudley’s position on the right tools and culture of the proposed systemic- risk regulator is a timely and possibly veiled reminder to Mr Geithner that apart from powers it is the culture and application of correct tools that matter. As most people would remember that Mr. Geithner headed the N.Y. Fed at the time the derivative trade went out of control during the 2002 – 2007 period when trading of huge volumes of unrecorded CDS was done by the toxic Banks before the electronic system of recording was set up. That still remains the Achilles heel of the credit crisis, the reason why no body wants to open the Pandora ’s Box of toxic derivatives.

However, the patient must bite the bitter pill if he has to recover. Europe has been so far ahead of the America. in ushering regulatory reforms despite internal resistance amongst few countries notably Britain, who are primarily wary of the financial power centre shift from London due to such increased regulatory controls to Brussels. In two landmark decisions the EU in the month of May have announced plans to provide stringent EU monitoring of Banks previously monitored only by their country of origin. The European Systemic Risk Council a body that will monitor trends and provide an early warning of possible risks and a European System of financial supervisors, which will monitor Banks across the EU.

To avoid responsibility and the right mix regulatory enforcement and controls, some of which have been already adopted by the EU, the Toxic Banks, the Fed and the Treasury have been lobbying desperately. The reason is simple. If the TARP and the bailout funds can bring about even a partial economic recovery and erase the black mood of the people and the politicians, they can get away without implementing the same and get another lease of life at their “Casino Royale” . Thus even academics from reputed U.S. Institutions have been roped in and Risk Management Conferences are being held across U.S. with a clear message that Risk Management is still rocket science. However Risk Management though complex is not impossible. It is definitely not dealing with “the known, unknown and unknowable” as some business school theorists have been of late proposing.

Rather it is time to redefine Risk. Risk today is no uncertainty. It is a certainty, and must be dealt as one. Talking of the unknowable’s make humans look like a perplexed caveman praying to the God of light, wind and fire, in awe of the natures mysteries. The Business Risk management series being currently presented at slide share.net is an attempt in this direction. It treats Risk as a quantifiable, measured element which has to be monitored each day by noting the variations of performance trends over the pre-set Terms of Reference or historical trends if the Terms of Reference are not adequately laid out. Simply speaking, this means that however innovative a methodology, if there is a vertical take off from a pre-set trend either positive or negative it is worth investigation and regulation if need be. If this basics are followed their will be no CDS crisis, no Madoffs, no Ponzi’s in the financial sector while leaving adequate room for innovation for guys willing to play straight.

In context of the above it is now heartening to hear dissenting voices in the Federal Reserve against the official line “We are too complex to manage, too big to fail” repeatedly chorused by the Bank lobby, the Fed and the Treasury. So far it was only Sheila Bair of the FDIC who had picked up cudgels against this official line, partly because her domain was being directly hurt by the wayward and unregulated Banks gambling and profiteering instincts.

"But we shouldn't kid ourselves about how difficult this will be to execute," Mr Dudley said. "You will need a flexible and dynamic governance process to be able to identify the important elements of systemic risk, to elevate those concerns to the appropriate level and then to act on those concerns in a timely manner." This statement is more in line with the sentiments across the world. That the time has come to move out from under the glass ceiling and get down to the brass tracks and create new and definitive risk management tools that fetch results. As Mr Dudley rightly points out, we can’t kid ourselves that it will be easy. However it is neither impossible even if the complexities are multidimensional including market based, credit based and operational variables like in the financial sector.

The Business Risk Management Series based on the Time Cycle Module is a fundamentally simple approach. It is based on operational variables which are extremely complex and subjective but are analyzed, measured and mitigated analytically by a step by step method using variance analysis. It has been showcased in slide share Finance section getting the most views and 18 downloads in the first 3 days. Follow up presentations with case studies are due to commence on the 6th of July. We request our readers to view it and critically assess it, especially as it is one of the latest tools in this critical area of business operations.