Wednesday, November 26, 2008

Risk Management at Top of List for Financial Regulatory Reform

It has become clear that the financial market crisis was partially caused by a failure of risk management. This is somewhat perplexing because the concept of risk management has been around for some years. But jawboning did not work, even the very excellent jawboning of Federal Reserve Board Governors Randy Kroszner and Susan Schmidt Bies. So now, there will be mandatory risk management for financial institutions under some form of federal oversight.

Effective risk management is part of sound corporate governance. It comes from having the right tone at the top and strong support at the board and senior management level. The risk management officer must report to a senior officer who has responsibility for effective risk management. Risk management must be independent of line duties and its officers must not have their compensation tied to performance incentives. There must be effective stress testing.