Banks warned over ‘criminal negligence’ in disregarding liquidity

The single biggest lesson risk managers can draw from the financial crisis is the critical importance of liquidity, said BlackRock’s chief risk officer, Bennett Golub, at the Risk USA conference in New York in October.

For financial firms, he equates the need to keep tabs on liquidity to the need for hospitals to maintain a power source for kidney dialysis machines. Failing to do so is “criminal negligence”, he says. “That isn’t to say there isn’t necessarily going to be that risk, but you need to think about it a whole lot.”

Liquidity is also pertinent when it comes to complex assets. Even when institutions have the financial wizardry to analyse and invest in these products, the liquidity of complex assets can easily break down, says Golub. During the crisis, there were many situations where companies with analytical know-how should have been investing aggressively in mortgage-backed securities, for instance. But those in a position to invest “had no capital and were clinging onto their lives for their jobs,” he says.

Elsewhere, the crisis has demonstrated that investors in securitised products need to go further than quantitative modelling techniques, Golub asserts. When using such models, firms need to be aware that data could be imperfect, incomplete or fraudulent.

Golub says market ructions have also brought a new type of risk to the fore – so-called policy risk. This is demonstrated by the rebound in markets for securitisations that are being supported by government programmes, he says. “There aren’t many quants that have a good idea of what goes on in Washington, but if you want to be an effective risk manager it’s very important.”