Heads in the sand

Editor's Letter

There is a growing sense of disquiet in the risk community that risk management, rather than profiting in influence and heightened status from the fallout of the global financial crisis, has reverted to hiding risk exposures as banks attempt to restore investor confidence. This is a worrying development, but not all that surprising - the public image of bankers and financial services firms has taken a beating over the past year. It is also not a new phenomenon. The classification of risks, particularly the myriad of risks attributed to operations, has often been used as a way to reduce the perceived risk level within a firm. Firms even break up large losses into many different categories of risk so that they become less visible in loss databases.

But sources tell me that a new risk type has been invented along the borders of operational risk and strategic risk, known as governance risk. It's a classification of risk that as yet has no regulatory requirement attached and so there is no need for it to be quantified or included in any models. Governance risk, so I am told, is attributed to any loss caused by greedy executives. But surely such a sweeping definition could be applied to all losses made in connection to the recent crisis? The events of the past year have demonstrated a need for supervisors to re-evaluate the classifications of different risk types as the boundaries between them continue to blur. In the process of doing so, one would hope that a development such as governance risk will not stay off their radar for long.

Also this month, the question of whether operational risk can be modelled at all has again been raised thanks to a recent UK government report (see news page 8). The challenges of operational risk modelling are well known, but given the advances that have been made in this space by combining both qualitative and quantitative techniques, it could be argued that operational risk modelling is much more advanced that the outdated market and credit risk models, which failed abysmally to predict the financial crisis. That said, few firms are practising advanced op risk modelling techniques and there is a sense that answers need to be found to some fundamental problems if the discipline is going to continue to evolve and not be discounted altogether.