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Member, Beacon International Group, Ltd.
One question that has come up repeatedly in the analysis of the global financial crisis is “Where was risk management?” It's a great question, and one that executives of many financial services entities have failed, or at least mightily struggled, to answer.
The release this week of a Deloitte & Touche L.L.P. study of risk management in banks and financial institutions may shed some light. Of 111 institutions surveyed, only 36% had an enterprise risk management program in place, though 23% are implementing one. Among the largest financial institutions, those with $100 billion or more of assets, 58% had an ERM program.
Stress testing is an important tool to determine the effectiveness of risk management plans, and the Deloitte study is not very assuring in this area either. Eighty percent of the institutions surveyed employ stress testing of banking and trading activities, but only 58% reported testing their structured product portfolios. As attentive readers will note, structured products, such as credit derivatives backed by subprime loans, were the culprit in the credit crisis. Of those institutions that stress tested such products, only 17% did such testing daily, while two-thirds tested quarterly or less often, according to Deloitte.
With risk management practices such as this, is it any wonder dozens of banks have failed and some insurers have reported massive writedowns on investments in structured financial products? The numbers in the study do not suggest ERM would have prevented the financial crisis, but in at least a few cases, it seems likely that an ERM function might have spotted trouble before it escalated to a global crisis.
Two ERM experts who spoke this spring to Business Insurance discussed the role ERM might have played in averting the financial disaster. See a video of their remarks. What’s your view? Was the lack of ERM the root cause of the financial crisis?