The Root of the Problem

Pauline Bird
Summer 2009
IRM FOCUS – Papers on Risk The City of London is the greatest employer of science
and maths graduates in the country. How could it be that a 1
disaster with such far reaching impacts was not spotted and
Risk and the dealt with before it brought the global economy to its knees?

Financial Crisis Let’s examine the root of the problem. In order to expand their
businesses the lending institutions needed to find new markets
for mortgage lending. Two of those markets were buy-to-let
owners (a new animal) and people whose credit history was
As risk’s management leading international suspect or who were unable to share the lender’s risk in the
education and training body, the Institute of mortgage lending by putting down a deposit. In a market where
lenders became ever keener, it was possible to obtain what
Risk Management (IRM) asked its members
was (in effect) a loan of 125% of the purchase price, allowing
for their views on the causes of the current borrowers to buy a run down property and renovate it. The
financial crisis and lessons for the future. IRM second category was ‘sub-prime’ loans, a term which recognised
the more risky nature of the lending.
is delighted to publish the following four essays.
Each approaches the subject from a slightly The lenders recognised the risk in this lending, and removed the
risk from their balance sheets by bundling up the sub-prime and
different angle, but all of them shed light on how other high risk loans and selling them to a company created for
we got here and some ways forward. the purpose, the special investment vehicle or SIV. The shares
in that company were sold to investors, who received the right to
the income from the loans. This had the effect of removing the
risk in the loans from the lender’s balance sheet, and, even better,
Contents allowing the lender to take the full value of the loans over their
lifetime of several years in one financial year, which improved the
The Root of the Problem lender’s financial results.

Pauline Bird, BDO Stoy Hayward..................................p.1 So far, so good. But what then possessed the lenders to buy
other people’s risk? The lender creating a SIV would discount the
value of the loans for (in effect) early payment. So long as the
loans continued to perform, the buyer would be getting a greater
CAMPARI on the Rocks return on the loan than they had paid for it. These deals would
Andrew Chapman, Anglia Ruskin University. ........p.3 also appear on the investor’s balance sheet as an investment,
and could appear in the accounts as a transaction ‘marked to
market’ – that is the entire profit from the lifetime of the contract
could be recognised in one financial year, which again would
The Naughty Years improve the apparent results for the investor in that year.
Gerard Joyce, LinkResQ........................................................p.4
These techniques are based on a number of critical assumptions,
the first being that borrowers with an impaired credit history
would continue to repay their loans, and the second, that the
Three Opportunities for property market would only increase in value. It is now clear that
these assumptions were wholly or partially invalid.
Risk Management
Clive Thompson, Willis UK and Ireland....................p.6 The value of the deals depended partly on the strength of the
underlying asset – either the repayment of the debt as expected
or the rising value of properties that could be repossessed and
sold to cover any default. Where the borrower was unable to
service the debt, or where there was a shortfall between the
forced sale value of the property and the lending, the investor in
the SIV was left with a loss.
The Institute of Risk Management The organisations that have exposures to sub-prime debt
www.theirm.org have been very coy about revealing the extent to which they
[email protected] are exposed, although all of them understand the accounting
+44 (0) 20 7709 9808 techniques that have been used to generate results in the past.
None of them can trust that the others’ declared exposures are an
The Institute of Risk Management is risk management’s leading
international professional education and training body. The Institute accurate reflection of the true risk exposure, and therefore none of
provides high quality education, training and professional development in
risk management at a range of levels, from introductory to expert.
The Institute of Risk Management
 them can risk lending to the others, which has resulted full value of a transaction that will produce results over
2 in a sudden drought in available credit with catastrophic
effects on business. Lenders whose business model
several years is fully accounted for in the first year and
there is considerable uncertainty about the actual (as
depended on the availability of cheap short-term finance opposed to the projected) outcome, reported results can
and the assumption that this would continue indefinitely be unduly flattering.
were in a very precarious position almost overnight.
What we can learn
Why did it happen? Before the current troubles, it was unthinkable that
Individuals are often driven more by their own interests old and respected City giants could fail, despite the
in a given situation than by the collective good of the collapse of Barings Bank in 1995. There has been
whole. The way that the City rewards its employees some suggestion that an answer to the current crisis
enforces this tendency, as a typical City reward system is to form a bank that is ‘too big to fail’. The collapse of
is based on a modest annual salary and an annual such giants as energy trader Enron and Barings should
bonus that may be a multiple of the salary depending on have weaned us off the idea that size is any predictor of
the organisation’s results. safety. If any organisation makes a sufficient number of
wrong calls it will collapse. The concept of ‘unthinkable’
It was in everybody’s interest in these organisations
is a very dangerous one.
that the annual results, as agreed by the auditors,
were as impressive as possible, hence the attraction The way that an organisation rewards its employees
of taking profits from loans in one financial year rather may have unintended consequences. If it is in the
than over the lifetime of the loan and making provision interest of individuals to find ways of portraying the
over time for defaults, which was possibly a more organisation’s results in a flattering light, they may do
prudent treatment. In fact, shortly after Swiss bank so if the personal rewards are great enough. Similarly,
UBS disclosed that it had some exposure to sub-prime it is important to understand what policies have been
lending in summer 2008, a commentator noted that applied in producing accounts, the implications of the
where the employees of an investment bank knew that policies and the potential distortions they introduce. A
a type of transaction would result in fat bonuses for four set of audited accounts is the product of some raw data
years and a crash in the fifth, the employees would take filtered through the organisation’s accounting policies
the fat bonuses – the crash would not be their problem. and subject to a number of opinions. It may appear that
everything in the garden is lovely, but some of the plants
The City is extremely aware of some risks, but possibly
may hide a snake.
insufficiently aware of others. For example, the
investment banks have extremely sophisticated software Risk culture is a very important safeguard against
for modelling market risk, but from the results that we collapse. This will be an interesting and on-going
now see, it appears that those who ultimately sanctioned challenge for the City. Is it acceptable to have an
the investment in the SIVs gave insufficient consideration approach to risk that gives great results for some years,
to the risk in the underlying asset. There has been some but puts the world economy to the sword as a result? Or
press commentary suggesting that risk management will it grasp the nettle and take a more holistic approach
departments were unhappy with the sub-prime deals, but to risk management? Probably, once the dust settles,
that the traders applied pressure to be allowed to make there will be calls for far stronger regulation. It is by no
markets in these products, and the traders won. means easy to see how regulation can be strengthened
effectively while still encouraging an appropriate level of
It is not an uncommon experience for risk managers
risk taking. The seeds of the next collapse are probably
to be over-ruled where it appears that there is a large
being sown in the technical department of a financial
profit to be made. If everything appears to be going
institution somewhere in the world at this very moment.
very well and large profits are being made, what
The problem is how to identify it?
could possibly go wrong? In these circumstances, risk
managers are regarded as party poopers, who would None of this is rocket science. Companies collapse
hamstring the organisation in its efforts to make money. for very prosaic reasons, and the reasons are often
The City is often seen as a young man’s environment very similar, irrespective of size. Some of the causes
– risk accepting and intolerant of nannying. Observers of failure of financial institutions are, in general terms,
have also noted a herd mentality – ‘everyone else eerily similar to that of Enron before them. It remains
is making money from this, why not us?’ The culture to be seen whether we will learn the lessons, or will we
prevalent in the City does not tend to encourage allow history to repeat itself?
excessive prudence.
The Financial Services Authority (FSA) is reported to be Pauline Bird MIRM is Senior Manager Business
unhappy about the way that mark to market accounting Restructuring Technical and Risk Management for
has been applied, and it is easy to see why. Where the accountants BDO Stoy Hayward.

The Institute of Risk Management www.theirm.org

CAMPARI on the Rocks
Andrew Chapman

It is difficult to comment on the current credit needed, although I knew some lenders were prepared
crisis and the risk issues that surround it without to lend up to 125% of the property value for a whole
variety of purposes.
3
appearing to be political, but I will try.
Amount – Many might recall that mortgage lenders
The first 26 years of my working life were spent in used to work on simple multipliers as a guide to the
banking. I worked in many different roles, but for many maximum they would lend. These used to be set at
of those years I was a lending manager. I will admit around three times sole income, or 2.5 times joint,
there were occasions when I got it wrong, but on the but over recent years these multipliers have become
whole I would like to think I got it right and helped many somewhat less restrictive. To borrow almost five times
businesses and individuals succeed. their income (much of which was indeterminable and
During most of that time, lending decisions were based unreliable) and almost the total value of the inflated
on a simple mnemonic, CAMPARI – character, ability, price of the house would seem to be bordering on
margin, purpose, amount, repayment and insurance, reckless. I again wondered to what extent this was
the latter referring to insurance in the broadest sense, influenced by the housing market boom.
as will be clearer later. These were described as the Repayment – This relied in the short term on a
canons of good lending. They provided the banker with government grant, earnings from part time employment
a tried and tested model for credit risk analysis, and and bonuses. In the longer term, it depended on my
helped ensure the correct risk/reward ratio. daughter securing full time employment on leaving
Over time analysts realised that many of the factors that university. Fortunately, the gamble paid off, but if it had
underpinned CAMPARI could in effect be scored, and not, I can only assume that the lender would have taken
so this model was gradually translated into what we comfort from the steadily increasing value of the property,
now call credit scoring. So how is it that what appears to once again relying heavily on the housing boom.
be a fairly robust model leads to irresponsible lending? Insurance – This really means security, and in this case
Good question, and one I have often asked myself. meant the house. If the borrower fails to pay, then the
In 2007, my daughter wanted a mortgage. Her fiancé lender seeks recourse to the security. Again, enormous
had had a job for a year or so, but she was still at emphasis was placed on the rising value of the asset,
university. To get the property they wanted, they needed so much so that, as you have probably guessed, the
to borrow almost five times their joint income, which mortgage was agreed on the spot, without a guarantee.
included her fiancé’s bonuses, her part-time income and
Poor pawn brokers
a government grant she received. My expectation was
that they would need dad’s guarantee to provide the How on earth did we get to this irresponsible
‘insurance’, as from my experience their request would credit culture? I feel certain that others would have
otherwise fail the CAMPARI test: been equally keen to lend to my daughter. Clearly
complacency set in, driven by greed, because of the
Character – They had no real track record, neither buoyant housing market. House prices were based on
of them had a credit card nor, indeed, any real credit demand fuelled by access to almost limitless credit. The
history. Also, the lender they had approached was high proportion of lending to value was not seen as a
neither my daughter’s nor her fiancé’s account holder. problem; indeed we know that 125% mortgages were
Ability – Quite correctly the mortgage adviser not at all unusual.
requested a detailed budget planner so that they could If you multiply my daughter’s experience many million
demonstrate that they could afford the repayments, times, you end up with a totally distorted market, where
but given the reliance on grants, part time work and profligate lending is the norm, which potentially has the
bonuses, affordability was at best questionable, even in makings of a global crisis.
the short term.
What does this say about how lending decisions in
Margin – This is very much about the risk/reward ratio. banking have changed and why they have been allowed
The actual reward was very modest since the mortgage to develop in this way? The fact is that the regulator,
products on offer were very competitive and therefore the Financial Services Authority (FSA), knew about the
had very fine interest margins, but on paper the risks problem even before taking responsibility for regulating
were massive. However, at this point the housing mortgage lending!
market factor seems to have started to cloud any
rational thinking. Addressing mortgage lenders in 2003, Philip Robinson,
a Director at the FSA1, used the CAMPARI model
Purpose – Mortgage lending for a house purchase to emphasise his misgivings about the state of the
would seem appropriate, a long term loan, for a long mortgage market. He expressed real concerns about
term purchase, and my daughter had no desire to sub-prime mortgages, the rate of growth in mortgage
borrow for any other purpose, or any more than was credit and too much emphasis on the current and future

www.theirm.org The Institute of Risk Management

 value of property. He likened their activities to pawn Clearly, the banks and building societies ignored the
4 broking, and clearly in that regard he was correct, albeit
hindsight has shown that they were very poor pawn
canons of good lending, and as a consequence some
very simple risk management principles. The regulator
brokers and should have stuck to banking. also seems to have abandoned basic risk principles.
The Government on the other hand may have had
His speech is quite prophetic and it is well worth reading
different motives for its inaction. What is evident is that
the full text. But despite these dire warnings, the
you abandon CAMPARI at your peril, be you a lender or
mortgage lenders failed to heed his advice and continued
a regulator!
as before. More worryingly is the apparent inaction of the
FSA given the evidence it had in its possession.
Andrew Chapman FIRM is Corporate Risk and Compliance
Why didn’t the Government intervene? The answers Officer at Anglia Ruskin University.
may be quite simple. Robinson also pointed out that
1 Robinson, Philip (2003). “The Mortgage Market and Credit Risk
consumers cashing in on the value of their properties Management”, CML/GEMI Credit Risk Management Workshop.
were supporting GDP growth. Another aspect to FSA [online] Available from: http://www.fsa.gov.uk/Pages/
consider is the contribution that banks were making Library/Communication/Speeches/2003/SP149.shtml
to the Treasury. In 2005, according to John Varley
2 Varley, John (2006) “Financial sector profits keep the balance
the CEO of Barclays2, the banking sector as well as of payment afloat”. Daily Telegraph online at : http://www.
contributing 7% to GDP, accounted for 25% of UK telegraph.co.uk/finance/2947053/Financial-sector-profits-keep-
corporation tax. Barclays alone paid £3bn in tax. the-balance-of-payment-afloat.html

The Naughty Years

Gerard Joyce

The first decade of the 21st century is not over capacity to repay in anything but a growing market. We
yet, but already the noughty years have become chose to forget the truism – Values can go down as well
‘the naughty years’, which sums up what can only as up. Has the constant repetition of this message at
be described (in risk management terms) as the the end of advertisements for financial products made
us oblivious to its significance?
tolerate years.
In my father’s time, you could only get a mortgage or a
Despite the warning signs of the Enron, Arthur Andersen loan if you could produce 20% of the money required to
and Tyco scandals and the dot.com bust, the nonsense purchase the asset. This was a good control. It meant
continued. Even the mighty US Sarbanes-Oxley served that the borrower had a history of saving and if the
only to fuel the compliance industry while being regarded borrower defaulted, the lender had a claim on an asset
as a spoil sport by some in the financial services sector. that was highly likely to cover the debt. These were
comfortable safety margins engineered in the same
With all the attention given to risk management since
way you would design safety into a machine that could
September 2001, one would think that this would have
physically hurt someone. And in a similar way, people
been a decade of risk management prowess. As a
forgot the reasons for the controls or believed them to
result of the introduction of risk management standards
be too restrictive and relaxed them... until something
and frameworks, such as A/NZ 4360, COSO, Basel II,
broke. The financial system that world economies are
etc, we had better tools to manage the risks. Financial
built on just broke!
regulators in the developed world were to be the
watchdogs and ensure that the financial community Risk management’s role in all of this
stayed within the boundaries.
Did risk managers tell their boards that they were sailing
So where did it all go so horribly wrong? Was it really into stormy waters? Are there many like Paul Moore,
the sub-prime market in the United States? That former Head of Group Regulatory Risk at HBOS, who feel
was certainly part of it, but not all of it. Allowing the that they were in a rowing boat trying to stop the tanker,
investment banks to leverage up to ratios of 30 or 40:1 when they really should have been the pilot employed to
is closer to the truth. And individuals are not totally steer the boat through a challenging course?
blameless; many borrowed sums that were beyond their

The Institute of Risk Management www.theirm.org

Could the errors made be somewhat explained by moral aligned with the organisation’s objectives. Without this
hazard. Were those who took the risks immune from
the consequences? Jérome Kerviel’s reckless trading at
alignment, there is a risk that too much energy will be
spent chasing risks of little consequence.
5
Société Générale was only one indicator of a systemic
The new definition of risk (ISO 31000 and its Guide
problem in the financial markets. How could he have gone
73) is “the effect of uncertainty on objectives”. This
undetected? He didn’t. The warning signs were ignored.
revised definition emphasises the effect of events on
Risk management controls are often perceived as the achievement of enterprise objectives and correctly
limiting; they are supposed to be. Over-riding the safety removes the focus from the events themselves. So you
controls on a cutting machine could cost you an arm or must define your objectives before you can begin to
a leg. Doing this in financial markets has had a similar identify and manage the risks to them.
outcome for many. When you leverage at a ratio of 40,
For example, if one of your objectives is to provide
the growth is huge on the way up and the fall is steep
the best and most innovative financial services to
on the way down.
customers, then you must measure what might be lost
The truth is that risk management is only now coming if you fail to achieve this objective – your customer
of age. For years risk managers have been pushing retention rate. This is an accurate measure of your
the elephant up the C-suite stairs. The professional risk performance in the achievement of this objective.
manager wants or wanted to do the right thing for all the
For each objective you need to identify what matters
right reasons, but often was seen, and used, to ensure
and measure it. If you can measure it, you can put a
that the enterprise was ‘compliant’ with all relevant
number on what your tolerance is: what level of loss
laws and regulations – a box ticking exercise and an
the organisation can sustain before it begins to hurt.
ineffective use of a valuable resource.
All employees at all levels need to understand what
Laws and regulations are by their nature generic level of risk the organisation is willing and able to bear
and only define the minimum standard required. and when limits are approached, appropriate corrective
What risk management seeks is a maximisation of action should be a natural response.
opportunity while minimising the downside. This is a
giant leap beyond the line of compliance and where risk Principles
management belongs. The new standard suggests several principles that should
Risk management did not fail. Organisations failed in be adhered to if an organisation’s risk management is to
their implementation of risk management. Mostly the be most effective. Risk management should;
failure was in the way responsibility was delegated • create value
to a few individuals, but the authority to cry “stop” lay • be an integral part of organisational processes
elsewhere. Risk manager is an unfortunate title as it • be part of decision making
conveys the impression that this person can manage • be systematic, structured and timely
all the risks an organisation faces. Everyone is a risk • be tailored (to the context)
manager – or should be – and organisations need • be dynamic, iterative and responsive to change
risk officers to direct and embed a culture of risk Many leaders of financial institutions claimed not
management. Realising that the leveraged growth to have known the extent of the exposure their
model was unsustainable, some risk managers treated organisations faced. Incredible! Would you drive
the risk and exited the highly leveraged products. When a car at 100mph without knowing that the brakes
the dust settles, they will emerge as survivors, the first work? Informed decision making is core to effective
rocks to appear when the swamp starts to drain. risk management. Complex financial products and
The way forward arrangements must be matched with appropriate
management information systems. In this 200th
The significance of risk management has prompted anniversary year of the birth of Charles Darwin, it
rating agencies, like Standard and Poor’s, to enhance seems appropriate to quote him: “Ignorance more
their ratings process through a risk management review. frequently begets confidence than does knowledge”.
They view enterprise-wide risk management as an
approach to assuring the firm is attending to all risks, If we are to recover from this current crisis, then trust
while setting clear expectations about which risks the must be restored. Big time. Greater transparency must
firm will and will not take. be achieved. Good risk taking must be rewarded and
reckless behaviour must be punished. Focus on long
The planned release of the ISO 31000 risk term shareholder value must return. Stop looking at the
management standard this year comes at a time when share price every five minutes! Top executives should be
a new approach is required and renewed energy to rewarded by what they achieve over three or five years,
appropriately and effectively manage risks must be not three months. Stakeholder theory and no longer
found. To be effective, risk management must be principle-agent theory should drive corporate governance.

www.theirm.org The Institute of Risk Management

 Employees, customers, suppliers and the community perhaps the next decade will be known as the Terrific
6 have also invested in organisations, and it is time
that the organisations recognise that their needs
Teens, led by informed risk taking, where stakeholders
who engage in the risk are bound to the consequences.
and expectations must also be considered when key
decisions are made. Enterprise risk management
recognises all stakeholders and places appropriately Gerard Joyce MIRM is a director of LinkResQ and
high emphasis on communication. Perhaps 2009 will Chairman of the National Standards Authority of Ireland
be the year when risk management comes of age and Consultative Committee on risk management.

Three Opportunities for Risk Management

Clive Thompson

How on earth did it happen: a house is Some banks correctly assessed the risks to their
repossessed in West Virginia and the global own portfolios, but they had insufficient information to
financial system falls down! identify the tsunami effect on the system which would
strike from September 2008.
• Was it a weakness in risk management? Some banks tried to take action to mitigate their
• Can we make sure it never happens again? exposure, but they could not transfer the impact of the
• Are there any opportunities for risk management system crashing. In effect, banks which took action
to grasp? were playing pass the parcel without leaving the room
In this paper I intend to argue the answers to those when the final unwrapping revealed an exploding bomb!
questions are No, No and Yes, this crisis will reveal Those banks which were observed in March 2008
opportunities for risk management. They will flow demonstrated the following:
from the need to increase transparency for external
investors, to support governance structures better
Best Practices Poor Practices
and to provide proof of professional risk management
application through academic qualification – the IRM Sharing information Business areas making
International Diploma. freely and proactively decisions in isolation,
But first, it is important to knock down any arguments that across businesses with failing to see the full picture
risk management got us into this mess, why it couldn’t be procedures for senior level (incomplete information)
avoided and why it will inevitably happen again. challenge/action

Was risk management to blame? Consistent, independent Over-reliance on credit

validation and measurement agency risk scoring, failing
Well, it was forecast. Regulators warned against over- of risk – or how risk profiles to challenge established
extending credit lines in 2005, 2006 and 2007. They knew would change under practice
the US tax system encouraged taking out loans and even challenging scenarios
rewarded top up mortgages which, as ‘silent second
liens’, the original lender knew nothing about. There was Managing risk by Failing to access
data in 2006 to suggest defaults were on the increase1. incentivising business information across the
Houses were being bought by people who were virtually lines to reflect the actual organisation thereby unable
guaranteed to be in negative equity 12 months after risk in their activity through to align their risk to their
moving in. And the US legal system incentivises borrowers internal pricing capital or liquidity positions
to just ‘hand back the keys’, increasing the risk of default.
Using qualitative Using outdated, static or
There is evidence that participants did apply risk assessment to gain insight inflexible assumptions which
management and that they identified the threat. This by means of flexible and lacked perspective into the
comes from studies of how 11 major banks reacted to dynamic risk scoring true nature of the risk
the initial shock and turmoil in financial markets in 2007, processes
released in March 20082.

The Institute of Risk Management www.theirm.org

This last point needs to be highlighted. Risk priced risk. Theoretically, long waves of economic
professionals brought their own ideas and challenge
to the data. Poor practice followed and established,
activity occur every 40 to 80 years: severe downturns
occurred in 1790, 1840, 1890, 1929, 1973, and now5.
7
almost tick box procedures.
A downturn every so often is necessary if we are
We can all learn from the ‘genuine surprises’ that to experience growth. The economy will eventually
regulators observed3: recover but future reverses will happen. The key is for
• The speed with which the banks were affected and regulators to identify and apply corrective measures in a
the way the crisis spread so severely to all parts of timely fashion to minimise the impact.
the globe were unexpected. The inter-linkage and
Regulation
global nature of business introduce a level of fragility
which should be catered for. The nature of regulation will change due to this crisis. I
• The role of securitisation was seriously under- think regulators could force through ‘regime change’:
estimated along with its impact on cash. It is very • Basle II could be re-drawn. The techniques where
unlikely that financially engineered products will be banks assess risks themselves and use credit
embraced in the foreseeable future. rating agencies to support their assessment have
• The weakness of capital cushions was a shock; both been found wanting6. Securitisations will be
the models used only limited data when a longer monitored more closely and risk managers will need
perspective may have revealed concerns. Use as to show regulators they are used to address risk
much data as possible. profiles responsibly in future.
I question if individual institutions could or should have • Banks could be forced to build up capital and liquidity
been aware of these issues and if they were whether buffers in good times so as to have better cushions
there was any action they could have taken, other then in bad times to avoid excessive procyclicality (the
closing down and returning shareholders’ funds. Banks cycles described above). This will affect both state
operated within the rules laid down for the “system” which owned and independent banks and has significant
encouraged thin capitalisation (hence securitisation) and implications for the cost of capital for all.
rating agency scoring among other problems. • Risk management in financial institutions will become
more transparent. Regulation will demand banking
I discuss later how I think regulation of financial markets products undertake rigorous risk analysis. The risk
will change and how I believe this will not only affect our analysis techniques they develop may themselves
banks but could have a creeping effect on the way we seep out to the wider community, and indeed risk
all do business, and hence manage risk. managers have tremendous opportunities as a result
of this crisis.
Can we make sure it never happens again?
We live in an increasingly regulated world and if certain
The financial system is unique. It needs ‘faith’ to thrive,
organisations cannot be allowed to fail and if the
and perception causes cycles of behaviour for markets to
taxpayer provides the safety net, then regulators have a
act in a positive or negative manner. Currently the Bank
duty to impose themselves much more in the intricacies
of England is desperately trying to avoid negative cycle 4:
of the system – and the state could legitimately take a
wider role in economic activity. Increasing regulation will
Risk and the Financial Crisis
bring new risks, and costs.
In a global system, organisations can choose where
to operate and how they are regulated. Global
development is happening in China and the Far and
Middle East where the state already plays a much
greater role in economic activity and remained relatively
unscathed. These countries do not participate in the
way we currently regulate our systems, but they are
being asked to help in the bail out. This dilemma will
probably be addressed in the next five years.

Three opportunities for risk management

(Source: Speech by Sir John Gieve, Deputy Governor of the External validation
Bank of England, to the Family Office Leadership Summit,
Companies will increasingly have to demonstrate
London, 22 September, 2008)
robustness in risk processes and procedures so
The reverse took place in the lead-up to 2007: over- that they can persuade investors of their worth. Risk
extended credit, over-inflated asset prices and under- officers can provide investors with a real sense of the

www.theirm.org The Institute of Risk Management

 uncertainty surrounding the activities the organisation The IRM has grasped this challenge early by launching
8 undertakes; the rating agency Standard and Poor’s now
includes enterprise risk management measures as a
a graduate level International Diploma in 2007. We
need to keep developing the Diploma’s syllabus to
feature of its scoring methodology. include learning from events, such as the financial
crisis, and to embrace advances in risk management
Statutory reporting is likely to become more frequent,
that will evolve over the coming years.
albeit with shorter reports concentrating on risk metrics.
Those metrics will be forward looking measures of
the uncertainty surrounding future events and will be Clive Thompson FIRM is Project Director for Willis UK
transparent. Risk management has the opportunity to and Ireland.
develop these tools and techniques to bring clarity to the
information available about risk profiles of companies. (Endnotes)

1 Bank of International Settlements, working papers no 259,

Internal support “The housing meltdown: why did it happen in the United
Board members will cry out for internal resource to States?” Ellis, September 2008. This refers to the 60% to 75%
stand apart from business lines and alert them to their of securitised mortgages in 2007 which were self certified, to
risks, for instance, that suddenly successful business teaser rates which were 3% to 4% cheaper for the first period
and to negative amortisation loans which were offered where
lines are precisely those which bring the greatest initial payments didn’t even need to meet the interest payment
uncertainty. Risk management will need to verify such
uncertainties independently. New ventures need to be 2 Senior Supervisors’ Group, “Observations on Risk Management
Practices during the Recent Market Turbulence” March 6, 2008
subjected to appropriate opportunity risk management
techniques developed by risk officers7. 3 Malcolm Knight, General Manager of the Bank of International
Settlements, “Now you see it, now you don’t: the nature of risk
Organisations will need to show their pay structures and the current financial turmoil”, speech delivered at the Ninth
deliver risk-adjusted rewards in future, particularly in Annual Risk Management Convention of the Global Association
financial organisations8 Risk officers are best placed of Risk Professionals, 26-27 February 2008.
to support remuneration committees in strengthening 4 Speech by Sir John Gieve, Deputy Governor of the Bank of
incentives to behave prudently. England, to the Family Office Leadership Summit, London,
22 September, 2008
Professional qualification 5 Smith, Marx, Kondratieff and Keynes, R.L. Norman, found at
To perform these functions effectively, indeed to http://www.southerndomains.com/SouthernBanks/ (10 Dec 2008)
become what I have alluded to as a risk officer, will 6 Wade, R (2008): “The first-world debt crisis of 2007-2010 in global
require someone who can gain respect and so exert perspective”, Challenge, vol 51, no 4, July/August, pp 23-54
influence with fellow workers. The best way to do 7 Refer to IRM’s Special Interest Group for Innovation, Value
this is to be practical but also to have a theoretical Creation and Opportunity. The author has benefitted from
understanding of risk and demonstrate academic the input of the core team and particularly Mark Boult, whose
achievement so that there is a ready agreement to comments have been very helpful.
the individual’s knowledge and understanding of the 8 See Letter from FSA to CEOs 13 October 2008 subject:
principles and practices surrounding risk. Remuneration policies

Institute of Risk Management Networking opportunities for those with a risk-related qualification, up
• Membership of any of the special interest to full Member and ultimately Fellow. Simply
Membership provides you with information, groups you want to join complete and return the application form from
our website (www.theirm.org) or phone us on
networking opportunities and recognition. • Membership of your local regional group +44 (0)20 7709 9808 to join.
Become a member and you get all the • Free annual lecture and other events focussing
following included in your subscription: on the topical issues in risk management The Institute provides a broad range of
courses to help you build your knowledge
• Discounted entry to the Risk Forum, the and skills. The International Certificate in Risk
Information Institute’s annual conference and dinner Management is an introductory qualification,
• The Institute’s magazine with a weekly with no entry requirement, which is studied
e-supplement containing news, articles and Recognition through distance learning.
job vacancies • The opportunity to study for an internationally
recognised risk qualification The International Diploma in Risk Management
• Free subscriptions to risk-related magazines is the postgraduate qualification for the risk
• Discounts on relevant activities such as • Designatory letters according to your management professional. It is designed
conferences and events from third parties membership grade to equip today’s practitioners to become
There are various grades of membership the risk managers of tomorrow, through the
• Unlimited access to the Institute’s online
starting with Affiliate, which has no entry development of a solid, progressive and
Risk Library
requirements and is open to everyone with an practical set of skills which in turn enhance
interest in risk management, through Specialist, career portability, personal status and reward.

Disclaimer: the opinions expressed in this publication do not necessarily reflect those of the IRM

The Institute of Risk Management www.theirm.org