FINANCIAL CRISIS
FINANCIAL CRISIS: WHERE DID RISK
MANAGEMENT FAIL?
Gabriele Sabato
Royal Bank of Scotland1
Abstract
The real estate market bubble and the subprime mortgages have been often identified as the causes of the current financial crisis, but this is not entirely true or, at least, they cannot be considered as the main cause. A poor regulatory framework based on the belief that banks could be trusted to regulate themselves is among the main sources of the crisis. At the same time, risk management at most banking institutions has failed to enforce the basic rules for a safe business: i.e., avoid strong concentrations and minimize volatility of returns.
The purpose of this study is to identify the reasons behind the risk management failure and offer a view on how they can be solved or improved going forward if we want to ensure a sounder financial system than today’s one. In particular, I examine the following issues: 1) lack of a defined capital allocation strategy, 2) disaggregated vision of risks and 3) inappropriate risk governance structure.
JEL classification: G21; G28
Keywords: Financial crisis; Capital allocation; Enterprise risk management; Banks’
1 The material and the opinions presented and expressed in this article are those of the author and do not necessarily reflect views of Royal Bank of Scotland. E-mail address: gabriele.sabato@rbs.com
Tel.: +31 6 51 39 99 07. Address: Group Credit Risk, Paasheuvelweg 25, (BT3345), 1105BP
Amsterdam, The Netherlands.
Electronic copy available at: http://ssrn.com/abstract=1460762
2
1. INTRODUCTION
When examining the causes for the financial crisis, most people start directly with the real estate market focusing on the subprime mortgages and unscrupulous lenders and casting the blame on the unsustainable real estate bubble which began to collapse in
2006. Whereas this is true, it is not the whole story. A poor regulatory framework based on the belief that banks could be trusted to regulate themselves
MANAGEMENT FAIL?
Gabriele Sabato
Royal Bank of Scotland1
Abstract
The real estate market bubble and the subprime mortgages have been often identified as the causes of the current financial crisis, but this is not entirely true or, at least, they cannot be considered as the main cause. A poor regulatory framework based on the belief that banks could be trusted to regulate themselves is among the main sources of the crisis. At the same time, risk management at most banking institutions has failed to enforce the basic rules for a safe business: i.e., avoid strong concentrations and minimize volatility of returns.
The purpose of this study is to identify the reasons behind the risk management failure and offer a view on how they can be solved or improved going forward if we want to ensure a sounder financial system than today’s one. In particular, I examine the following issues: 1) lack of a defined capital allocation strategy, 2) disaggregated vision of risks and 3) inappropriate risk governance structure.
JEL classification: G21; G28
Keywords: Financial crisis; Capital allocation; Enterprise risk management; Banks’
1 The material and the opinions presented and expressed in this article are those of the author and do not necessarily reflect views of Royal Bank of Scotland. E-mail address: gabriele.sabato@rbs.com
Tel.: +31 6 51 39 99 07. Address: Group Credit Risk, Paasheuvelweg 25, (BT3345), 1105BP
Amsterdam, The Netherlands.
Electronic copy available at: http://ssrn.com/abstract=1460762
2
1. INTRODUCTION
When examining the causes for the financial crisis, most people start directly with the real estate market focusing on the subprime mortgages and unscrupulous lenders and casting the blame on the unsustainable real estate bubble which began to collapse in
2006. Whereas this is true, it is not the whole story. A poor regulatory framework based on the belief that banks could be trusted to regulate themselves