Risk Management

Everyone has an intuitive definition of risk (or at least they should!), and it probably goes along the lines of the chance of something bad happening. But try to pin the concept down more carefully, in a prescribed context and defined circumstances and quickly something uncomfortable transpires. When looking up more formal and precise meanings of the term Risk we are confronted with a surprising situation. There is no satisfying and authoritative general purpose definition that we can adopt without second thoughts. In fact, various definitions in use appear to be wildly different, and some are even essentially wrong.[1]

What is going on?

Making Open Risk Data easier

In an earlier blog post we discussed the promise of Open Risk Data and how the widespread availability of good information that is relevant for risk management can substantially help mitigate diverse risks.

The list of Open Risk Data providers, particularly from public sector, keeps increasing and we are aiming to document all available datasets in the dedicated page of the Open Risk Manual.

The integration of climate risk and broader sustainability constraints into risk management is a monumental task and many tools are still lacking. Yet there is strong support and bold initiatives from policy bodies and an increasing focus from the private sector side.

What is a Risk Taxonomy?

There are various formal definitions of risk taxonomies (and we will go over those below), but it might be useful to first look at a very intuitive example of a risk taxonomy: the classification of fire hazards (also known as fire classes)

Limit frameworks are fundamental tools for risk management

A Limit Framework is a set of policies used by financial institutions (or other firms that actively assume quantifiable risks) to govern in a quantitative manner the maximum risk exposure permitted for an individual, trading desk, business line etc.

Credit Portfolio Management in the IFRS 9 / CECL and Stress Testing Era

The post-crisis world presents portfolio managers with the significant challenge to assimilate in day-to-day management the variety of conceptual frameworks now simultaneously applicable in the assessment of portfolio credit risk:

• The first major strand is the widespread application of regulatory stress testing methodologies in the estimation of regulatory risk capital requirements
• The second major strand is the introduction of new accounting standards (IFRS 9 / CECL) for the measurement and disclosure of expected credit losses While both Regulatory Stress Testing and IFRS 9 / CECL accounting require investment in analytic capabilities and provide unique new insights, both are aimed at satisfying evolving prudential or investor disclosure requirements. Neither is designed to help credit portfolio managers analyse and steer their portfolios in the bottom-up fashion that is an essential part their mandate.

The above developments are overlaid into pre-existing conceptual and practical frameworks such as

The Data Privacy genie is out of the bottle

From Yahoo’s massive email data leaks, to Equifax’s exposing of sensitive data for a large segment of the US population, to Apple’s resisting the bypassing the security features of the iPhone, not a week goes by without some alarming piece of news around data privacy.

How to Stress Test Financial Weapons of Mass Destruction

In recent decades we have been collectively spared the haunting images and existential anxiety provoked by the sight of detonating nuclear weapons for testing purposes - not to mention the increased levels of radiation in the atmosphere and other side-effects. This achievement is largely thanks to a series of treaties to control nuclear bomb testing that have been signed and enforced by most (unhappily not all) countries worldwide.

The Promise of Open Risk Data

There is a legend that every time a data set is released into the open, somewhere dies a black swan

Well, it is not a true legend. Legends take centuries of oral storytelling to form. In our frantic age, dominated by the daily news cycle and viral twitter storms, legends have been replaced by the rather more short-lived memes and #hashtags.

Seeking clues for financial stability from quantum physics

How physicists discovered why the world is stable

Physics is one of those remarkably successful branches of science that have helped shape the modern era. Let your gaze drop on any man made gadget in your surroundings and its likely that its working principles go back to a fundamental discovery in physical science that dates back no more than two hundred years or so.

If banks were airlines

Ever since the scary turbulence of the Great Financial Crisis it has been instructive and illuminating to compare the travails of the financial industry with the state of other industries, especially those more down to earth, also known as real world industries.

Fintech Risk Events

Fintech Risk Events is an open catalog of observed and publicized operational failures of fintech business models. The catalog aims to document, in due course, such events reasonably accurately, to allow risk managers understand the ( potentially new) vulnerabilities of new financial services models.

Scope

The scope of the operational risk database is Fintech companies. By that we mean newly established financial services providers that operate exclusively via new (digital) platforms and are (mostly) unregulated. The fintech sector is distinct from established financial services firms that operate with a mix of technology platforms and are (mostly) regulated.

The Atlas was discovered recently in archaeological work studying pre-crisis civilizations. Despite the obvious wear and tear, all key risk failure areas have been preserved. We note the remarkable diversity of organizational forms and economic structures. Most interestingly, there is even an uncharted territory that was rumored to be inhabited by black swans.

ΝΒ: This is not a post about real whales and the ongoing struggle to keep these magnificent mammals alive for future generations to marvel at. Hopefully the individuals who have risked their lives to bring the near extinction of many whale species to worldwide attention will not take offense with us usurping imagery linked to this valiant campaign. We simply want to draw attention to another, rather more armchair type of campaign, namely: saving the_AMA risk model. A bit more esoteric as a cause, but ultimately a good cause nevertheless_

In finance, it’s the best of times, it’s the worst of times

It is a special moment to start a career in financial services. We are walking amid the ruins of the previous financial order. Fallen banks, broken markets, negative interest rates, shell-shocked economies and discredited theoretical assumptions. We see the enormous cost and impact to the welfare of society of a less than perfect financial system which has not kept pace with the advancement of our general knowledge and technical capabilities in most other domains.

Open Risk White Paper 7: Risk Capital for Non-Performing Loans

We develop a conceptual framework for risk capital calculation for portfolios of non-performing loans. In general banking practice, loans that pass a threshold of delinquency are declared non-performing and are provisioned. Yet there is a residual risk that the provisioning is not sufficient. This risk must be covered by capital buffers. The literature for risk capital requirements for NPL portfolios is very limited, which implies that Stress Testing and Internal Capital Adequacy Assessment (ICAAP) requirements for non-performing loans are harder to meet. Our framework builds on tools used in portfolio credit risk modeling and provides a structured approach to address the risk profile that is specific to non-performing loans.

A stress testing methodology for analyzing FX lending risk. The methodology extends standard credit risk modelling tools to capture the increased risks of FX lending in a consistent way

Open Risk White Paper 6: Stress Testing Methodology for FX Lending

We develop a simple methodology for stress testing portfolios of credit instruments classified as foreign exchange lending. Loans whose repayment schedule is denominated in a currency other than that of the borrower’s domestic currency are commonly seen in many jurisdictions and have a risk profile that is considerably more complicated than domestic currency loans. Yet the literature for credit risk assessment and stress testing of portfolios of such loans is very limited, which means that Stress Testing and Internal Capital Adequacy Assessment (ICAAP) requirements are harder to meet. Our methodology builds on existing standard tools used in portfolio credit risk modeling and enables obtaining insights into the additional risk factors embedded in foreign currency lending.

Business Model Risk - The Forgotten Risk Type

Sustainable business models that demonstrate adequate profitability over long horizons are key to a healthy market economy. This applies to firms and organizations of any size and in any sector. But how do we determine what is sustainable and how can we tell a risky business structure from a stable one?

Open Risk White Paper 5: Identification Framework for Business Model Risks

We develop an analytical framework for the systematic identification of business model risks. The framework utilizes as a starting point a simplified business model schema known as the Business Model Canvas. We review each one of the elements of the schema in turn, identifying the main risk characteristics associated with each.