Managing Extreme Financial Risk

Section 1: The Need for a New Approach to Tail-Risk Management

Chapter 1. Sustainability Management is Critical

Abstract

1.1 Disciplined Emphasis on Protection from Extreme Operational Risk

1.2 No Similar Emphasis on Protection from Extreme Financial Risk

1.3 Absence of Objective Parameters Accounts for the Lack of Proactive Emphasis

1.4 Do Regulatory Requirements Address Effective Management of Tail Risk?

1.5 Stress Testing

1.6 Living-Will Provision

1.7 Liquidity Reserves

1.8 Going-Concern Management and Tail Risk

1.9 Is the Need For Tail-Risk Management New?

Chapter 2. Tail Risk is the Culprit: Tail Wagging the Dog?

Abstract

Prologue

2.1 Credit Policy: A Watchdog Function without Any Glamor

2.2 Credit Policy Role at Continental Bank

2.3 Evolution of Revenue Models and the Watchdog Function

2.4 Could the Problems of 2008 Have Been Avoided?

Epilogue

References

Chapter 3. Need for a Distinct Focus on Tail Risk: In No Uncertain Terms

Abstract

3.1 Why a Distinct Approach?

3.2 Effective Management Calls for a Distinct Focus on Sustainability Issues

3.3 Sustainability Management Needs Distinct Parameters

3.4 Three Distinct Legs of Risk Governance

3.5 Is the Sole Focus on Risk Management Prudent?

Chapter 4. Sole Focus On Traditional Risk Management Can Be Dangerous: Days of Future Passed

Abstract

4.1 A Mature Industry

4.2 A New Driver of Revenues

4.3 Days of Future Passed

4.4 And Then a Blind-Side Blow

4.5 A False Sense of Security

4.6 Misplaced Use of Models

4.7 Missing Focus on Tail Risk

4.8 Regulatory Emphasis Encouraged Improper Use

4.9 Sole Focus on Traditional Risk Management—Driven By Statistical Models—Can Be Misleading

References

Chapter 5. Usefulness and Limits of Quant Models

Abstract

5.1 Chaos Theory Given Assumption of Normality

5.2 Chaos Theory Given Assumption of Extreme Crisis

References

Section 2: Elements of Sustainaliblity Management

Chapter 6. If you Can’t Measure it, You Can’t Manage it: Taming Something That’s Lurking Around

Abstract

6.1 Prerequisite to an Effective Management Process

6.2 An Example

6.3 You Can Manage Exposure from Tail Risk Only if you can Measure it

Chapter 7. Simplicity to Counter Complexities of Revenue Models

Abstract

7.1 Decision Making Enhanced by Advances in Technology

7.2 Despite Technology and Quant Advances Human Decision Making Remains Simple

7.3 Decisions Regarding Unquantifiable Uncertainty Require A Different Approach

7.4 The Need for Simplicity is Critical In Complex Models

7.5 Post-2008 Developments Have Increased Complexity

7.6 A Simple Measure is Needed as Responding to Complexity with Complexity is a Recipe for Disaster

References

Chapter 8. A New Measure for Effective Sustainability Management: Probable Maximum Loss

Abstract

8.1 A Simple Measure to Gauge the Sustainability of a Complex Model

8.2 PML, As a Measure of Exposure from Extreme Tail Risk, Has Several Advantages

8.3 PML Provides a Solid Tool for the Effective Management of Tail Risk

Chapter 9. Continuous Readiness is Critical: A senior executive who wishes to remain anonymous

Abstract

9.1 Plans Are Useless, Planning is Indispensable

9.2 Readiness Defined

9.3 Degrees of Readiness

9.4 Ready Intellectually and Emotionally

9.5 Ready Intellectually, but Not Emotionally

9.6 Ready Neither Intellectually, Nor …

References

Section 3: Implementation Issues and the Wide-Reaching Impact on Institutions and the Financial System

Chapter 10. Effective Sustainability Management: From Top to Bottom

Abstract

10.1 Key Parameters to Drive Risk Governance

10.2 PML as a Measure of the Extreme Exposure Parameter

10.3 Effective Tail-Risk or Sustainability Management

10.4 Effective Sustainability Management to Protect Capital

Chapter 11. Paradoxical Capital Problem

Abstract

11.1 The Need for a Bigger Cushion is Real Because of the Increased Pressure on Capital

11.2 Increased Capital Solutions are Not Sustainable

11.3 Increased Capital Solutions are Not Realistic

11.4 A New Approach to Addressing the Need for a Bigger Cushion is Required

11.5 Sustainability Management Offers a New Solution by Alleviating the Pressure on Capital

11.6 Another Reason for a New Approach

11.7 A Change is Needed in How Capital is Deployed

References

Chapter 12. Capital as the Last Defense vs the First Defense

Abstract

12.1 More and Stronger Defenses Mean Less Pressure on Capital

12.2 Sustainability-Enhancement Programs

Chapter 13. Tail Risk, Regulatory Supervision, and Systemic Risk: Missing Links

Abstract

13.1 Regulatory Objectives

13.2 Institutional Response

13.3 Reconciling Objectives

References

Chapter 14. Convergence of Regulatory Objectives and Institutional Interests: Alignment of Goals to Enhance Sustainability and Reduce Systemic Risk

Abstract

14.1 Apparent Conflict

14.2 The Challenge

14.3 Convergence towards Common Goals

14.4 Reduction of Systemic Risk

Chapter 15. Telling Your Story Effectively to Alleviate Marketplace Anxiety

Abstract

15.1 High Level of Anxiety

15.2 A New Approach to Communicating Tail Risk Is Needed

15.3 Reducing Anxiety, Building Greater Confidence, and Adding Shareholder Value

15.4 Objective Public Policy Debate

15.5 Too Complex to Manage?

Chapter 16. Critical Factors in Preparing for an Extreme Financial Crisis: A former senior executive who wishes to remain anonymous

Abstract

16.1 AIG Timeline

16.2 Key Observations

16.3 Sound Human Judgment, Not Rocket Science

16.4 Readiness at the Senior-Most Level

16.5 Simplicity to Counter Complexities and Maintain Control

16.6 Conclusions

Chapter 17. From the Bane of the Revenue Model to a Competitive Advantage

Abstract

17.1 The Bane of a Financial Institution’s Revenue Model

17.2 Urgent Need for Proactive Tail-Risk or Sustainability Management

17.3 Proactive Tail-Risk Management Enhances the Ability to Respond to Crises

17.4 Effective Sustainability Management Leads to Many Significant Advantages

Chapter 18. Adapting Organizations to Effective Sustainability Management

Abstract

18.1 Organization Focus

18.2 Implementation

18.3 Conclusion

Epilogue

Appendix. The Wall Street Journal

The Fed’s Stress Tests Add Risk to the Financial System