The trigger of the crisis: Sloppy risk management?

Risk management is a systematic process of identifying and assessing company risks and taking actions to protect a company against them.” (Reference for Business)

In his previous blog post “Anticipating risks in 2011… but can we?bravenewloock emphasized how important it is for businesses to identify their risks. Following up on this post, I will take a look on how the attitude towards risks before the financial crisis played a major role in the latest economic downturn.

Being the first step towards risk management the identification process leads to anticipating the possible impacts some of these risks might have. As a last step, a company needs to find some measures of protection against those impacts. (Müller, 2010)

What did particularly banks do to reduce risks or “hedge” their business?

Risk Map 2007

Risk Map 2007

Let’s go back to the year 2007: In January a similar global risk map, as introduced by bravenewloock in his previous post, was published by the World Economic Forum.

As you can clearly see, one of the biggest expected risks was the Asset price collapse.

This should have had the banks thinking of how to prepare for the worst, to survive it.

The article “Eggheads and long tails”, published by the Economist on May 17th in 2007, describes – despite being a bit skeptical about their functionality – some of the great risk management systems put in place by the big investment banks.

This is all nice and it seems the banks did actually prepare for some of the risks they might face.

But not the occupation of some risk managers or mathematicians who calculate the risks were the biggest part of the banks risk management system.

Instead, they just introduced new financial vehicles, as described in this article on stock-market-investors.com.

Banks pooled the highly risky mortgages into securities, which have been sold to investors, who then could resell them, and so on. The clue about this system is, that through the pooling of many mortgages into one security, these securities were highly diversified and could come clean on their Risk rating. Additionally, the risk has been spread through the whole financial system.

A British Banker “compares the process of transferring risk around the financial system to spreading butter on toast. With luck, he says, the butter will not be rancid.” (Economist)

Now, in 2011, we know how high these risks have been. In my opinion, the attitude towards rather earning more money with taking more risks than securing their business is one of the most important triggers for the current economic (not only financial) crisis.

The question is: Did the world learn to take risk maps more seriously, try to assess the possible impact of those risks and anticipate to them?

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3 Responses to The trigger of the crisis: Sloppy risk management?

  1. olexa5 says:

    I love the ‘spreading butter’ quote and I will keep that one in mind.

    Referring to mathematical risk management systems, I’m starting to think about them from a different perspective. I find it not that hard to believe that the reliability the world developed towards them, also has a downside.
    The question is: What happenes with our so called gut feeling during this process.

    I think risk maps are definitely not taken seriouse enough. They are probably one of the best methods to develop an overall feeling for the environment and its risky factors and so they can be actual helpful when reviving our natural sense for risks behavior.

  2. Pingback: Germany at the risk of being raided | BraveNewFinance.

  3. stuerzele says:

    Thank you for your opinion on this. I agree, the basic instincts of people get lost by all those mathematical approaches.

    Now, I found a youtube video explaining the latest measure by the World Economic Forum to rise responsiveness to risks all around the world: A risk response network.

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