Financial Bankers: How Risk-Tolerant Are They?

With the near collapse of the financial system in October of 2008, financial bankers have had to do an assessment of their understanding and appreciation for risk and risk exposure to their clients.  The failure of several prominent banks and Wall Street firms and the near collapse of the world’s largest insurance company, AIG, sent a wake up call to the industry regarding a banker’s role as a risk manager.

Risk Tolerance

Risk tolerant measures the level of comfort a person, or institution such as a bank, has toward the varying degree of risk or volatility in the market.  There is a basic principle on risk as it relates to the amount of return or reward received. The greater the risk that a person is willing to take (which is the opportunity to lose everything or volatility) the greater the return or reward. Bank’s tended to be more conservative with respect to their approach to risk but as the lines of delineation between commercial banks and investment banks blurred, many banks found it appropriate from a business standpoint to increase their risks in order to remain competitive.

The Role of Risk Management in Banking

People assume a certain level of risk to be associated with their money; however when it comes to their banking relationship, their assumption is that my money is as safe their as if it were being kept under their mattress.  The banker took the responsibility of using proper risk management tools to assess the appropriate level of risk that was prudent for a give customer.

With the growth of exotic investment products and the entry of banks and insurance companies into areas traditionally only engaged in by investment banks and broker-dealers, soon the traditional banking risk model gave way to a casino-like culture of fast money that contributed in part to the near collapse of the financial sector.

Enhancements to the Risk Management Process

There are enhancements being contemplated to the risk management system to make more difficult for banks to engage in the types of risky behaviors that led to the near collapse of the financial system and massive bailouts that have since ensued. It is a fine balancing act for the government to pursue because on the one hand, a free economy requires a need for risk taking and innovation; however, not to the detriment of the public’s faith and confidence.

The failure of several banks due to their lack of proper risk management controls provide us with an excellent opportunity to set aside partisanship and work to ensure that the crisis that almost became an economic disaster does not occur again in our lifetime or that of our children.