Subprime crisis exposes deficiencies in risk management globally

The recent crisis in the subprime lending market exposed structural deficiencies in the financial system globally, particularly around the area of risk management, finds a new report.

New research finds that many financial institutions continue to view and manage risk in the traditional fashion - as a threat that may bear a negative impact in the future. Lacking a more comprehensive, proactive and integrated view of risk, many institutions mandate narrowly-focused risk control and mitigation strategies, and then overreact when unforeseen or damaging events arise.

The report finds that in today's changing world, most financial services institutions are predominantly risk averse. But as the balance between product mix and capital adequacy shows greater variance, business models are becoming noticeably polarized - with progressive institutions understanding and managing risks and financials more holistically.

Guillermo Kopp, executive director and global research fellow at TowerGroup and author of the research, said: "Risk analyses that are 'siloed' in one area of an institution may exaggerate the danger attached to new products or services, thus leading institutions to stifle innovation and forgo growth opportunities."

"On the other side of the coin, poor integration of risk management across an organization masks the interdependencies of risk and financial indicators - potentially exposing financial institutions to severe losses. Unfortunately many institutions only become aware of their risk management pitfalls once a lapse in controls or unforeseen interdependencies between events causes a major business problem," he added.

The key findings of the research include:

“Risk analyses that are 'siloed' in one area of an institution may exaggerate the danger attached to new products or services, thus leading institutions to stifle innovation and forgo growth opportunities.

Guillermo Kopp, executive director and global research fellow at TowerGroup

The recent subprime lending crisis served as a harsh reminder that financial risks (i.e., credit and liquidity) are deeply and globally interdependent.

Organizations must work to integrate the management of financials with operational and other risk types - such as brand damage, business continuity, disruption of the supply chain, and geopolitical unrest.

Beyond defending against threats to the organization, a more integrated approach to risk management can drive other business and client-centric benefits, including: improved quality and transparency of information; relationship pricing; process simplicity and efficiency; more effective decision making; and overall resilience.

The heads of financial institutions must understand the changing variables in today's interconnected world and continually watch for early warning signs. Proactive leadership, in which chief financial officers and risk managers play key roles, is critical to achieving integration and sustaining competitive advantage.

Kopp noted that a reactive position based on lagging indicators and reports is becoming completely inadequate to steer organizations through today's increasingly demanding marketplace. "Achieving effective functional integration inside and outside a financial institution requires a tough and long transformation journey. Success factors include a determined leadership team and a strategic road map that 'staggers' changes in organization, process, and technology."