Financial Sector Supervision: Lessons from Recent Turmoil

1
Financial Sector SupervisionLessons from Recent
Turmoil

• William Rutledge
• Executive Vice President
• Federal Reserve Bank of New York
• 18 June 2008
• The views expressed here are not necessarily
  those of
• the Federal Reserve Bank of New York or the
  Federal Reserve System

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Overview

• Themes from the Senior Supervisors Group (SSG)
  review
• Historical lessons and new elements
• Supervisory response to crisis

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Themes from SSG review

• Effectiveness of firm-wide risk identification
• Rigor of valuation practices
• Effectiveness of balance sheet and liquidity
  management
• Quality of risk metrics
• Quality of stress testing

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Effectiveness of firm-wide risk identification

• Successful firms
• Emphasized comprehensive, firm-wide view in
  assessing risk exposures of the firm
• Routine discussions of evolving market conditions
  and implications for risks across firm
• Less successful firms
• More silo-ing of business line risks and
  decision-making
• Less emphasis on consolidated view

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Rigor of valuation practices

• Successful firms
• Emphasized mark-to-market discipline
• Developed in-house pricing models and specialized
  staff expertise
• Less successful firms
• More passive approach to valuation
• Heavier reliance on external assessments

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Effectiveness of balance sheet and liquidity
management

• Successful firms
• Before turmoil strong processes around
  allocation and pricing of liquidity
• During turmoil actively managed positions using
  quantitative and qualitative information
• Less successful firms
• Not as focused on consolidated positions
• Weak or missing controls, particularly around
  contingent liquidity (broader shortcomings in
  contingency funding planning)

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Quality of risk metrics

• Successful firms
• Recognized VaR limitations
• Used a wide range of risk measures
• Changing correlations in stressed market
• Integrated metrics across business lines
• Less successful firms
• Limited alternative views on risk
• Less aware of firm-wide concentrations

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Quality of stress testing

• Successful firms
• Blending of quantitative and qualitative
• Senior management involvement and support
• Link to business strategy
• Less successful firms
• Less flexible MIS
• Limited senior management support

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New wine, old bottle

• Some historical lessons reinforced
• Asset bubbles breaking
• Risk management principles
• New elements for banking organizations in the
  market turmoil
• Complexity of instruments
• Importance of funding liquidity
• Increased importance of market risks

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Supervisory response to crisis

• Supervision of individual firms
• International and domestic guidance
• Capital raising activities
• International supervisory coordination
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