PM could flag website to fix risk holes

Published in The Australian Financial Review

In “Bad risk mismanagement, not VaR” (Letter, October 23) Frank Ashe defends the banking industry risk measure standard VaR (Value at Risk) and blames the crisis on bad risk management. He then lists a comedy of risk management errors behind the UBS $US37 billion debacle. I doubt the same comedy of errors explains the silence of all bank boards, regulators and academics before the risk bomb exploded.

Published cartoon - AFR - 27 Oct 2008

Of course it was bad risk management. Risk management has three aspects, 1. risk measurement, 2. risk reshaping and 3. getting the first two right. Frank Ashe’s list of UBS errors fits nicely into point 3. Had the UBS risks been measured properly and transparent their massive risks would not have survived long enough to be mis-managed. At least one of the UBS board, its shareholders or its regulators would have moved like lightning to close the risk holes.

This is why I say the real root cause of the banking crisis was poor risk measurement, VaR. It’s the reason why bankers, regulators, investors, analysts and academics were caught out en masse and silent before the risk bomb exploded. The risks were not seen because the industry risk standard VaR hides catastrophic risks. Imagine cars built with speed meters that show variable measures for the same speed and never a speed over 60 KPH. The law on speed limit would be meaningless. VaR is the variable risk meter for banks. Two banks can report the same VaR – one may be safe, the other destined to crash.

I invite Prime Minister Kevin Rudd to take to the November 15 G-20 financial summit the idea from Australia that a website be established where all banks must report daily their exposure to wide ranging movements in all the economic variables to which they are exposed. The academics might like to show how such a website would have appeared over the last decade, including the VaR measures as a comparison. Add to this a permanent online global opinion market that harvests ideas from risk experts and ranks them live with democratic voting for all to see.

Published version – AFR – 27 Oct 2008

Tags: banking crisis, banking industry, banks, Value at Risk, VAR