Fooled by regulations?
There is a an unintended consequence to the financial industry regulation that professionals need to become conscious of...
Firms can too easily (...or without recognising it) find comfort in the fact that they are meeting regulatory requirements.
Any regulation creates a standard, a reference point and this risks providing an unintended confirmation that what is being done is appropriate or sufficient.
We've seen throughout history that:
🤕Every crisis is different
🤕Risks are always changing
🤕Risks are obvious in hindsight
🤕Contagion risk can easily be underestimated or misunderstood
🤕Models are...just models and reality can defeat them
🤕Management, policy makers and the public can easily become overconfident or victims of the status quo
🤕99% confidence estimates might lead us to overlook or underestimate the tail risk
As a result, regulation is not a one-size fits all panacea.
❗Meeting the requirements in terms of capital, liquidity, asset quality etc does not replace the need for strong decision making processes. To achieve this:
✅Adopt ongoing questionning
✅Strive for bias management
✅Be careful of acting as if risk management is the primarily the responsibility of the risk department. Efficient risk management is reflected in the company's culture and depends on accountability, cross functional teams, psychological safety etc
❗it's important to be mindful and do not let rules become mental anchors.
❗It's important to look with an outsider's eye at how risks are assessed in your Board.
Do you find this worth it?
Do you find it easy? (I think it's not easy cause it goes against many unsconsious processes and it gets easier with understanding them)