Why banks don’t listen to their risk managers – and risk losing billions

Woodbine Associates says analysis of the crisis striking UBS is not one of rogue trading, but of failure of management caused by factors such as accounting practices and behavioural biases. And it will not be the last company to suffer this way.

While details are thin, the announcement last week of an unprecedented $2 billion equity trading loss by UBS in London, and the arrest on criminal fraud charges of the alleged 31-year-old “rogue trader,” have attracted global attention. This would be the third-largest trading loss of its kind in banking history.

Onlookers are scratching their heads asking – once again –  how one person,trading basic instruments, could accrue such eye-popping losses under the supposedly watchful eyes of experienced management.

The problem is decades old and rampant in financial services. Strong risk management oversight in financial institutions is perceived as hindering production and eroding profit potential, thus is often underfunded and overruled. Senior managers must face their responsibilities and run – not walk – to adequately fund, develop, and support enhanced risk management. Otherwise they are gambling (like UBS) with firm capital and shareholder interests and risk failure of the entire enterprise – and make no mistake, the failures will be those of management, not of so-called “rogue traders.”

Need for controls

Enterprise-wide risk management has been an industry best practice since the Barings Bank failure in 1995. Infamous “rogue trader” Nick Leeson was able to sink Barings thanks to substantial oversight and control deficiencies; these enabled him to trade AND oversee settlement operations in the firm’s Singapore office. Leeson lost roughly $1.3bn due to speculative investing, primarily in futures contracts.

Since then, virtually all substantial financial services entities have implemented risk management functions that are fully independent of business development groups. Risk managers quantify and aggregate risk, develop controls, and create oversight plans. Their role is perceived as essential. Publicly, senior management and line managers praise and support risk managers.

While senior management is often publicly pleased to have risk groups measure consolidated market, credit, and operational risks, they can be considerably less pleased when risk managers attempt to block transactions that generate considerable outright revenue. It is not uncommon for management to overrule risk managers in these instances. Such actions can belittle the risk managers’ role – and place a firm at risk.

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