Firmwide Risk Management*
This chapter turns to best practices for firmwide management of financial risks. The financial industry has come to realize that risk management should be implemented on a firmwide basis, across business lines and types of risk. This is due to a number of factors, including (1) increased exposures to more global sources of risk as institutions expand their operations, (2) interactions between risk factors, and (3) linkages in products across types of market risks as well as types of financial risks. These linkages make it important to consider correlations among risks and products. Interactions between types of risk bear emphasis, as they are too often ignored.
There is another, more pragmatic reason for attempting to measure risk on a wider basis. The industry has made great strides in the measurement of market risk, credit risk, and even operational risk. Once measured, risk can be penalized, as with risk-adjusted return on capital (RAROC) measures. The danger with this approach, however, is that this creates an incentive to move risk to areas where it is not well measured or controlled.
All of these reasons explain the trend toward integrated, or firmwide, risk management. Integrated risk management provides a consistent and global picture of risk across the whole institution. This requires measuring risk across all business units and all risk factors, using consistent methodologies, systems, and data.
Section 27.1 presents the framework ...