Risk Management and Financial Institutions, + Web Site, 3rd Edition

CHAPTER 24

Risk Management Mistakes to Avoid

Since the mid-1980s, there have been some spectacular losses in financial markets. This chapter explores the lessons we can learn from them and reviews key points made in earlier chapters. The losses that we will consider are listed in Business Snapshot 24.1.

One remarkable aspect of the list in Business Snapshot 24.1 is the number of times huge losses were caused by the activities of a single person. In 1995, Nick Leeson’s trading brought a 200-year-old British bank, Barings, to its knees; in 1994, Robert Citron’s trading led to Orange County, a municipality in California, losing about $2 billion. Joseph Jett’s trading for Kidder Peabody caused losses of $350 million. John Rusnak’s losses of $700 million at Allied Irish Bank came to light in 2002. Jérôme Kerviel lost over $7 billion for Société Générale in 2008. Kweku Adoboli lost $2.3 billion for UBS in 2011.

A key lesson from the losses is the importance of internal controls. Many of the losses we will consider occurred because systems were inadequate so that the risky positions being taken were simply not known. It is also important for risk managers to continually “think outside the box” about what could go wrong so that as many potential adverse events as possible are identified.

24.1 RISK LIMITS

The first and most important lesson from the losses concerns risk limits. It is essential that all companies (financial and nonfinancial) define in a clear and unambiguous way limits ...