Systemic Risk and Challenges for Risk Management

Prof Tan Eng Chye
Prof Duan Jin-chuan

Distinguished speakers, guests, ladies and gentlemen

1   Good morning and welcome!  It gives me great pleasure to join you today at the Third Annual Risk Management Conference organised by the NUS Risk Management Institute.

Introduction

2   For three years now, this conference has successfully brought together regulators, policy makers, risk managers and researchers to debate critical issues pertaining to risk.  The theme of this year’s conference, “Systemic Risk and Challenges for Risk Management”, is very timely and highly appropriate.  The protracted crisis has re-emphasized, not just the significance of robust and sound risk management, but also the importance of identifying, monitoring and managing systemic risk. 

3   I am happy to see that today’s policy forum provides an opportunity for globally recognised experts in financial risk, to come together and share their insights on the challenges of managing systemic risk.  I am equally pleased that the following one-and-a-half day scientific program would allow in-depth discussions on research topics related to financial risk management.  On the whole, I’m confident that this conference will provide a useful platform for experienced regulators, risk managers, academics and eager students to share experiences and exchange views on various risk topics. 

4   Allow me to now share some thoughts on the current crisis.

Market, Credit, Liquidity Risks

5   There are many valuable learning points from this crisis.  Let me highlight two specific points which are of relevance to risk management.

6   First, apart from funding liquidity, we should be concerned with how asset liquidity affects credit risk.  Recent research from the Basel Committee of Banking Supervision shows that during crises, falls in liquidity tend to have larger impact on prices of financial products with greater credit risk.  Conversely, valuation uncertainties or shocks that accentuate actual or perceived credit risks can cause illiquidity in the affected product.  This is a huge challenge for risk management because under a high-stress scenario, the two elements of asset-liquidity and credit-risk, systemically feed on each other in a vicious downward spiral.

7   Second, we need to better understand correlations between different risk drivers to help us in pre-empting future crises.  Currently, the Basel II capital accord requires banks to set aside regulatory capital for credit and market risks, but not for the correlation risks between them.  In a systemic event, such correlation risks rise substantially, so ignoring them in our models undermines the efficacy of our responses to tail events.  How these risks react with, and to one another under different stress scenarios, should be further studied to better comprehend them. 

8   Clearly, there is much to be done and I’ve no doubt that the importance of your role as risk managers, academics and researchers will be further enhanced.  Let me briefly touch on a few challenges you face.

Challenges for Risk Managers

9   First, risk managers will have to examine risk measures that are less pro-cyclical.  For example, Value at Risk (VaR) benchmarks potential losses against recent events, making it somewhat like a point-in-time measure.  Consequently, conventional VaR would ‘under-predict’ potential losses if previous years were good, and ‘over-estimate’ potential losses if previous years were bad.  Risk managers could explore the use of alternate measures such as the Hybrid-VaR.  The Hybrid-VaR combines conventional VaR with the potential worst-loss from a selection of stress-tested scenarios, in order to give a weighted anti-cyclical statistic that projects potential losses through-the-cycle.  If well implemented, this could be a more robust measure than conventional VaR.  But I must caution that we must learn not to get too obsessed over numbers that are generated from models.  Outputs from models must always be complemented with the expert judgment of risk managers, even if such judgment could be subjective at times.

10   The second challenge concerns the firm-wide ethos of risk management.  Risk management should be the responsibility of everyone, not just risk managers.  The tone from the top is very important in what risk culture permeates an organisation.  The Board has to set the risk tolerance of an institution, while senior management should develop and implement strategies, policies and procedures, to ensure that the institution remains within the risk boundaries.  Risk managers should make sure that they have the necessary expertise and systems to identify, measure, monitor and control risks.  Ultimately, risk-taking should align with the risk appetite of the institution.

Role of Academics and Training Institutes

11   Lets now turn to the role of academics and training institutes.  Innovation in risk management techniques has become even more important, and we need academics to continue brainstorming for new, break-through ideas and solutions.  More crucially, academics must be aware that complicated financial engineering concepts have to be made simple so that practitioners can understand and implement the ideas, and put them to good use.    

12   Universities and training institutes should also take advantage of the current environment to further build the talent pool and intellectual capacity in risk management.  The Risk Management Institute in particular, should press ahead with efforts to produce more experts in the area of financial risk management, and train individuals who are able to see and understand risk from the global, regional, and local contexts. 

Conclusion

13   In conclusion, risk managers, academics and researchers will have more important roles to play.  There are many lessons to be learnt from this crisis, and if we learn them well, we will all emerge stronger and better prepared for future challenges. 

14   With that, I wish you a fruitful discussion at this year’s conference. For those who have come from overseas, may I also wish you a pleasant stay in Singapore.

Thank you.