December 04, 2010
Credit Crisis and the GreyING Anatomy: Touring from Germany to Romania in presentation of my thoughts in risk conferences
Credit Crisis is not an event now; this has grown into a starting point of a series of systematic risk-inducing financial events that may trigger further crisis. I am not bullish about regulatory measures like proposed Basel III , as I believe these measures of forcing the banks to push up higher capital asset ratio and shrink risk assets will lead to plunge on M3 ( largest in Money Supply) which was never successful historically even during Great Depression. Further my hindsight goes that the self-induced innovations to save on equity may lead further re-engineering which will undermine the basic purpose of capital regulation, to the detriment of the regulators, and instead of pre-empting the crisis, on the contrary, this will fine-tune the proliferate more systematically.
While I have focused my present research interest on the effect of post credit crisis and systematic risk, which is in addition to my normal professional life as a risk practitioner, and presented some of my thoughts in risk conferences in Germany and Romania, for feed back to learn further and enhance my research, but still at the end of the visit, I am unable to convince myself that shadow of credit crisis is over yet, at least systematic risk point of view, regulation wise. This is for me a Real Identity Crisis!
My presentation in Germany and Aftermath: the other Octobor Fest
Indeed the CEQURA conference is more scintillating for me rather than the October fest in the background as the speakers are knowledgeable and the list includes European Central Bank. I was very curious about the Germany as a strong EU country, specially I noted with surprise the comments of European Central Bank President Jean-Claude Trichet that "Their (Basel III) contribution to long-term financial stability and growth will be substantial." You doubt or I doubt!
The CEQURA Conference on Advances in Financial and Insurance Risk Management was organized in collaboration with the Federal Reserve Bank of Richmond and the Bayerisches Finanz Zentrum, as a platform for presenting and discussing current developments and fosters the exchange between academics and practitioners from the risk management community.
The web link of the conference is
http://www.cequra.uni-muenchen.de/conference/
My presentation was “Turbulent Times & EVT Approach: Indian Experience” which was based on our paper. This paper is co-authored by me with Professor Dr. Basabi Bhattacharya who was my guide for my completed PhD. We tried to estimate the transmitted effect of credit crisis in Indian stock market applying Extreme Value Theory. Our study showed the evidence of transmitted effect of credit crisis in stock market though many hard-nosed say that our system is too strong to be penetrated, which is too hard for me to believe. However out study is under further enhancement and are waiting for more convincing results.
A base version of my presentation may be had at the following link:
http://www.slideshare.net/good123/slideshows
In fact our understanding, as in our paper, synchronizes with the comments by the keynote speaker Paul Embrechts, Department of Mathematics, Director of RiskLab, ETH Zurich who quoted in his presentation "The Financial Crisis: Warnings, Guilt and a Mathematical Theorem" :
..These LCFIs ignored their own business model of securitization and chose not to transfer credit risk to other investors. Instead they employed securitization to manufacture and retain tail-risk
that was systemic in nature and inadequately capitalized..
I strongly feel thagt enough work is required to address this tail risk as the present Basel III framework does not address the possible non-disclosure of the risk in the tails by present Value-at-risk models and even much-talked-about Gaussian Copula which could do even worse by fattening the tails. I believe there is enough scope to address tail risk through appropriate regulations “Now or Never”, as there is not enough time left.
While I am impressed by Cristina Danciulescu of Trondheim Business School on “Backtesting Value-at-Risk Models:A Multivariate Approach” for uniqueness of the approach, Tina Yener of CEQURA spoke on “Operational Risk:Estimation and Effects of Dependencies”, which really highly technically sound addressing operational risk modelling issues using my favourite EVT approach. Kerstin Bernoth of DIW Berlin on “Forecasting the fragility of the banking and insurance sector” is a cse in point and she agreed that “Credit crunch of 2007/08 demonstrated that financial institutions cannot be regarded as self-standing and independent”, which make me understand the Berlin Wall!
My presentation in Romania and Aftermath: Looking for the other Dracula
Though I could not find my all-time favorite Count Dracula in nice windy breezes of Romania, the other Dracula of credit crisis haunted me in the well-managed conference organized by PRMIA Bucharest. I should thank Andrea and Valentin, the co-regional directors of PRMIA Bucharest Chapter. This is a great learning for me as all speakers are hard core practitioners like me and shared their concerns and remedies.
The name of conference was Annual Global Credit Risk Event as organized by Bucharest Chapter of Professional Risk management International Association (PRMIA) in Bucharest in Romania from 11th to 12th November 2010. The speakers include from Moody’s, Reserve Bank of Boston. , KPMG Romania & Greece.
The conference web link is
http://www.prmia.org/events/view_events.php?eventID=4248
My presentation was “The impact of the credit crisis on acceptance and design of credit rating models for banks: the way forward" where I tried to estimate the effect of the credit crisis on design and validation of internal rating model as the challenges of discriminatory and calibrating power of the rating systems take a paradigm shift during and post crisis. The dilemma haunts me whether Through-The-Cycle (TTC) rating system need be supplemented by a Point-In-Time (PIT) rating system.
A basic version of my presentation may be had at the following link:
http://www.slideshare.net/good123/slideshows
As I see the challenge post crisis:
Challenge 1 - Discrimination: After Credit Crisis, how well will a rating system rank borrowers according to their true probability of default (PD)?
Challenge 2 -Calibration: After Credit Crisis, how well will estimated PDs match true PDs?
While the logic of the risk assessment process along with the rating system’s design and operation need to be revisited now, what is most important is to establish the right feed back loop post credit crisis. In my presenation through discussion, I tried to explore what could a preferred road map to address these issues, as the audience are seasoned bankers/practitioners.
The IRB approach which had a great touch point with my presentation, I am really impressed by the progress made by Romanian banks, even under many constraints. The presentation by Ada Valcea, Executive Director, Group Risk Controlling & Portfolio Management , Raiffeisen Bank S.A. Romania (One of the largest Banks in the region) addressed issues under the regulatory framework, which are :
(1) Appropriate and consistent segmentation into exposure classes (NBR R15/20/2006)
(2) Validated rating models (NBR R15/20/2006)
(3) Corresponding risk management processes (NBR R15/20/2006)
(4) Efficient definition and detection of defaults, collection of default data (NBR R15/20/2006)
(5) Sound Parameter estimation/calculation
(6) Methods of credit risk mitigation and
(7) Correct regulatory capital calculation.
As I see it , there is reaslistic requirement to revisit the choice of models, existing or prospective – as a preferred choice in the current context. among the following, based on issues of localization and benchmarking:
a) Expert-judgement based: qualitative/subjective ratings criteria; lacks transparency and consistency (e.g., LDPs); or
b) Model-based: ratings based on objective risk factors using mathematical equations; or
c) Constrained judgment or Hybrid: combines elements of both expert-judgment and model-based systems; or
d) Vendor Models: external third-party rating systems;
While I was vey moved intellectually by the presentation of Angela Manolache, Director, Financial Services, KPMG, Romania , on “Proposed changes to the IFRS impairment model for financial assets (IFRS 9)” which is amazingly detailed ( too detailed for me!) and content-rich, I am rather confused about credit stress testing method proposed by IFRS regime which is significantly different by Credit stress testing method prescribed by Basel II and will give two different results, adequate enough to confuse senior management. I doubt why no synchronization is made between two regulations where end objective of the bothe regime is to achieve solvency of the bank. Andrea Dochia , Senior Manager, KPMG, Romania, spoke on Credit risk stress testing in the ICAAP (NBR R18/2009). Challanges for banks using the standardized approach for credit risk” which is very content-rich.The key concern I still have about credit stress testing is about factoring in Macroeconomic variables like the effects on credit risk (measured by NPL) of real GDP growth and credit volume growth, as well as the effects of unemployment rate and lagged inflation rate, where regulators are not prescriptive, discreetly! However I am impressed by Preston Thompson , AVP, Federal Reserve Bank of Boston on his talk on “Aligning Risk, Risk Appetite and Capital” which is in fact I am trying to implement professionally, as I see this is the day for identifying adequate headroom for economic capital in compliance with risk appetite. No adequate headroom means no head at all!
Afterthoughts
Credit Crisis is the risk management marketers’ all-time-favorite dream but a realistic agony for serious risk managers due to sincere doubts about relevance and efectiveness of evolving risk regulations, as most serious risks are SYSTEMATIC in nature and needs to be handled adequately at Macro level rather just at micro level by risk managers.Please send me your comments which make feel I am not lonely in my thoughts!
Posted by ddutta7 at 12:25 PM
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