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Managing Extreme Financial Risk

Book Description

Managing Extreme Financial Risk addresses the need for better management strategies in light of increased market risk and volatility in financial institutions' revenue models.  Top officials from the financial and regulatory industries point to real corporate issues, showing how institutions react to financial crises. From first-hand experiences, they explain how effective sustainability management does not just prevent being blindsided; it also leads to proactive solutions that enhance an institution's strength to weather a sudden financial crisis, add significant shareholder value, and reduce systemic risk. Readable, coherent, and logical, Managing Extreme Financial Risk shows how extreme risk needs to be handled when the cost of being wrong means the difference between life and death of the institution.



  • Based on the firsthand experiences and perspectives of senior-level executives
  • Concentrates on extreme risk, when the cost of being wrong is not the loss of profits, but the death of the institution
  • Written to be easily understood without algorithms, models, and quants

Table of Contents

  1. Cover image
  2. Title page
  3. Table of Contents
  4. Copyright
  5. Dedicated to Walter B. Wriston
  6. Foreword
  7. About the Author
  8. About the Contributors
  9. Acknowledgments
  10. Introduction
  11. Prologue
  12. Section 1: The Need for a New Approach to Tail-Risk Management
    1. Chapter 1. Sustainability Management is Critical
      1. Abstract
      2. 1.1 Disciplined Emphasis on Protection from Extreme Operational Risk
      3. 1.2 No Similar Emphasis on Protection from Extreme Financial Risk
      4. 1.3 Absence of Objective Parameters Accounts for the Lack of Proactive Emphasis
      5. 1.4 Do Regulatory Requirements Address Effective Management of Tail Risk?
      6. 1.5 Stress Testing
      7. 1.6 Living-Will Provision
      8. 1.7 Liquidity Reserves
      9. 1.8 Going-Concern Management and Tail Risk
      10. 1.9 Is the Need For Tail-Risk Management New?
    2. Chapter 2. Tail Risk is the Culprit: Tail Wagging the Dog?
      1. Abstract
      2. Prologue
      3. 2.1 Credit Policy: A Watchdog Function without Any Glamor
      4. 2.2 Credit Policy Role at Continental Bank
      5. 2.3 Evolution of Revenue Models and the Watchdog Function
      6. 2.4 Could the Problems of 2008 Have Been Avoided?
      7. Epilogue
      8. References
    3. Chapter 3. Need for a Distinct Focus on Tail Risk: In No Uncertain Terms
      1. Abstract
      2. 3.1 Why a Distinct Approach?
      3. 3.2 Effective Management Calls for a Distinct Focus on Sustainability Issues
      4. 3.3 Sustainability Management Needs Distinct Parameters
      5. 3.4 Three Distinct Legs of Risk Governance
      6. 3.5 Is the Sole Focus on Risk Management Prudent?
    4. Chapter 4. Sole Focus On Traditional Risk Management Can Be Dangerous: Days of Future Passed
      1. Abstract
      2. 4.1 A Mature Industry
      3. 4.2 A New Driver of Revenues
      4. 4.3 Days of Future Passed
      5. 4.4 And Then a Blind-Side Blow
      6. 4.5 A False Sense of Security
      7. 4.6 Misplaced Use of Models
      8. 4.7 Missing Focus on Tail Risk
      9. 4.8 Regulatory Emphasis Encouraged Improper Use
      10. 4.9 Sole Focus on Traditional Risk Management—Driven By Statistical Models—Can Be Misleading
      11. References
    5. Chapter 5. Usefulness and Limits of Quant Models
      1. Abstract
      2. 5.1 Chaos Theory Given Assumption of Normality
      3. 5.2 Chaos Theory Given Assumption of Extreme Crisis
      4. References
  13. Section 2: Elements of Sustainaliblity Management
    1. Chapter 6. If you Can’t Measure it, You Can’t Manage it: Taming Something That’s Lurking Around
      1. Abstract
      2. 6.1 Prerequisite to an Effective Management Process
      3. 6.2 An Example
      4. 6.3 You Can Manage Exposure from Tail Risk Only if you can Measure it
    2. Chapter 7. Simplicity to Counter Complexities of Revenue Models
      1. Abstract
      2. 7.1 Decision Making Enhanced by Advances in Technology
      3. 7.2 Despite Technology and Quant Advances Human Decision Making Remains Simple
      4. 7.3 Decisions Regarding Unquantifiable Uncertainty Require A Different Approach
      5. 7.4 The Need for Simplicity is Critical In Complex Models
      6. 7.5 Post-2008 Developments Have Increased Complexity
      7. 7.6 A Simple Measure is Needed as Responding to Complexity with Complexity is a Recipe for Disaster
      8. References
    3. Chapter 8. A New Measure for Effective Sustainability Management: Probable Maximum Loss
      1. Abstract
      2. 8.1 A Simple Measure to Gauge the Sustainability of a Complex Model
      3. 8.2 PML, As a Measure of Exposure from Extreme Tail Risk, Has Several Advantages
      4. 8.3 PML Provides a Solid Tool for the Effective Management of Tail Risk
    4. Chapter 9. Continuous Readiness is Critical: A senior executive who wishes to remain anonymous
      1. Abstract
      2. 9.1 Plans Are Useless, Planning is Indispensable
      3. 9.2 Readiness Defined
      4. 9.3 Degrees of Readiness
      5. 9.4 Ready Intellectually and Emotionally
      6. 9.5 Ready Intellectually, but Not Emotionally
      7. 9.6 Ready Neither Intellectually, Nor …
      8. References
  14. Section 3: Implementation Issues and the Wide-Reaching Impact on Institutions and the Financial System
    1. Chapter 10. Effective Sustainability Management: From Top to Bottom
      1. Abstract
      2. 10.1 Key Parameters to Drive Risk Governance
      3. 10.2 PML as a Measure of the Extreme Exposure Parameter
      4. 10.3 Effective Tail-Risk or Sustainability Management
      5. 10.4 Effective Sustainability Management to Protect Capital
    2. Chapter 11. Paradoxical Capital Problem
      1. Abstract
      2. 11.1 The Need for a Bigger Cushion is Real Because of the Increased Pressure on Capital
      3. 11.2 Increased Capital Solutions are Not Sustainable
      4. 11.3 Increased Capital Solutions are Not Realistic
      5. 11.4 A New Approach to Addressing the Need for a Bigger Cushion is Required
      6. 11.5 Sustainability Management Offers a New Solution by Alleviating the Pressure on Capital
      7. 11.6 Another Reason for a New Approach
      8. 11.7 A Change is Needed in How Capital is Deployed
      9. References
    3. Chapter 12. Capital as the Last Defense vs the First Defense
      1. Abstract
      2. 12.1 More and Stronger Defenses Mean Less Pressure on Capital
      3. 12.2 Sustainability-Enhancement Programs
    4. Chapter 13. Tail Risk, Regulatory Supervision, and Systemic Risk: Missing Links
      1. Abstract
      2. 13.1 Regulatory Objectives
      3. 13.2 Institutional Response
      4. 13.3 Reconciling Objectives
      5. References
    5. Chapter 14. Convergence of Regulatory Objectives and Institutional Interests: Alignment of Goals to Enhance Sustainability and Reduce Systemic Risk
      1. Abstract
      2. 14.1 Apparent Conflict
      3. 14.2 The Challenge
      4. 14.3 Convergence towards Common Goals
      5. 14.4 Reduction of Systemic Risk
    6. Chapter 15. Telling Your Story Effectively to Alleviate Marketplace Anxiety
      1. Abstract
      2. 15.1 High Level of Anxiety
      3. 15.2 A New Approach to Communicating Tail Risk Is Needed
      4. 15.3 Reducing Anxiety, Building Greater Confidence, and Adding Shareholder Value
      5. 15.4 Objective Public Policy Debate
      6. 15.5 Too Complex to Manage?
    7. Chapter 16. Critical Factors in Preparing for an Extreme Financial Crisis: A former senior executive who wishes to remain anonymous
      1. Abstract
      2. 16.1 AIG Timeline
      3. 16.2 Key Observations
      4. 16.3 Sound Human Judgment, Not Rocket Science
      5. 16.4 Readiness at the Senior-Most Level
      6. 16.5 Simplicity to Counter Complexities and Maintain Control
      7. 16.6 Conclusions
    8. Chapter 17. From the Bane of the Revenue Model to a Competitive Advantage
      1. Abstract
      2. 17.1 The Bane of a Financial Institution’s Revenue Model
      3. 17.2 Urgent Need for Proactive Tail-Risk or Sustainability Management
      4. 17.3 Proactive Tail-Risk Management Enhances the Ability to Respond to Crises
      5. 17.4 Effective Sustainability Management Leads to Many Significant Advantages
    9. Chapter 18. Adapting Organizations to Effective Sustainability Management
      1. Abstract
      2. 18.1 Organization Focus
      3. 18.2 Implementation
      4. 18.3 Conclusion
  15. Epilogue
  16. Appendix. The Wall Street Journal
    1. The Fed’s Stress Tests Add Risk to the Financial System
  17. Index