Financial Crisis: Where did Risk Management Fail?

Abstract:     
The real estate market bubble and the subprime mortgages have been often identified as the causes of the current financial crisis, but this is not entirely true or, at least, they cannot be considered as the main cause. A poor regulatory framework based on the belief that banks could be trusted to regulate themselves is among the main sources of the crisis. At the same time, risk management at most banking institutions has failed to enforce the basic rules for a safe business: i.e., avoid strong concentrations and minimize volatility of returns. The purpose of this study is to identify the reasons behind the risk management failure and offer a view on how they can be solved or improved going forward if we want to ensure a sounder financial system than today’s one. In particular, I examine the following issues: 1) lack of a defined capital allocation strategy, 2) disaggregated vision of risks and 3) inappropriate risk governance structure.

Number of Pages in PDF File: 17

Keywords: Financial crisis, Capital allocation, Enterprise risk management, Banks’ governance structure

JEL Classification: G21, G28

working papers series