Thursday, October 22, 2009

Bank risk controls need much work, regulators say

Posted on Reuters by John Parry:

Banks across the world have much work to do in improving risk management and internal controls following the financial crisis, global regulators said in a report released on Wednesday.

The report, called "Risk Management Lessons from the Global Banking Crisis of 2008," was done by regulators from seven countries in the Senior Supervisors Group. Information for the report was gathered between March 2008 and last month, said a source familiar with the report.

The regulators concluded that despite firms' recent progress in improving risk management practices, substantial work is needed on underlying weaknesses in governance, incentive structures, information technology infrastructure and internal controls, said a release from the Federal Reserve Bank of New York.

In September, the Group of 20 nations endorsed a statement by its coordinating arm, the Financial Stability Board, recommending new rules for bankers' pay, one of which was that the size of the bonus pool should depend in part on the health of the balance sheet of a bank.

However, the global regulators' report released on Wednesday said, "supervisors are concerned about the durability of proposed changes," to compensation practices at financial firms.

Senior Supervisors Group Chairman William Rutledge, presenting the report, wrote in a letter dated Wednesday to Mario Draghi, Chairman of the Financial Stability Board at the Bank for International Settlements.

On practices at some financial institutions that contributed to the crisis, the letter cited "the failure of some boards of directors and senior managers to establish, measure, and adhere to a level of risk acceptable to the firm," and also "compensation programs that conflicted with the control objectives of the firm."

The report, a joint effort among nine supervisory agencies, "evaluates how weaknesses in risk management and internal controls contributed to industry distress during the financial crisis," the release said.

The banking crisis of 2008 -- the biggest financial shock since the Great Depression -- culminated in the fall of Lehman Brothers and the near collapse of the global financial system.

Lax risk management and heavy exposure to risky securities were among the catalysts that triggered the crisis, analysts say.

To keep the financial system working and counteract the severe shock to major economies, governments and central banks pumped trillions of dollars of support into financial institutions and securities markets.

The report identifies some progress in reducing global financial risks since then, including the financial industry's efforts to standardize practices and cut backlogs of unconfirmed over-the-counter (OTC) derivatives positions. These efforts "appear to have significantly mitigated a substantial systemic risk," the report said.

Regulators who undertook the report include; the Canadian Office of the Superintendent of Financial Institutions, the French Banking Commission, the German Federal Financial Supervisory Authority, the Japanese Financial Services Agency, the Swiss Financial Market Supervisory Authority, the U.K. Financial Services Authority, and, in the United States, the Federal Reserve, the Office of the Comptroller of the Currency and the Securities and Exchange Commission.

The report can be downloaded here.

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