1. Could you please describe your career, especially in risk management?
My career spans 16 years in several facets of Banking and Finance. I started working in the Credit Cards business, and then transitioned into Treasury & Risk Management. Next I was a Branch Manager with several sales platforms such as banking, Investment Products, and Insurance. Finally, I have spent the last 5 years in the field of Planning & Analysis including Business Performance Management, Financial Reporting, and Analytics/Metrics.I was first exposed to Risk-Management as a Treasury Funds Manager where we studied the impacts of actions such as buying and selling of securities, engaging in Repos and Reverse Repos on the interest-rate risks and sensitivities in the balance sheet as well as direct securities gains and losses (mark-to-market). We also had to look at the overall structural planning and trends in the balance sheet and tie it into the actions we took in the Treasury markets. We quantified overall risk to the bottom line or what banks call ‘spread-risk’ (the risk to the spread between loans and deposits) and ran several stress scenarios. We also had to plan manage liquidity risk around all the financial risk models. Of course, when there were fundamental changes in the economic environment, interest rates, the behavior of buyers and seller, things would turn out quite differently than what assumptions we took, but that’s quite normal I suppose. A couple of very interesting risk-events that I worked on was the Indo-Pak nuclear tests crises in 1998 and then in 1999 I also worked on a risk-management team that studied the interest-rate fluctuation risk to earning for Citibank’s acquisition of Bank Handlowy in Poland.
2. Could you describe briefly the main points of your book?
The main point of the book is to discover the deep underlying reasons as to why after a series of financial crises over the past 20 years we are really never able to avoid the next big one. What are the problems (not the symptoms) that need to be addressed? Some people say that this is simply a product of economic cycles but there is a sentiment in the larger community that financial organisms have gotten overly complex and running wild – that they are not manageable. We tend to forget that the world of Finance is not just about Finance (its objective is to serve and facilitate the greater economic platform), so the book reaches out into other dimensions: how technology and geo-political forces have shaped Finance (the post Bretton-Woods era) in recent history. It even touches upon on sales practices and corporate culture / behaviors. Also, the role of government and governing frameworks laws is covered. Finally, it makes a few proposals and something to offer as thought-provokers.
3. Why did you write this book?
I wrote the book because
I am concerned and distraught with the discourse in the Financial world. The
book follows my career inside Citigroup which came out of a merger between
Citibank and Travelers Group in 1997. Citigroup was a microcosm of the global
financial industry and it faltered terribly in the contemporary crises. It
became overly complex and convoluted. And it became representative of
irresponsible and rash management as well as risk-taking. All of a sudden I
found a world of negative and ugly sentiments around banking companies. So I
took it upon myself to bring perspective to a world that is somewhat
mysterious, overly complex and unruly to the layman and the larger society.
4. If you were appointed
as an adviser to the Basle 2 Committee what would you suggest?
I would press them on a few particular issues that have made the financial industry riskier. One is the complex and interwoven nature (including regulation) of the industry today. Banking and Finance are perplexingly; something that has directly attributed to the failure of Citigroup. Holding companies operate banks, investment houses and insurance companies – this is why disruption-events these days reverberate through the system like shockwaves from an earthquake. This is one of the main problems I discuss in the book. Here in the USA there was much integration in the industry. The Glass-Steagall Act which kept the banking, insurance and investment domains separate was repealed with what I would say have been disastrous consequences.
Next, there is the ubiquitous securitization of loans by banks and lenders. Loans are securitized to manage risk on the balance sheet but they have two very high-risk features. First, they lead to increased and more loose origination of loans; since banks don’t hold the loans anymore they’re not as careful about the risk and seek to ramp up originations to make more revenue. And, just because the ownership of these securities is spread out in the market (risk-dispersion) doesn’t mean they are any less risky. In fact, now the risk has spread through they system. Lastly, they are securities so they drop in value sharply in economic downturns whereas on-balance sheet accrual-loans don’t have the market-value risk dimension. Risk-dispersion is not risk-mitigation: look at what happened to Greece. So, what is Basel II proposing to address this situation?
Lastly, we are over-regulating. There is all this reactionary legislation after-the-fact. And now Basel II wants to add an ‘Operating-Risk’ dimension on top. Experts are weary any of this will work. The complex formulas used by Basel Committee need a PHD financial-engineer to unravel. The financial system should not be too complex for the layman to comprehend, let alone people who work in Finance. We are running after symptoms and trying to clean-up with more laws – that’s the wrong approach. We need to address problems with the right frameworks and principles. And, ask ourselves the question: Is Capital Adequacy (what Basel aspires to do) even the right concept to manage overall financial risk? Banks are highly leveraged organisms by nature. They must circulate (or invest/lend) a high volume of their obligations (deposits or borrowings) to survive. So they will always falter in economic downturns. No amount of equity can adequately mitigate this risk. So, at the risk of repeating myself, it’s more about simplifying and returning to traditional forms of the business.
5. How the balance of economical power is shifting at the moment and what will be the outcome of this process? Better world or more complicated un-ruled world?
It is shifting and it is not. With the American consumer de-leveraging out of high amounts of credit card and exotic-mortgages, hopefully some economic consumption burden will shift out of the US. But, there is no saying that fold won’t return once the ground levels in a few years. We have been trying to reduce the world’s dependency on the American consumer for 50 years now. People also talk about India and China coming up sharply but it’s not a given how much of a dent they can make. The Chinese don’t spend – their idea of prosperity is to export and save. India has a robust economy and democracy but it is also saddled with crushing poverty and corruption. The European Union makes me nervous – how do you devise one monetary policy for Germany, Spain, France, Greece etc..? It just doesn’t sound right. Europe is not America. It’s uniquely different cultures, countries, habits etc. So, this leaves USA as still the best product on the market.
Another issue these days is what is known as ‘quantitative easing’ which I believe is just another word for monetary expansion. Central banks have been keen to keep markets liquid and rates low. They have printed a lot of new money when economies are more or less or even contracted somewhat. This is not without risk – too much money without economic value can cause devaluation. Experts say that central banks can suck it out quickly – yes, they can but not without upsetting economic recovery. I think we have to lay off this quantitative easing now, it’s starting to feel uneasy.
As for if it’s a better world or a more unruly world, I think I already answered that in the previous question.
6. Which is the most important opportunity for risk specialists in the coming year?
Well, it’s an exciting time for Risk specialists. A lot of CEOs have to pay attention to what their Risk Managers are saying. There is a lot of talk about implementing robust Mark-to-Market models. Risk Managers can weave a lot of influence these days and help determine the structure of their balance sheets, the choice of assets and what kinds of transactions and business models provide an equitable mix of profit and caution. But, the test always comes when the going is good and people start quantifying risk differently in order to increase profit. Risk is a dynamic concept – it means different things in times of prosperity and recession. So, it’s more an art and personality thing than a science. For example, here in the USA, Jamie Dimon and Chase Bank decided to dump risky sub-prime mortgages parting with profit before the market crashed and while the mortgage-securities were still profitable. Needless to say, they benefited enormously.
7. How can you verify that a specific risk management strategy is working?
Unfortunately, in the world of Banking and Finance, you can never really know until it is tested. The example I gave above of Chase Bank is one where the strategy itself was changed to meet a change in the risk of the instrument. So, that is obviously important to have the right strategy for the right moment but also to have a framework that can cater to the vagaries of the economic cycle. Whether it’s mark-to-market, interest-rate risk, capital adequacy, operational risk or compliance risk, you won’t know if it works till you know if it works. And then, if you find your models were not geared to account for newly arrived risks or changing definition, changing them after-the-fact is little more than redundant formality – like nothing out of something.
8. What are the main lessons from the current crisis from your point of view?
My book covers the
following as the main lessons from the crisis . . .
I feel the most important
lesson is that with markets and finance we are dealing with a social science –
there are things you can account for, but there are also things you cannot
account for. It is now over 15 years since the collapse of Long Term Capital
Management – the Hedge Fund engineered by Nobel Laureate Myron Scholes which
sought to prove that financial markets operated like scientific mechanisms and
they bet $80 billion that the spread risk between US Treasuries and AAA
Corporate Bonds will not exceed 5 basis points (a concept in Market Perfection
Theories). Well, in those days when the financial crises hit, nobody cared
about Corporate Bonds; $80 billion went up in smoke. So, we learn from history
that we learn nothing.
Recently I had lunch with the CFO of a top 25 bank in the US. He said that all the increased cost of enhanced regulation is going to lead to a round of consolidations in the banking industry. And instead of resisting ‘Too Big to Fail’, we will end up falling into it. And the next crises will be even bigger. In the USA, there are 300 less banks than when the crises started. Some big national banking companies who had been around for decades like Washington Mutual and Wachovia are gone, so have Bear Sterns, Lehman Brothers and Merrill Lynch – this is now a different era, much more of an Oligopoly-era. I don’t think I’ve met anyone who feels that history will not repeat itself. I also sense that we may now be unwittingly drawn into some unsavory phase of Keynesian Economics with big government and mega-banks that will hurt vitality and innovation. And, the system will become more intertwined with government and central banks.
Next, we need to understand how technology has evolved in work culture and generally in the industry/markets. Our modeling of markets and balance sheets has grown immensely complex. Also, technology has caused unprecedented fragmentation in the workplace. Today, you may have a colleague in some other part of the country or world who you rarely or never get to see. So, the enrichment of professional collaboration within an organization can be severely diminished. These may be different kinds of risks but they are just as relevant.
Lastly, more regulation or multi-dimensional regulation and more complex regulation is not the answer. We are running after the symptoms and not the problem. We need the right frameworks and the right principles. We need simplification and unraveling. Practice won’t make perfect if we keep practicing the wrong thing.
9. How GlobalRisk
Community can contribute to the process of better understanding and integrating
of risks and how can we improve?
In a way this is an
exciting time in Risk Management – Can Risk Managers save the world or not? Can
they unravel and demystify the beast? And help bridge the comprehension gap
that is growing between the financial community and the rest of the world (as
well as within the financial community). Forums like GlobalRisk are very relevant
today where risk managers can interact by questioning, challenging and helping
each other as well as non-risk managers. Risk Managers must engage the larger
the world and convince them that they are capable of a true watchdog function.
That they can guard against casino-banking and challenge CEOs. I look forward
to having some robust discussions here.
10. What are your plans for the coming future?
I plan to continue on the path of discovery and unravel more about this defiantly complex financial system and figure out some way to make it interesting enough to write another book perhaps. Hopefully, I will find some good book-material at GlobalRisk. Let’s see.
Also available at hundreds of bookstores.
Readers can contact the author at email@example.com.
The book is now available to read excerpts on line. Anyone can read a large body of the material for free online at google via the following link: http://tinyurl.com/26npwpk
Amer Chaudri graduated from Boston