Managing a bank without sophisticated risk management tools in this day and age is a little like flying an airplane without an instrument panel: Sooner or later, you'll crash.
Although bankers have known this for a long time, it is only in recent years that, after more than a little regulatory prodding, they have stepped up to the task of adopting technologies for monitoring and managing risk enterprisewide.
"Technology is vital to the risk management process," said Tanya Styblo Beder, principal at Capital Market Risk Advisors Inc., New York.
Indeed, risk management has become a huge technology business. Ms. Beder estimated the global market for risk management at about $30 billion. Costs at the individual institution range from about $100,000 a year to upward of $1 billion at global institutions, she said. And that's just for the technology.
Bankers who are versed in risk management, however, say the costs are dwarfed by the benefits to those who adopt these systems. "In the past, we relied more on intuition and cobbling together of systems," said Steve Vinson, senior vice president at Credit Lyonnais Americas in New York.
New technology and a new risk management structure have changed all that, however, Mr. Vinson said. "We can now be in front of risk," he said, "instead of always lagging behind."
Mr. Vinson, who earned a doctorate in investment management and statistics and held jobs in trading and risk management at Citibank and Chase Manhattan Bank before joining Credit Lyonnais two years ago, is one of a new breed of banker. He's Credit Lyonnais' independent risk oversight executive.
The job makes him responsible for identifying, measuring, and monitoring market risk activities throughout the bank's Western Hemisphere operations. He reports directly to the chief executive officer in New York.
Credit Lyonnais Americas is among the largest foreign banks in the United States, with $40 billion of assets and a staff of 1,300 in this country and Canada. The bank's parent, Paris-based Credit Lyonnais, operates in 80 countries and reported global assets exceeding $339 billion at yearend 1995.
Having internal risk management "czars" is a relatively new development at most banks; it grew out of recommendations made by the Group of 30 in 1993.
At that time, noted William G. Ferrell, president and chief executive of Ferrell Capital Management, Greenwich, Conn., a handful of very progressive banks had adopted such a strategy. Now, he said, institutions in all segments of banking, and all corners of the globe, are heeding the call and installing management structures that can better support risk management enterprisewide. "The pace of change has been increasing rapidly," he said.
For Credit Lyonnais, the change has meant a new organizational structure supported by new technology. Its technology solution, a software system called RiskWatch, offers a comprehensive set of tools for measuring, monitoring, simulating, and restructuring risk. It was developed by Algorithmics Inc., a Toronto firm specializing in risk management tools.
RiskWatch, installed for about a year, allows Credit Lyonnais to view all its risks, said Mr. Vinson. The bank, he noted, trades about 25 types of product, from fixed-income securities to money market derivatives to equities. Keeping tabs on the various risks presented by these activities, and by the interactions of each, requires sophisticated analytical tools that many banks would be unable to develop alone.
Ron Dembo, president of Algorithmics, said a company like his is well positioned to help banks analyze and react to risk. A mathematician by training, Mr. Dembo said he believes he and his staff bring a measure of expertise to risk management that banks couldn't duplicate in-house.
Algorithmics' staff includes more than 30 people with doctorates and scores of experts with master's degrees in areas such as mathematics, computer science, and finance.
Not that theory, alone, could effectively manage a bank's risk exposure. A system like RiskWatch, explained Mr. Vinson, is only one element in the risk management equation, albeit an important one. "But it doesn't dismiss the need for practical day-to-day market knowledge," he said. "Sometimes, the devil is in the details."
Mr. Vinson said he sees his job at Credit Lyonnais as protecting the interests of stakeholders. "Risk management is in place to protect the stakeholder's value in the institution," he said. That means keeping tabs on the bank's market activities, as well as ensuring the efficient use of capital.
Once a bank has adopted tools that allow it to analyze risks, controlling risk becomes inherently easier, Mr. Vinson suggested. The result is an ability to understand better the relative risks of individual products and even to assign capital on the basis of risks.
Consider, for example, two lines of business, one generating $10 million in gross earnings and another generating $5 million. Although at first glance, the $5 million business may seem to be contributing less to the organization's profitability, analysis may show that the business incurs far less risk than the $10 million business.
RiskWatch, said Mr. Vinson, provides a basis for such an analysis. "We can make objective decisions about what makes better quality earnings," he said.
In fact, Mr. Vinson suggested, it may even lead to changes in the way the bank compensates traders. "In theory, at least, we can ultimately tie a more rational compensation policy to this," he said.
But there are limits to technology. Mr. Vinson knows that no software system alone could thwart a rogue trader intent on breaking the rules; it takes systems, practical expertise, and rigid oversight, he said.
What a system like RiskWatch does, explained Mr. Vinson, is make it easier for the experts to police areas requiring special attention. "It helps by clearing the underbrush so that you have a better view of the forest," he said.
Ms. Murphy is a regular contributor to Management Strategies.