Sub-prime crisis highlights need for enterprise- wide approach to risk management: Datamonitor

London: The inability to aggregate an organisations' overall risk position allowed a failing of credit risk principles in a relatively small section of the US housing market, to spill into a wider liquidity risk for global wholesale finance markets. This is according to a new report by independent market analyst Datamonitor.

The report, 'The Evolution of Enterprise Risk Management, says the ongoing sub-prime crisis has highlighted the need for a truly enterprise- wide approach to risk management.

According to Datamonitor, over reliance on models and the continuing silo structure within the majority of organizations resulted in a lack of transparency which led to a breakdown of confidence as market participants' exposure was unknown.
 
The report concludes that this will provide the impetus for financial services institutions (FSIs) globally to re-evaluate their enterprise risk strategy and to leverage regulatory driven technology spend into operational risk based performance management in the search for competitive advantage.
 
Spend on operational risk related technology to top $1 billion by 2010.
Operational risk is the risk of loss resulting from failed internal processes, systems and people, and external events. Datamonitor expects global spend by FSIs on operational risk technology to grow from $754 million in 2007 to $1,056 million in 2010, representing an average annual increase of almost 12 per cent.
 
''With the proliferation of structured finance securities such as collateralised debt obligations (CDOs), the means to accurately value them due to a lack of depth in the market led to many valuations being 'marked to model', or 'mark to fantasy' as it turned out,'' says Damian Shaw-Williams, financial services technology senior analyst with Datamonitor, and the report's author.
 
The modelling of exposure to CDOs also failed to address the highly leveraged nature of many funds, leaving many exposed to any downgrades, the effect of which is thus amplified and can lead to a further sell-off of assets, which can contribute to a downward price spiral.
 
According to Shaw-Williams, ''a re-evaluation of the modelling tools used will provide the motivation to evaluate more powerful modelling platforms. In addition, comprehensive databases of underlying macro and historical data will increase the utility of common methodologies.''
 
Operational Risk Management – the next frontier
While FSIs have always needed to manage operational risks, the practice of operational risk management (ORM) as a separate discipline is still evolving. In recent years, many risk professionals have considered the discipline of ORM the 'next frontier' in risk management.
 
Relative to credit risk and market risk, operational risk is more difficult to define, quantify and manage. Nonetheless, the imperative to improve governance, risk and compliance processes at financial institutions has never been greater.
 
''More than ever, corporate directors, business executives and risk professionals realize that operational risk is critical not only for regulatory compliance but also for operational efficiency and effectiveness,'' concludes Shaw-Williams.