Tags: banks | risk | strategy | currency

Banks' Risk Management Strategy Suffers From 'Boiled Frog Syndrome'

By    |   Wednesday, 30 April 2014 11:03 AM

Banks fail to recognize gradually increasing risks in their portfolios, warns a banking expert, saying they suffer from the "boiled frog syndrome."

If you drop a frog into boiling water, it jumps out, explains banking consultant J.V. Rizzi in an article for American Banker. But if you put a frog in cold water then boil the water gradually, it stays put, passively still while being boiled to death.

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"Institutions become comfortable with the nominal profit increases from higher risk and ignore the warning signs," states Rizzi, an instructor at DePaul University in Chicago. "It is hard to recognize a problem when you are paid not to see it."

Boards, regulators and shareholders often don't see the increasing risks, due to banks' opaque nature, hard-to-value assets, voluminous financial reports and multiple subsidiaries. Plus, banks' budgets and bonuses make it difficult to turn away more risk, he says, citing second liens, covenant-light leveraged loans and the return of commercial real estate lending as recent examples of growing risks.

"Strong active board oversight and due diligence by experienced independent directors with skin in the game are critical," he stresses, saying risk appetite changes must consider the bank's strategy and capacity for sustaining losses.

Banks must accept only risks they understand, and understand the fatal flaw in every investment, Rizzi warns. They must realize that if they can make money, they can lose money. High returns mean high risks.

Complex products are dangerous and full of difficult-to-see risks. Banks must avoid risks that could threaten their solvency no matter how unlikely.

"Banks failing to distinguish the long-term effect of gradual risk level changes do not know what they are doing. They, like our hapless boiled frog, are likely to face an unpleasant future."
 
Comptroller of the Currency Thomas Curry said large banks may be too big to properly manage risk, Reuters reports. They must do a better job of handling their risks, he said at a Reuters Financial Regulation Summit.

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Banks fail to recognize gradually increasing risks in their portfolios, warns a banking expert, saying they suffer from the boiled frog syndrome.
banks, risk, strategy, currency
347
2014-03-30
Wednesday, 30 April 2014 11:03 AM
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