The current financial market turbulence underscores the importance of getting the fundamentals of sound risk management right”, FED Governor Randall Kroszner said in a speech before the American Bankers Association in Washington. Concentrating on the importance of fundamentals in risk management Kroszner critisized that senior management was not fully aware of the firm's latent concentrations to U.S. subprime mortgages, “because they did not realize that in addition to the subprime mortgages on their books, they had exposure through off-balance sheet vehicles holding mortgages, through claims on counterparties exposed to subprime, and through certain complex securities.”
“Latent risks from certain complex products and certain risky activities should be properly recognized”, Kroszner recognized and suggested that stress testing and scenario analysis are tools that can reveal potential concentrations of risk that may not be apparent from using information gleaned from normal times.
"We see the trouble that risk concentrations can cause if an institution has not tried to identify them in advance and take steps to mitigate their effects," Kroszner said. "Supervisors suggest extensive use of firm-wide stress testing to ensure the incorporation of low-probability but potentially severe liquidity events that may have the potential to converge."
Full speech
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