25 April 2008

Joint Forum 'risk concentrations paper' underlines integrated management approach

It is especially important for those firms with a significant presence in the risk transfer markets to have an integrated risk concentration management approach across risk categories, the Joint Forum states. All business lines and relationships need to be evaluated and a firm-wide view of exposures is necessary to capture potential concentrations, the paper says. This should result in an assessment of whether a number of business lines are at risk of being affected by a single scenario or risk factor and the possible scope and scale of that impact across the firm.

The paper assesses the progress made by financial conglomerates in identifying, measuring and managing risk concentrations on a firm-wide basis and across the major risks to which these firms are exposed, and also includes observations and lessons drawn from the market turmoil. The paper entitled ‘Cross-sectoral review of group-wide identification and management of risk concentrations’

"This paper highlights critical issues in firms' ability to identify risk concentrations and one of these relates to stress testing” John Dugan, Chairman of the Joint Forum said. “Not only do firms need to factor liquidity risk into firm-wide, integrated stress tests but they also need to take into consideration second-order effects in the development of stress test scenarios.“

The report notes that risk concentrations at most financial conglomerates are still chiefly identified, measured and managed within separate risk categories and within business lines. However, some financial conglomerates are striving for a more ‘horizontal’ view of risk concentrations as it becomes increasingly clear that risk concentrations may arise from interrelated exposures across risk categories.

The report makes two other broad observations:

- first, when compared with other risk types, the management of liquidity risk tends not to be as well integrated in a scheme of cross risk analysis (probably because it is not measured in the same way as other risks); and

- second, insurance-led conglomerates seem to be somewhat more experienced in undertaking the design of integrated cross risk scenario analysis, perhaps because the nature of insurance business risks, particularly in the property and casualty business, are less readily amenable to linear analysis.

Joint Forum Paper

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