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26 May 2010

ECB González-Páramo: Common sense risk management practices had been abandoned


González-Páramo criticised the exclusive reliance on external assessments for the management of their credit risk. He also reminded that potential conflicts of interest were embedded in the CRAs business models and criticized the performance of their ratings in the last two years.

González-Páramo critized the role played by CRAs and said that the trend witnessed in recent years for many market participants to exclusively rely on external assessments for the management of their credit risk. These assessments have been often provided by only a small number of specialised institutions (rating agencies).
Common sense risk management practices such as “know your counterparties”, “invest only in products you understand”, “do not outsource credit risk management by relying exclusively on external credit assessments”, “do not rely exclusively on quantitative models, however sophisticated” had been abandoned, he said.
The critique on the role of rating agencies has become a recurring theme in all analysis of the current crisis. In addition to potential conflicts of interest embedded in their business models, rating agencies have faced questions on their methodology, in particular in the area of structured finance, and the lack of transparency in their activities. The ex-post assessment of the performance of their ratings in the last two years has raised serious concerns.
He concluded by saying that “it appears that periods of “irrational exuberance” can lead us to forget well established practices on how to prudently manage risks. Financial crises like the current one remind us of their importance. Also central banks have learned valuable lessons in their own risk management and have made steps in solidifying their defences, while remaining faithful to their objectives of ensuring price stability while also safeguarding financial stability.”
 
 


© ECB - European Central Bank


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