This should be required reading for the head of every bank in the world. This excellent read from Ohio State argues that managers should always expect for the worst and prepare for the best. As we’ve seen over the course of the last 25 years there remains an extraordinarily low level of risk management across all sectors of the financial world – from the Federal Reserve to the banks to the consumers. Good risk management can’t eliminate downturns, but can certainly smooth them out.
A large loss is not evidence of a risk management failure because a large loss can happen even if risk management is flawless. I provide a typology of risk management failures and show how various types of risk management failures occur. Because of the limitations of past data in assessing the probability and the implications of a financial crisis, I conclude that financial institutions should use scenarios for credible financial crisis threats even if they perceive the probability of such events to be extremely small.