Time in the Market
               Not Timing the Market

THE CHIEF RISK OFFICER :- THE 5th BEATLE

The Chief Risk Officer in any financial institution, whether it be Banking, Commodity Trading, Crypto, or Investment/Asset Management, is as important as ‘Lennon’ was to ‘McCartney’, and both were to the Beatles. In this partnership, each member plays an integral role in the creation and success of the final product. In this context, I’m referring to managing and mitigating risks that could threaten the institution’s stability and success. 

Like the Beatles, we have witnessed numerous record-breaking ‘Hits’ in risk management bangers, soaring through the charts of the ‘greatest hits of bad risk management’. The recent collapse of the Silicon Valley Bank (SVB), with its substantial $175 billion in deposits and $209 billion in assets, serves as a prime example of the consequences that can arise from inadequate risk management practices.

Although the actual cause of the collapse at SVB remains cloudy and may only become apparent over time, it is evident that the CRO at SVB, Signature Bank, and Silvergate Capital was probably out with Lucy in some sky, looking for diamonds when they should have been preparing to mitigate the risks that ultimately led to their institutions, going down like a Yellow Submarine.

The last time a major banking collapse occurred, it felt like “A Hard Day’s Night” as a flood of bank shutdowns followed, making many people wonder, “Will you still need me, will you still feed me, when I’m sixty-four?”

After banks reported billions in subprime-mortgage losses in late 2007, the sentiment began to “Come Together” and shift. As losses snowballed in 2008, it triggered a “Revolution” on shadow banks—institutions that aren’t regulated like banks but perform “A Day in the Life” of similar actions.

Back then, banks and shadow banks held “Paperback Writer” foreclosed mortgages as collateral. At the time, it was also challenging to determine the value of these assets, making them feel like a “Magical Mystery Tour.” A credit crisis spurred a wave of bank collapses, leading many to exclaim, “Help! I need somebody!

Below are some of the Greatest Hits of Financial Institutions collapsing over the years :-

  • In 2008, Lehman Brothers collapsed, with around $639 billion in assets, due to a culmination of factors including excessive risk-taking, a lack of transparency, and overexposure to the subprime mortgage market..
  • Washington Mutual, the largest bank failure in U.S. history, collapsed in 2008 with around $307 billion in assets, primarily due to its aggressive expansion strategy involving risky lending practices and inadequate risk management.
  • IndyMac Bank collapsed in 2008 with around $32 billion in assets, primarily due to its heavy reliance on risky mortgage loans and inadequate risk management.
  • In 2011, MF Global collapsed with around $41 billion in assets, largely due to poor risk management, particularly the firm’s overexposure to European sovereign debt.
  • Bear Stearns collapsed in 2008 with around $395 billion in assets, because of overexposure to the subprime mortgage market, excessive risk-taking, and a lack of transparency.

Recently, record-breaking financial collapses in certain banks can be attributed to poor risk management practices. These banks held U.S. Treasuries as collateral, whose value declined due to spiking interest rates. Moreover, they had concentrated customer bases, leading to decreased diversification. For example, Silicon Valley Bank focused on venture-backed technology startups, while Silvergate Capital primarily worked with high-risk cryptocurrency firms.

The investment of deposits in long-term bonds during historically low-interest-rate periods highlights these institutions’ inadequate risk management and the assumption that interest rates would remain consistently low.

Drawing from my experience in the Commodities sector, the principles and the CRO’s involvement remain consistent despite differences between a CRO in Commodities Trading and a CRO in other financial sectors. They must navigate various personalities and senior positions, particularly traders.

When things go south, the CRO often becomes the center of attention and needs to assume the role of the lead singer in the band. An effective CRO should combine technical expertise, strategic thinking, and strong leadership qualities, much like the presence of McCartney or Lennon within their organization. They must comprehensively understand various risk categories and be adept at analyzing complex data to identify trends and assess potential risks.

A successful CRO anticipates risks, develops proactive mitigation plans, and short-term balances goals with long-term objectives, ensuring the organization’s risk appetite aligns with its strategy. Effective communication is also crucial, as a CRO must actively engage with traders and portfolio managers on the floor to promote a risk-aware culture.

Therefore, my message to CEOs and Board/Executive Committees is that just as the Beatles created timeless music still celebrated today, a financial institution’s success relies heavily on the partnership between its Chief Risk Officer and other key players within the organization. The CRO is the McCartney to the institution’s Lennon, playing an integral role in managing and mitigating risks that could potentially threaten the organization’s stability and success.

By anticipating risks, developing proactive mitigation plans, and promoting a risk-aware culture, the CRO ensures that the organization’s risk appetite aligns with its strategy, just like how McCartney and Lennon’s partnership created musical magic. As the famous Beatles song goes, “We can work it out” – a sentiment that holds for successful partnerships in music and finance.

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