FSA 2009 Financial Risk Outlook

The Financial Services Authority (FSA), the British financial services regulator, published its 2009 Financial Risk Outlook. For those who wish to read the 90 page report, please click here

The 2009 report, according to the Foreword, has a different structure in consideration of "the scale of the financial crisis and the uncertainty over the future of the financial system, in particular the banking system" and in view of the increased regulatory policies to contain financial risks.

There were key messages that are listed at the end of each section and I would like to draw attention to a few that I think bears relevance to this organization.

• Setting the tone Senior Management should ensure appropriate risk management is undertaken and that there is a clear understanding of the underlying risks to their business model, particularly risks associated with complex hedging strategies. Firms need to satisfy themselves that key risks are appropriately managed and continually re-assessed as financial market and economic conditions evolve.
• Measurement Stress testing and scenario analysis should form an integral part of firms’ risk management, business strategy and capital planning decisions. It is of particular importance in this unpredictable environment, when the financial sector is vulnerable to further shocks, that firms also consider the implications of deteriorating economic conditions and the long-term viability of and weaknesses present in their business models. In addition, the financial sector and economy will also remain vulnerable to potential shocks, such as a large-scale terrorist attack. Firms should continue to consider such risks in their business planning to ensure effective plans are in place for dealing with these shocks.
• Liquidity Risk Firms need to be aware of the vulnerabilities of their capital arising from the closure of individual markets and ensure that they have diversified funding channels and a varied investor base within each funding source. They also need a clear understanding of the availability of liquid assets which could be converted to cash if funding is suddenly unavailable, and the extent of their over-reliance on such ‘liquidity through marketability’. Many financial institutions continue to face liquidity pressures. Firms
  need to manage liquidity risk to ensure any gaps are filled by appropriate funding strategies. Internal risk management of liquidity issues needs to be addressed and reported effectively.
• Risk Management Is A Business Strategy Strategies need to be underpinned by strong risk management systems and controls for all areas of risk: credit; market and operational risk; conduct of business risks; compliance with relevant rules, codes and standards; and managing risks of fraud and financial crime.
• Do Your Own Due Diligence As a credit rating represents only one opinion on the creditworthiness of a particular product, a rating should not replace appropriate due diligence. Investors should assess how much reliance is appropriate to attach to the ratings produced by third parties, in light of rating performance and other forms of risk assessment relevant for the security concerned. Factors such as liquidity risk and price volatility can be as important in making an appropriate decision, and should be considered alongside other relevant indicators regarding the creditworthiness of an investment. (Refer to previous posting on Lloyd Blankfein and the similarities)
• Valuation Controls Systems and controls should also be in place to manage valuation difficulties and to ensure that questionable prices are identified. Appropriate governance procedures are also important when using non-independently sourced values.
• Disclosures To enhance market confidence, it is important that firms provide sufficient disclosures about the key judgements and uncertainties concerning valuations and any reclassifications in the accounts.