Regulators Should Mandate Risk Management

Ben Bernanke is giving a clear signal to banks that the government stress tests were just the tip of the iceberg. The 19 banks that were tested 'passed' the stress tests, which measured trading and market risk, but they now have more work to do. Bernanke told a group of Federal Reserve Bankers at a conference this week that these banks will have to take internal measures to test liquidity, operational and reputational risk. He said this was 'important' and that regulators would be watching to make sure it happened. I have long been a believer that risk management has to be better regulated. Most investment banks put disaster recovery plans into effect after September 11, 2001 when they lost buildings and people in New York City. But few have been willing to really test what would happen if liquidity dried up - like it did in fixed income derivatives last year. Or what would happen if they couldn't meet capital requirements at any given time - ditto. Stress testing should be done using the most extreme, even unlikely, circumstances. Risk managers need the support of the board and of the trading department - which generally tends to push them away. A good dose of curiosity would also help - a risk manager who actually enjoys testing extreme scenarios and dissecting the consequences. And has the stones to stand up to management to tell them what needs to be done to better protect the firm's downside.