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September 1, 2014

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‘Ability to assemble data quickly is significant’

EFFECTIVE risk management means avoiding the types of losses suffered by others in similar situations, said David Rowe, senior strategist at the London-based banking software company called Misys.

In a wide-ranging conversation with Shanghai Daily, Rowe said the current regulatory structure of punishing law violations is flawed. Turning to Shanghai’s new Free Trade Zone, he said the success of pilot programs there may be the prerequisite for further liberalization of the wider economy.

Rowe has spent his entire career in financial services. At Mysis, his role involves risk management and regulatory compliance. He has written a monthly column for London’s Risk magazine since 1999.

Earlier in his career Rowe spent more than 25 years in banking and in economic forecasting. Most recently, he was senior vice president of risk management information at Bank of America in San Francisco. In that role, he was responsible for the design, deployment, maintenance and operation of market and credit risk systems for the bank’s global foreign-exchange, derivative and securities trading activities.

Q: What’s your view on the US imposing huge fines on global banks for violating sanctions?

A: I believe that enforcement as currently practiced is seriously misdirected. Imposing fines on private corporations, including banks, penalizes current and prospective shareholders and customers. It does little or nothing to penalize the individuals responsible for managing or performing the offending actions. My own view is that conscious violation of the law performed by an employee may justify fines on an institution if it has been negligent in its oversight function, but the primary penalties, including criminal penalties, should be imposed on the offending individuals.

One other comment about the current environment is the deplorable practice of allocating much of this type of fine to the prosecuting agency. This risks corrupting the objective execution of the laws by tying the institutional well-being of the prosecuting agency to the size of a settlement. Even if this does not alter the prosecutor’s judgment, it clearly raises the appearance of conflict of interest, and it is an arrangement that needs to be eliminated.

Q: Although Chinese banks have a relatively low level of internationalization currently, what lessons could they learn from the multi-billion dollar fines on global banks?

A: I think the basic lesson is that a central and uncompromising management directive must be that actions that break the law are forbidden. Those found to have committed such acts in full knowledge of their illegality will be dismissed for cause. It often appears that “stretching the limits of the law” can offer short-term advantages, but experience clearly shows that the eventual costs can be far greater than any conceivable short-term gain.

Q: Chinese banks are accelerating their overseas expansion. What are the main hurdles they face at this stage?

A: The sheer cost of building and maintaining the systems for compliance with increasingly complex regulations in multiple jurisdictions is an important hurdle. Beyond that, banking is a highly competitive industry throughout the world and establishing a recognized market presence can be a slow and costly process before significant profits are realized.

Q: What are the major risks Chinese banks face amid financial reforms?

A: I believe the biggest risk facing all banks globally is their inability to assemble the internal information required to analyze new and emerging types of risk. This is especially important for markets in transition, such as China. In such markets, scenario analysis and stress testing of potential or emerging circumstances, often driven by unpredictable shifts in public policy, are particularly important. Since the nature of the relevant scenarios can shift suddenly, the ability to assemble data quickly is especially significant. The main obstacle to this is the way information is currently stored in highly structured databases that don’t allow the effective application of indexing and search techniques.

Misys is pioneering the use of document-based data storage techniques that will ultimately be able to address this problem at its source. In the meantime, we are also developing the ability to store and analyze massive amounts of detailed risk simulation results that can be aggregated and consolidated in multiple ways on demand. While not an ultimate solution, this offers a significant advance over traditional procedures, where much of this detail is discarded once pre-defined aggregate results are derived.

Q: What’s your view of the free trade zone account mechanism that is aimed at confining selected types of transactions and financial risks to that area?

A: China’s large and growing role in world trade automatically promotes the importance of the yuan as a global currency. To date, however, concerns over capital restrictions and limited convertibility have been major obstacles to its moving into that role. The initiation of the free trade account mechanism within the free trade zone is a cautious but positive step toward the yuan’s achieving a role consistent with China’s place in the world economy.

The new arrangement will require strict account segregation to assure continued control of capital flows between the FTZ and the rest of the economy, with associated reporting to assure compliance. This will require enhancements for many existing accounting systems. Or, perhaps, even of more interest to the authorities will be the development of risk assessment and management systems to protect institutions from unexpected currency flows and sudden price changes in the increasingly open environment. Demonstration of the effectiveness of such systems to the satisfaction of the authorities is likely to be a prerequisite for further capital account liberalization in the wider economy.

Q: Each bank may have a slightly different risk analysis model. And can you determine if certain model is successful?

A: This is a very broad question and the answer is not simple. One point worth making is that good risk management is widely viewed as a public good. In other words, one firm is not injured by its customer or even its competitors have better risk management. This is why, since financial risk management emerged as a self-conscious profession in the mid-1980s, practitioners have consistently been willing to share ideas and techniques among themselves.

In the end, success must be measured over an extended period. More stable earnings and a consistent pattern of avoiding the types of losses suffered by others in similar situations is the best indication of effective risk management. Unfortunately, some types of threats occur so rarely that it is hard to determine an institution’s ability to control its exposure to such threats until they actually occur.




 

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