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Risk management ‘hot job’ of the decade Back  
Nicola Flavin looks at the rising role of the risk manager within Irish businesses and finds that it is the ‘hot job’ of the moment.
At the end of the 1980s the Trader stood centre stage. The embodiment of success, he was powerful, wealthy, the mover and shaker of the capital markets.

Over 10 years later, a new star is rising. After a decade marked by financial disasters and bank failures, the era of unquestioned profit-making would appear to be at an end. Disasters such as the Barings collapse and the financial turbulence of East Asia in 1997 and 1998 upset an industry which was previously viewed as an unstoppable profit machine. Bitter experience has resulted in the steady development of Risk Management.

The practice of Risk Management has changed almost beyond recognition since the occurrence of the aforementioned financial crises. Driven by changes in the competitive and regulatory environment of the financial services industry, advances in technology, and progress in the mathematical modelling of market and credit risks, Risk Management has become a new discipline with its own set of principles and standards. Originating as a sideline, managing market and credit risk evolved initially into a condition of staying in business. Banks who understand their products and markets are more likely to agree now that managing and transferring the risk inherent in their products is their business.

Regulators of the financial services industry concentrate on three main types of risk.

Credit risk is the risk of a trading partner not fulfilling his obligations in full on the due date or any time thereafter. Among the risks that face financial institutes, credit risk is the one with which we are most familiar. It is also the risk to which supervisors of financial institutions pay the closest attention because it has been the risk most likely to cause a bank to fail. The recent case of UBS/LTCM (1998) is a notorious example of the hazards of credit risk.

Market risk is risk that arises due to uncertainty about general market factors, such as exchange rates, interest rates or the volatilities of those factors. As a risk, market risk only gained a high profile when the Basle Committee on Banking Supervision published ‘The Supervisory Treatment of Market Risks’ in April 1993. This was heavily criticised and has since been superseded but was important because it sought, for the first time, to extend the 1988 Capital Accord for credit risks to incorporate market risks.

Settlement risk is the risk that a settlement in a transfer system does not take place as expected. The risk that transactions cannot be settled affects every type of asset and instrument which requires a transfer system to pass from one party to another. But as a risk it features most in currency trading because the daily settlement flows in foreign exchange dwarf everything else. BIS estimates that the average daily turnover of global currencies in spot, forward and foreign exchange swap contracts is $1,230 billion. Since each trade could involve two or more payments, daily settlement flows are likely to amount to a multiple of this figure. Even more frightening, it is estimated that a bank’s maximum foreign exchange settlement exposure could be equal or even greater than the amount receivable for three days worth of trades, so that at any point in time, the amount of risk to even a single counterparty could exceed a bank’s capital.

Regulators recognise that there are other significant risks beside market, credit and settlement. The most important of these are: liquidity risk, legal risk and operational risk. The latter is probably the most well recognised and indeed the cause of the notorious collapse of Barings. The Bank of England’s report on the subject glaringly exposes the deficiencies in Barings’ information and internal control systems, which allowed Nick Leeson to amass positions worth a notional $27 billion (compared with the bank’s capital of $615 million.) The conclusion to the report states that this massive position went unnoticed because there was a complete absence of internal controls, a lack of segregation of Leeson’s duties and Leeson himself went largely unsupervised.

Financial institutions have been forced to recognise the magnitude and potential costs of multiple forms of risk in their strategic and business planning. This involves the putting in place of a structured way of identifying and analysing potential risk and devising and implementing responses appropriate to the impact of that risk. This is essentially the role of the Risk Manager.

The new Risk Manager has many tools at his disposal, such as securitisation or the use of new kinds of derivatives. But the core of the new discipline is the use of rigorous quantitative methods to define the business’s risk appetite and then to measure the risk taken to achieve a given amount of profit. The ability to work with very quantitative tools sets the Risk Manager apart. The education of a Market/Credit Risk Analyst will typically include a degree in a quantitative subject (maths/finance/economics) and a PhD/MBA in a similar discipline. The Global Association of Risk Professionals (GARP), in their 2001 salary survey note that about 86 per cent of Risk Managers surveyed had postgraduate training, despite the average age of 34. The Market Risk professional will normally also have a strong background in numerical simulations and quantitative techniques, possibly a knowledge of C++ and certainly a good understanding of techniques such as Value at Risk, Scenario testing and Stress testing. The Credit Risk Manager will have a similar educational background coupled with a strong knowledge of credit-scoring tools. Operational risk focuses on regular operational risk / Turnbull reporting requiring a different skill set - the Operational Risk Manager will typically hold an ACA/ACCA qualification and originate from a background in Accounting, Audit or Compliance.

Risk Managers are charged with an important function within financial institutions and in order to attract high calibre candidates, salary levels tend to be competitive. A Risk Analyst with 1-2 yrs. professional experience will earn a mid-range basic salary of ?40,000 (Dublin). A Risk Manager with 4+ yrs. experience can command a basic salary of up to ?70,000 (Dublin). This compares favourably with counterparts in more developed financial centres around the world. The GARP 2001 salary survey produced the following basic salaries per region: Asia - $56 180, US - $77 753, UK - ?82 136, Asia/Pacific - $51 233.

What also transpired is that pay levels vary according to the type of risk under management, with market risk emerging as the clear winner. Interestingly also, it emerged that Risk Managers like their job, but also believe that they are underpaid!

The future looks good for this particular professional. A new business title, CRO (or Chief Risk Officer) is beginning to emerge, right up there with the CFO. The Risk Manager is becoming less and less the enemy of the risk-taking and profit-seeking part of the business and more of a partner in its success. The November 2000 issue of ‘U.S. News & World Report’ has listed ‘Risk Manager’ as one of 21 ‘Hot Jobs for the Year 2000’ adding ‘Progressive firms are relying on risk managers, previously the worriers who recommended safety plans and disaster insurance, to plan the future’.

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