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Tuesday, 10 February 2009

Risk analysis and its part in the banking collapse

Alex Masterley has an excellent piece on his blog today regarding the role of risk analysis in the fall of the banking system. There are some technical points but all of it should be easily understandable by those of us outside of (but with an interest in) banking. I reproduce here his last paragraph as I think it really makes the point well:
"When risk assessments were made in banks the one question that was not asked was "What happens if X market goes away?" because the likely answer was "it ain't gonna happen, but if it does we all go to hell in handcart, you , me, the Governor of the Bank of England and the whole economy". The risk was put in the very low risk category, not factored into any pricing models and generally ignored. On a deal by deal basis that made perfect sense because the loss on any deal was limited to the values related to that particular deal. On an aggregate basis the numbers were so huge that no bank would contemplate the losses resulting from any individual deal, so deals got done and the market consensus was that these sorts of things did not and would not happen. Which meant that the market grew and grew and the issues that were ignored were precisely those that occurred because nobody was worrying abut them."

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