The Sooner, The Better

Last week, a document was released by the Group of Thirty that provides some interesting ideas and insight into the future of our financial regulatory system.  For those unfamiliar with the Group of Thirty, it is a private, nonprofit, international body composed of very senior representatives of the private and public sectors and academia that aims to deepen understanding of international economic and financial issues, to explore the international repercussions of decisions taken in the public and private sectors, and to examine the choices available to market practitioners and policymakers.  Notable members of the Group of Thirty include Paul Volcker, Tim Geithner, and Lawrence Summers - all future members of the Obama Administration.  

The document is entitled "Financial Reform: A Framework for Financial Stability" and provides recommendations for improving our financial system once we have moved beyond the immediate financial crisis we are in today.  Of particular interest to readers of this blog are the following set of recommendations focused on governance and risk management. 

Regulatory standards for governance and risk management should be raised, with particular emphasis on:

a. Strengthening boards of directors with greater engagement of independent members having financial industry and risk management expertise;

b. Coordinating board oversight of compensation and risk management policies, with the aim of balancing risk taking with prudence and the long-run interests of and returns to shareholders;

c. Ensuring systematic board-level reviews and exercises aimed at establishing the most important parameters for setting the firm’s risk tolerance and evaluating its risk profile relative to those parameters;

d. Ensuring the risk management and auditing functions are fully independent and adequately resourced areas of the firm. The risk management function should report directly to the chief executive officer rather than through the head of another functional area;

e. Conducting periodic reviews of a firm’s potential vulnerability to risk arising from credit concentrations, excessive maturity mismatches, excessive leverage, or undue reliance on asset market liquidity;

f. Ensuring that all large firms have the capacity to continuously monitor, within a matter of hours, their largest counterparty credit exposures on an enterprisewide basis and to make that information available, as appropriate, to its senior management, its board, and its prudential regulator and central bank;

g. Ensuring industrywide acceptance of and action on the many specific risk management practice improvements contained in the reports of the Counterparty Risk Management Policy Group (CRMPG) and the Institute of International Finance.

These are great recommendations that will certainly strengthen the governance and risk management of our financial institutions.   However, implementation of these recommendations will take a great deal of effort and time.  The sooner we can begin to address these recommendations, the better.