Page 140 - Risk Management in current scenario

Broadening risk management

domain to understand tail risks

better

T his article discusses the current practices adopted in risk

management by analyzing micro risks but ignoring macro risk
analysis. The article identify few key global risks and recommend
that such macro level risk assessment should be made part of risk
management process by regulators to reduce the chances of future global
level crisis.

Current focus on risk management

The current focus of risk management process is managing around micro
risks such as market risk, insurance risk, operational risk etc. to help
optimize risk based capital. One of the key measures used in computing
the risk based capital is Value at Risk methodology which is a maximum
loss that can occur to the business within a defined time frame and
defined probability confidence level. However, the risks that can devastate
a financial institution are risks sitting in the tail of the distribution whose
probability is very small but impact is very high. Such events are often
difficult to predict and sources of insolvencies.

To assess these tail risks better, modern day risk management techniques
are using stress test to know the level of loss that can occur if tail event
crystallizes. The key in the success of stress test is identification of likely
tail scenarios that may happen so that such stresses can be formulated.
However, different countries and different regulatory regimes are using

138 | Risk Management in Current Scenario