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Tuesday, March 11, 2008

Fed's Kroszner on Risk Management

by Calculated Risk on 3/11/2008 12:48:00 PM

From Fed Governor Randall S. Kroszner: The Importance of Fundamentals in Risk Management

Kroszner blasted banks for ignoring excessive risk concentration:

[I]n particular cases, senior management was not fully aware of the firm's latent concentrations to U.S. subprime mortgages, because they did not realize that in addition to the subprime mortgages on their books, they had exposure through off-balance sheet vehicles holding mortgages, through claims on counterparties exposed to subprime, and through certain complex securities.
And then he cautions on commercial real estate (CRE) loan concentrations:
Banks should also remember that past experience is not always predictive of future events, meaning that they should be somewhat creative in designing potential shocks. In CRE, for example, banks should move beyond considering single-name risk and include scenarios involving broader risks to the CRE sector and how such risk may be correlated in times of stress with other parts of the portfolio.
It's interesting that the Fed issued a guidance cautioning about CRE loan concentrations at the end of 2006, and yet the evidence suggests CRE loan concentrations at small and medium-sized institutions still continued to increase.