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Erschienen in:
Records and Information Management for Financial Analysis and Risk Management Kapitel lesen Erstes Kapitel lesen

2013 | OriginalPaper | Buchkapitel

3. The Office on Financial Research and Operational Risk

verfasst von : Willi Brammertz

Erschienen in: Financial Analysis and Risk Management

Verlag: Springer Berlin Heidelberg

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Abstract

We argue that the single largest operational risk (OR) for the Office of Financial Research (OFR) is to be inundated with indecipherable financial contract data. Clear semantics on the attribute level alone is not sufficient for risk avoidance; the OFR needs a semantic system capable of describing the entire intent of the financial contract. We introduce the concept of Contract Types (CT), which encapsulates this semantic. The idea of CTs overrides the cherished yet unexamined separation of data and algorithms, which lies at the core of the observed data chaos in banks. We distinguish the mechanical parts of finance, where separation is counterproductive, from the subjective parts, where a separation makes sense. We conclude with a model that contributes to an operational OFR.

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Vorheriges Kapitel Monitoring Financial Stability in a Complex World
Nächstes Kapitel Using Conceptual Models to Theorize about the Relationship Between Records and Risk in the Global Financial Crisis
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Fußnoten
1
See section B of Basel III: a global regulatory framework for more resilient banks and banking systems (Basel Committee on Banking Supervision 2010).
 
2
The cost of loss is defined by its impact multiplied by its frequency. If high impact low frequency cases are considered very costly then they are found on the left side of the graph; otherwise they are on the right side.
 
3
Of course, the cost of losses cannot be counted on purely a monetary basis but must include human hardship etc. It has to be recognized though, that even after taking all this into account, there is a point where risks have to be accepted on a purely economic basis.
 
4
See for example “Silo but deadly” (The Economist 2009): ‘…most in the industry agree that its woeful I.T. systems have, in Mr Bänziger's (Deutsche Bank) words, “exacerbated the crisis”. The industry spent billions on being able to trade faster and make more money, but not nearly enough on creating the necessary transparency.’ Mr. Bänziger was head of the risk management of the Deutsche Bank during and after the crisis.
 
5
“This bill doesn't just look through the rear-view mirror to address the failures that caused the economic crisis. It looks through the windshield toward a safer, stronger and more prosperous American economy” (Dodd 2010)
 
6
It is common to think in legal terms in relationship to contracts which is also correct. For analytical purposes it is, however, more expedient to think in a set of logical algorithms.
 
7
Suppose a market value of a certain bond is declared to be x. This is actually a short form of saying that a) the bond with a certain cash-flow payment pattern under b) such and such market environment (interest rates, FX rates) and c) under the current expected probability of default has a value of x. Although the number x contains all this information, it cannot, since compressed into a single number, reveal it anymore.
 
8
Although presented in a conceptual style, the ideas put forward in this section are not just derived from theory. They are based on twenty years of practical work and experience across almost all Western countries and more than a dozen countries in the rest of the world. “Appendix B: A simple data model and process” examines the idea on a more practical level.
 
9
A short description of the Legal Identity Identifier is given in “Technical features of the Legal Entity Identifier (LEI),” (FSB 2012).
 
10
There are other challenges such as complex relationships and ensuring that the data are kept up to date. However we assume that they are taken care of elsewhere.
 
11
See for example Sect. 153 (c), (2) STANDARDIZATION—Member agencies, in consultation with the Office, shall implement regulations promulgated by the Office under Para (1) to standardize the types and formats of data reported and collected on behalf of the Council, as described in Sect. (a)(2). If a member agency fails to implement such regulations prior to the expiration of the 3-year period following the date of publication of final regulations, the Office, in consultation with the Chairperson, may implement such regulations with respect to the financial entities under the jurisdiction of the member agency. This paragraph shall not supersede or interfere with the independent authority of a member agency under other law to collect data, in such format and manner, as the member agency requires.
 
12
See Appendix A: exotic products for a discussion of outliers
 
13
It has been pointed out that this is a bad analogy since DOS is considered a bad standard by many, an example the OFR should not follow. While I agree with this objection, I lack a better example. What was achieved, while with a bad standard, was a defragmentation of a fragmented market.
 
14
Although this should be the only obvious way of dealing with such problems, it is in no way a common practice in financial institutions and especially not in regulation. Traditional regulation does not start with the input elements and then progress towards the analysis elements. Rather, it demands analysis elements (mostly a book or market value) from the member banks in order to sum them up. OFR demands a shift from the analysis elements to the input elements in order to empower the regulators to perform any analysis themselves. Regulators are not the only ones liable to this type of reversed engineered thinking. Accountants also start their thinking process with a balance sheet that represents “value”. Even modern finance falls into the same trap: courses on modern finance tend to start with a professor writing something like the Black-Sholes formula with C(S,t) = …., the value of a call option.
 
15
From my personal experience I found generally two intentions behind this tendency:
  • Protectionism: Standardization is the enemy of obfuscation. Since obfuscation pays in the financial sector, it must be fought even by those who profit from it.
  • Intellectual curiosity: Quants like exotic products. I was in many sales situations where the topic quickly turned to exotic products and how the system can handle it. Most of the time was consumed by this topic. When asking how many of the products discussed they had on the books the answer was either “a very few” or “none”. Besides intellectual curiosity, such discussions were driven by the assumption that a system that can handle exotic options can also handle simple products, which is a fallacy. I have yet to see a system specialized in exotic options that can handle day-to-day loans or even saving products.
 
16
This is probably an effect of the strong presence of trading oriented personnel in such exercises.
 
17
Most behaviour models (for example, withdrawal patterns of saving accounts) are proprietary due to the individual customer base of each bank. Nonetheless there are exceptions, especially in the area of prepayment of U.S. mortgages.
 
18
Event generating engine would be more appropriate however we stick with the commonly used term cash-flow generator. Events (in contrast to cash flow) contain the combined information covering liquidity, income, and value, while cash flows can only represent either liquidity or income/value.
 
19
Risk calculation means in many cases moving or shocking the risk factors and recalculating liquidity, value, and income under shocked or Monte Carlo conditions (a technique used to approximate the probability of certain outcomes by running multiple simulations using random variables). In some cases, such as parametric Value at Risk (VaR), it can be directly deducted and published as a code.
 
20
A short word yet on mapping of nonstandard contracts. In order to communicate nonstandard contracts, the same process as for the standards has to be gone through, albeit on an individual and repetitive basis. If there are nonstandard attributes, they must be clearly described and communicated with the potential consumers of the data. A cash-flow generating code must be made equally available. This is obviously a tedious job and one of the following results is to be expected:
  • There will be less nonstandard products, since their additional value is often small or nil and does not justify additional efforts. The need to openly declare it as nonstandard will have further deterring effects on the demand side. Special regulatory charges for such products could further discourage use.
  • If the nonstandard product is still considered valid, then it is likely that the industry will add this CT as a standard, thus keeping the system on a natural basis.
 
Literatur
Brammertz W, Akkizidis I, Breymann W, Entin R, Rustmann M (2009) Unified financial analysis: the missing links of finance. Wiley Financial Series, Hoboken
Metadaten
Titel
The Office on Financial Research and Operational Risk
verfasst von
Willi Brammertz
Copyright-Jahr
2013
Verlag
Springer Berlin Heidelberg
Buch
Financial Analysis and Risk Management

Print ISBN: 978-3-642-32231-0

Electronic ISBN: 978-3-642-32232-7

Copyright-Jahr: 2013

DOI
https://doi.org/10.1007/978-3-642-32232-7_3