The model bubble

28 March 2007 By Martin Hutchinson

60% of institutions use this statistical method to keep tabs on how much money they might lose. It relies on overly optimistic assumptions. The model says that things go wrong in isolation. But in finance, troubles tend to feed on each other.

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Deloitte's annual Global Risk Management Survey showed that 84% of the 130 financial institutions surveyed have a Chief Risk Officer in place, who reports typically to the Chief Executive Officer or the Board. While 73% of institutions believe their risk management practices are effective for market risk, credit risk and liquidity risk, only 47% considered themselves effective in managing Information Technology risk, 43% for operational and vendor risk and 35% for geopolitical risk.

60% of institutions in the Deloitte survey use ValueatRisk for fixed income, foreign exchange and equity, while 41% use VAR for credit derivatives.

Deloitte expect that once the fixed floors of regulatory capital mandated by the Basel II regulations are removed (currently expected in 2010), Basel II's capital requirements for the most sophisticated institutions will descend to the levels mandated by VAR and equivalent risk management models, which are usually significantly less than the current Basel II requirements.

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