Senior financial supervisors from five countries - France, Germany, Switzerland, the United Kingdom and the United States - have issued a report assessing various risk management practices that banks and other financial services organizations have used that contributed to the recent turmoil in the world markets.
The report summarizes a joint review that financial supervisors from the various countries conducted this past autumn and also reflects the results of a roundtable discussion held with industry representatives on Feb. 19, 2008, at the Federal Reserve Bank of New York.
"The predominant source of losses for firms in the survey through year-end 2007 was the firms' concentrated exposure to securitizations of U.S. subprime mortgage-related credit," wrote William L. Rutledge, chairman of the Federal Reserve bank of New York, in a letter accompanying the report. "In particular, some firms made strategic decisions to retain large exposures to super-senior tranches of collateralized debt obligations that far exceeded the firms' understanding of the risks inherent in such instruments, and failed to take appropriate steps to control or mitigate those risks."
Another risk management challenge involved the firms' control over their potential balance sheet growth and liquidity needs, he noted. Some firms failed to properly price the risk of exposure to off-balance-sheet vehicles and found that they could not syndicate their holdings of leveraged loans because of reduced investor appetite, nor could they cancel their commitments to fund those loans.
The resulting effects on the balance sheets of major firms from these sources have been substantial, Rutledge noted, although the impact on capital ratios has been significantly less than the effect from the write-downs on their exposures to securitizations of subprime mortgage-related credit.
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