Risk Management Approaches and Lessons LearnedFrom the 2008 Global Financial Crisis

Abstract

The 2008 Global Financial Crisis (GFC) highlighted inherent inadequacies in existing financial institutions and regulators' risk management practices, which caused extensive disruption to the global economy. The purpose of this study was to review the practices prior to the GFC, identify systemic weaknesses and appraise the success of subsequent reforms by applying a mixedmethods approach. Quantitative analysis covered significant financial indicators such as leverage levels of above 30:1, Tier 1 capital levels of less than 6%, rising non-performing loan levels from 2% to 12% and liquidity coverage ratios (LCRs) of below 100%, whilst governance and cultural perspectives were examined via qualitative case studies. The analysis shows that undue reliance on value-at-risk (VaR) models, poor incentive alignment and poorly coordinated regulators led to an unsustainable system. Reforms applied post-crisis; adoption of enterprise risk management (ERM), introduction of Basel III capital regulations (Tier 1 10%), improvement in liquidity buffers (LCRs of 100%) and enhancement of governance structures, show improvement in resilience and the reduction of risk adjusted losses by between 25% and 30% in well-capitalized institutions. Conclusions illustrate the importance of both quantitative and qualitative analyses and how the importance of culture (ethical risk aware attitudes) transparency and cross-border regulatory cooperation is paramount. These results can provide guidance for managers and policy makers and offer forward-looking, system-wide oriented solutions to risks that would apply not only to the financial sector, but also the wider non-financial sector.