Striking the right balance in risk-management and capital-allocation decisions.
The collapse of global credit markets exposed profound flaws in banks' management of risk and capital, papered over by soaring growth.
By now, the problem is fairly well known. With investors hungry for higher returns and short-term growth, bankers rushed to oblige, placing their trust in "black box" models to control risk as they worked to boost earnings. They created exotic new products and added debt that moved them rapidly up the risk curve. Incentives helped fuel the excess, rewarding managers for hitting short-term performance goals that encouraged excessive risk taking. Meanwhile, the risk-control tools they relied on to guard against dangerous exposure provided a false sense of security. Banks thought they had sound risk control mechanisms in place, when in fact they only had pieces with no end-to-end decision-making processes.
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