RISK CHIEFS and CEOs from many of the world’s major financial institutions say lax risk management standards in the face of “favourable market conditions” and strong competition was one of the primary reasons the credit crunch occurred.

But the committee of the Institute of International Finance (IIF) – which is tasked with determining the financial sectors response to the credit crunch – has also joined the chorus of groups calling for greater oversight of credit rating agencies.

The IIF, which counts 380 financial institutions as its members, formed a Committee on Market Best Practices in October last year and released its findings last month in a 213-page report.

“Let me emphasise at the outset that the financial services industry recognises its responsibilities,” Josef Ackermann, chair of the board of directors of the IIF, said.

“We acknowledge the serious weaknesses in business practices across a range of financial institutions that developed in the run-up to the turmoil in an environment of strong global growth, ample liquidity and low interest rates.”

In a speech to the US National Press Club, Ackermann, who is also chair of Deutsche Bank AG, outlined the financial industry’s plan to address the global financial crisis.

“Risk management is the centrepiece of our report, and, I must say, for good reasons,” he said. Risk, he said, needed to be taken to remain competitive, but “the right balance” also had to be struck between taking on too much risk and not enough.

He said that the complexity of global markets and the investment products created to take advantage of low interest rates had made effective risk management more difficult to achieve – but that was not an excuse.

“As challenging as risk management has become, it is, of course, within our power to get it right. In fact, it is not our lack of technical capability in risk management that caused the trouble,” he said.

“It was, rather, a growing laxity in risk management practices in recent years, in the context of the favourable global economic and financial environment. The turmoil that ensued made the need to restore high standards in risk management practices absolutely clear.”

Ackermann said chief risk officers needed to work more closely with CEOs and other members of senior management to ensure a consistent and comprehensive approach to “firm-wide risk management” was taken.

“One of the most important tasks of senior management and the board in the risk management area is to ensure that a robust risk culture pervades throughout the firm and that, against this backdrop, a well-understood risk appetite is articulated,” he added.

“This should take into consideration all types of risk …but also those arising from the firm’s relationship to off-balance sheet vehicles.”

The Principles of Conduct and Best Practice Recommendations contained in the report highlight: the need to make it clear that senior management and the CEO are ultimately responsible for risk management; the need to develop a “robust risk culture”, including setting the firm’s risk appetite; and ensuring it is adopted throughout the company and continually monitoring the performance of the strategy.

The report also said that the “responsibility for risk management should be assigned at a senior level”, to either a chief risk officer, or equivalent position. It said they should have sufficient seniority, voice and independence and the ability to influence key decision makers.

The report also recommends incentives should take into account the performance of the firm and incentive payments and pay in general shouldn’t “induce risk-taking in excess of the firm’s risk appetite”, and that bonuses should be “carefully related to the timing of risk-adjusted profit”.

Some of the recommendations

? Boards and CEO need to embed a firm-wide focus on risk and make clear

that senior management is responsible for risk management and develop

robust risk culture.

? Set basic goals for risk appetite and strategy and monitor how performance

against such strategy evolves over time

? CRO should have the ability to influence key decision-makers in the firm

? Ensure RM does not rely on a single risk methodology, and analyse group-

wide risks on an aggregate basis.

? Integrate areas such as credit, market, operational, liquidity, and reputa

tional risk

? Ensure the governance structure that has been adopted is implemented in

managing day-to-day business.