Post-Crisis Era Dawns With Risk Awareness
By Kim Tae-gyu
People have different preferences for risk taking but conventional wisdom is that they tend to dislike any. That is particularly the case for investors, who want to avert huge variations in their expected returns.
To put it another way, the phrase ``high risks, high returns'' is what investors learn as soon as they enter the market. But what's the use of the high returns if they cost a heart attack along the way?
Ahead of the global financial crisis that shook the world last year, however, risk preference appeared to have changed dramatically as everybody took prohibitively high risks in the mid-2000s.
Mortgages, including sub-prime ones, were ubiquitous, super-detrimental derivatives were traded on the over-the-counter markets and leveraged buyouts were prevalent across the world.
Yet, the economic turmoil changed the risk preference once and for all toward a very conservative direction and observers point out the buzzword in the financial market would be risk management for the time being.
``The pendulum is swinging fast toward the risk management and the trend is highly likely to continue in the foreseeable future,'' Shinhan Financial Investment economist Lee Sun-yup said.
``Financial regulators or policymakers are also expected to put the risk management on the front burner as amply demonstrated by the global cooperation to monitor huge financial institutes,'' he said.
The Samsung Economic Research Institute (SERI), a private think tank affiliated with the Samsung Group, concurs.
``The conservative atmosphere will prevail in the financial segment. The Bank for International Settlements (BIS) ratio will become so important as a decreasing number of people are ready to take risks,'' SERI researcher Park Hyun-soo said.
``In particular, regulators are set to come up with strong oversight. This will beef up the conservative atmosphere down the road, at least the next five to 10 years,'' Park said.
The BIS capital adequacy ratio measures the financial soundness of a specific bank by comparing its capital to risk-weighted assets. A bigger BIS ratio represents better status and vice versa.
Typically, 8 percent is regarded as the benchmark but lenders have tried to crank up the ratio to higher than 10 percent in the aftermath of the financial distress.
Regulatory Systems ― Supervisory College
As far as the regulators are concerned, one of their top priorities appears to prevent the recurrence of the Lehman Brothers debacle, which collapsed last September due to a huge pile of debts.
Toward that end, regulators have teamed up to forge an international network of supervisory colleges, which take charge of overseeing cross-border financial groups, dubbed ``systemically important financial institutions.''
The Financial Stability Board (FSB) recommended regulators to form the supervisory colleges for 34 systemically significant financial firms and such frameworks were set up for most of the large-sized outfits including insurers and banks.
As a successor to the Financial Stability Forum, the FSB itself is the brainchild of the G20 meeting, which was formed late last year as a part of efforts to fight the unprecedented financial swoon.
``The bankruptcy of U.S.-based Lehman Brothers affected not only the United States but also Europe and Asia. But regulators failed to deal with the cross-border event in a preemptive way,'' Financial Supervisory Services official Ban Young-hee said.
``To address this problem, financial regulations are required to cross borders in line with large-sized financial companies, which go multi-national. The idea zeros in on the supervisory colleges,'' he said.
In other words, the supervisory colleges are all about the risk management beyond national borders.
Decline of Freshwater Economist
SERI researcher Park said the paradigm shift toward stressing risk management is in tune with the theoretical change in economics ― the so-called ``freshwater'' economics declines while ``saltwater'' economics emerges.
Freshwater economics sprang up in such places as the University of Chicago and the University of Rochester, which are situated close to the Great Lakes. As seen by the monetarists at the University of Chicago, they are against government intervention.
In comparison, the saltwater school has been developed in universities including Princeton, Yale and Harvard, which are located near the east and west coast of the U.S.
Having something to do with Keynesians, they are inclined to buy the idea that the government can play a crucial role in the economic system.
``Market-oriented economic ideas have taken the central stage since the early 1980s led by the freshwater economists but they are now losing prowess in the wake of the crisis,'' Park said.
``By contrast, saltwater economists are gaining clout with the government shelling out big bucks in the pump-priming measures. Have a look at Prof. Paul Krugman at Princeton,'' he said.
Krugman, who won the Nobel Prize in economics last year amid the financial crisis, have claimed the importance of the government's proactive role.
In Korea, a self-proclaimed Keynesian even became prime minister of Asia's fourth-largest economy where a set of stimulus packages have been carried out.
Chung Un-chan, the former head of the Seoul National University who gained a Ph.D. in economics at Princeton, became the second-in-chief of late.
``The change of the academic landscapes buttresses the paradigm shift that is now underway in the financial industry. As market-can-solve-it-all ideas fade away, few economists would urge the government to allow excessive risk-taking,'' Park said.
Other Notable Changes ― Commercial Investment Bank
As other notable changes are triggered by the financial tsunami, many market watchers pick the advent of commercial investment banks, which came into existence through mergers between investment banks and commercial lenders.
Before the financial crisis, there were five big investment banks of Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns.
Lehman Brothers went under while Merrill Lynch and Bear Stearns were acquired by commercial banks. Goldman Sachs and Morgan Stanley adopted a holding company system.
In a nutshell, all of the big five were forced to change abruptly to stay afloat. Many European investment banks also followed the lead of their U.S. rivals over the past year.
``I am not sure whether or not the heyday of investment banks would come. But if so, they will not be able to splurge with super-high leverage as they did before the recession because the after-crisis world is different from one before the crisis,'' a Seoul analyst said.