José Manuel González-Páramo: Rethinking risk management – from lessons learned to taking action Speech by Mr José Manuel González-Páramo, Member of the Executive Board of the European Central Bank, at the Risk and Return South Africa conference, Cape Town, 4 March 2011. * 1. *  *  Introduction  Good afternoon, I was very pleased to accept the organisers’ kind invitation to participate in this conference and to speak about a topic that at the European Central Bank (ECB) we consider of utmost relevance: How to adjust our financial risk management frameworks in the light of the lessons learned from the crisis. Indeed, the ECB has always placed a great importance on the design, development and implementation of sound risk management practices. The financial and economic crisis that started in 2007 and that continues affecting the global economy has prompted us to rethink and further strengthen the risk management function at the ECB and within the Eurosystem (consisting of the ECB and of the national central banks of the seventeen countries that have adopted the euro). Therefore, it is a pleasure to have the opportunity to share our recent experience with distinguished professionals from the financial industry, such as those present in this room. My intention is to comment upon a number of issues that may have probably been already touched upon in the previous sessions. More specifically, I will first summarise some of the general lessons for risk managers that we have learned from the financial crisis.
Those models, measures and opinions are still valid tools, but need to be used in a correct manner, and need to be complemented by other tools and, more generally, by expert judgement. Risk managers should not simply take comfort in recent historical regularities and in wellestablished standards for risk measurement. Discomfort should be their habitat. All business areas of the institution should contribute and challenge the risk management function to look at risks in a different manner and to adopt better communication strategies. We have recently lived through many “what-ifs” that almost nobody thought of, and although risk management is all about dealing with uncertainty rather than making point forecasts, our warm and placid financial models, fed with short-sighted inputs, were not capable of adequately capturing the risks that ended up materialising. In hindsight it seems unbelievable that we believed in models that were predicting that nothing terrible could happen in 99 out of 100 years, usually using less than 10 years of data to construct such prediction. In the last 100 years, not counting the recent crisis, we have experienced 2 world wars, the Great Depression and an increasingly frequent number of financial crises affecting specific sectors and regions that have often been a source of contagion. It does not take a statistician to prove that the models were fundamentally misused. It just takes common sense, but as the saying goes, this may be the least common of the senses.