In the banking industry, for example, statistical and computational analyses developed for evaluating exposures to market risk led, over the past decade or so, to the application of similar techniques to credit risk. Indeed, the introduction of increasingly reliable estimates of the drivers of credit risk, such as the probability of default, led to many of the proposals that form the basis for the Basel II bank capital framework, as I will discuss in a few minutes. The Joint Forum found that the “ultimate expression” of risk aggregation is the summation of many types of risk into a single risk measure. This measure, often called “economic capital,” estimates the amount of capital a firm requires to protect itself against all risks with a certain degree of confidence. But the benefits of developing more aggregated measures of risk across diverse business lines are especially appealing to complex financial organisations whose activities span many kinds of activities. 2  BIS Review 32/2004  As a result, it is not surprising that large, mixed financial conglomerates have tended to invest the most in the development of economic capital estimates. III. The structure of financial supervision  The two trends in the financial services sector to integrate risk management into a dedicated function and to aggregate risk measures into a single measure of economic capital form the first part of the “virtuous circle.” These trends are influencing much more than the behaviour of individual firms. They are similarly influencing the structure of financial supervision.
Integration of the risk management function  One of the most notable advances in risk management across all three financial services sectors is the growing emphasis on developing a firm-wide assessment of risk. This constitutes the first trend in the Joint Forum’s report. Improvements in technology and telecommunications have made it easier for firms to gather, collect, and analyse large amounts of data on their exposures and business activities efficiently and increasingly in near “real time.” To make the best use of firm-wide data, some organisations have established a dedicated risk management function to foster more highly integrated and systematic approaches to risk measurement and management. The risk management function typically promotes the use of common risk measures across business lines. It can then report the firm-wide risk data to senior management. Reports may range from daily updates on “value-at-risk” trading positions to regular, if less frequent, compilations of the results of stress testing. The broader use of shared definitions to guide the comprehensive reporting of risk across the firm enables the integrated risk management function to identify concentrations of risk. Concentrations matter particularly when various business lines within the firm have different kinds of exposures to the same counterparty. Comprehensive and consistent reporting helps, moreover, to ensure that the firm is aware of the wide range of risks to which it is exposed; that it understands the relative importance of various risks and how they may interact; and that the firm is less likely to ignore material sources of risk.