Chapter 10: The Global Financial Crises: Back to Basics, Bank Supervision in Developing Countries
* Thomas Lutton and Joseph Cauthen 1 INTRODUCTION The global financial crisis (GFC) established an incontrovertible fact. Regulators in developed countries with access to the latest technology and management information systems were caught by surprise. As a group, regulators failed to anticipate the onset and scope of the GFC of 2008 and 2009. Despite a variety of sophisticated on- and off-site early warning and risk assessment systems, manned by thousands of examiners adhering to a supervision by risk (SBR) examination process, risks went undetected until they ultimately materialized as losses. Many depository and nondepository financial institutions took what turned out to be extremely risky positions. They became dangerously illiquid if not insolvent under the not-so-watchful eye of regulators and rating agencies who were supposed to be monitoring risk. Risk-based pricing, risk-based supervision, risk-based assets, and risk management overall took a convincing hit in the eyes of financial regulators in less-developed economies. Although the fundamental causes of the GFC will be the focus of research studies for many years, bank supervisors and regulators in developing countries do not have the luxury of time to address what appears to be a fundamental question. If the ‘more advanced’ safety and soundness monitoring processes proved so deficient in developed economies, what risk assessment and monitoring processes should they pursue? To place this question in context, many central banks have been struggling to implement Basel II economic capital measures. They have had difficulty in estimating the parameters of unconditional loss distributions for market, credit, and operational...
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