An international actuaries report has
proposed a new global risk management framework to prevent future financial
crises which includes stricter capital requirements for financial institutions with
remuneration incentives focused “excessively” on the short term, and the
appointment of a country chief risk supervisor. The report, written by the
International Actuarial Association (IAA) and titled Dealing
with Predictable Irrationality – Actuarial Ideas to Strengthen Global Financial
Risk Management, calls for the introduction of
counter cyclical regulatory arrangements which require changes in capital
requirements when early warnings of bubbles emerge, and wider use of risk
management concepts at a micro level.

Such moves would ensure individual entities
such as superannuation funds and banks, as well as non-regulated entities,
anticipate extreme events and more consistently measure and report on risk
indicators, the IAA notes. Tony Coleman, chair of the IAA’s enterprise and
financial risk committee, said remuneration incentives should be linked to risk
culture to drive behavioural change. “Remuneration is a key driver of cultural
change and so we support increasing capital requirements for market
participants with remuneration incentives focused excessively on short term
results,” he said.

He said bonus-type remuneration should not be focused just
on one-year profit, but rather focused heavily on the longer term vesting of
shares in the organisation over a three to five year time horizon. This way,
even if a chief executive leaves an organisation, they may not receive the full
value of their incentives until three years after leaving the firm. According
to the IAA, risk management and co-operation between national jurisdictions
would be improved through the creation of a chief risk supervisor, whose
responsibilities would include developing an agreed risk appetite policy for
key market-wide risk indicators, and monitoring and managing those indicators.

said the role would sit between the Reserve Bank of

Australia and the Australian
Prudential Regulation Authority (APRA). Publicly reporting macro risk
indicators and facilitating risk identification and communication with
appropriate decision-makers at both the national and international levels would
also fall within the supervisor’s remit.

The IAA has put forward a number of
new “systemic risk indicators”, including: leverage in the economy (household
debt/GDP); leverage in institutions (total assets/capital); volatility,
turnover and bid spreads in major financial markets; credit spreads; growth in
derivatives markets, particularly options; major changes (especially concentrations)
in market sectors; real interest rates – actual or implied, and bonus levels
paid by financial firms.

While many of the indicators are already available,
the report argues for a more holistic approach to monitoring these risks. Trevor
Thompson, president of the
Actuaries of

Australia, said the report had
wide-reaching implications for regulators globally as they consider measures to
strengthen the financial system. “While

Australia’s banking system has
proven its robustness, we are clearly not insulated from global events,” he said.


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