DIFC Economic Forum checks on GCC risk assessment

Greater transparency would significantly aid risk managers in the GCC countries, as would more independent regulators and businesses. Nonetheless, the personalized professional relations that bankers enjoy with their clients in the region means that risk assessment can often be based on solid knowledge of clients' intent and operation.

Pierre Cailleteau opened the discussion with his perspective on the state of risk assessment, that is, how to judge the risks you face in extremely - and increasingly - complex environments. "Risk managers," he said, "face a very different task from financial accountants. Risk assessment is probabilistic and imprecise, with levels of confidence as a percentage, say 80%" on how events could effect some investment or loan. In contrast, accountants can employ "precise measurement tools" to balance sheets: either there is a profit or loss, x amount of debt, etc. "Somehow," he argued, "we must better integrate these two methods."

To evaluate the state of his profession, Cailleteau attempted to describe "what we know, what we should know, what we think we know, and what we don't know."

First, he said,

"We know that there are a number of financial innovations impacting risk, leveraging is high, opaqueness exists, and perverse events occur."

Second, "we should know more information that would help us to assess risks and how to select what is relevant." The risk assessment profession needs to enhance transparency and intelligibility. "Only that way," he said, "can we match the quantity of information with its quality."

Third, according to Cailleteau, "we think we have a pretty good idea of contingent liabilities," that is, the precision of the risk calibration. For example, he explained, "we know some sovereign government will intervene to support a given corporation, but we have to somehow measure the impact of that action."

The list of what he didn't know was long, including:

•Who bears the risk in the financial world? As we head from a bank-dominated financial system to one that is market-based, risk is dispersed. But how,? Who will be touched by some event? "Where is the risk is and how it is dispersed," he said, "cannot be known and never will be. The notion is too complex." The larger the uncertainty, he argued, "the more capital buffers we need in the system."
•Correlation, contagion, and spillover from one domain to another are also virtually impossible to discern clearly.
•3) Political risk is also an unknown that cannot be calibrated or measured with any degree of accuracy. "We make educated guesses," he admitted.
•Cailleteau was also uncertain how risk managers should "disentangle structural and cyclical factors." Cyclical events, he said, tend to be more controllable than structural ones, which have deeper causes.

In conclusion, Cailleteau described his profession's understanding of completely unpredictable events. "We call them 'black swans'," he said. "They occur outside of our expectations and experience." How, he asked, can black swans be better taken into account? While war and terrorism remain risks in the region, the panelists agreed, their impact had to be taken into account, but is highly unpredictable.

In the view of Georges El Hage, it is useful to distinguish what his firm wants to do in the long term versus the short term.

"If you are committed to a community and know it," he said, "then you can ask what type of business you want there in the long term." Moreover, the existence of "risk in one country or region", he said, "makes us assess everything more closely, more conservatively."

Arab banks, according to El Hage, "are very close to their customers. We understand their businesses, see what is happening to them everyday, and know what they want to do...We develop a feeling for risk in that way. It is very personal."

In conclusion, El Hage argued that in risk assessments, attention must be paid to both the numerator - expected losses at the time of the loan - with the denominator, or the amount lent out. "That is black-swan trouble," he believed, and if it occurs, "you will lend more, so you need to look at both sides."

From the global bankers' perspective, Robert Scanlon argued that his institution needed to understand the government, the local economy, and the extent to which they could depend on the rule of law. "We need more transparency," he explained, "and governments need to remove themselves from the working of the economy."

At the present time, he believed, governments remained very involved. His group's standard procedure, he said, is to look at companies as stand-alone entities with independent strategies. "If they are doing badly," he continued, "then we consult governments about what they intend to do." In particular, he worried about the number of aircraft being purchased by the airline company of the United Arab Emirates. "It will create a horrific economic weight into the future," he advised.

In conclusion, the panelists agreed on the need for new regulations to enhance transparency and solvency requirements. The Basel II accord, they noted, could help in this respect, in particular regarding the internationalization of accepted standards, which could be brought to the GCC countries. "You can't anticipate a problem," Scanlon concluded, "if you don't look at it. If you discuss it early, you may be able to do something. The greatest danger is to miss it."