Tag Archives: compensation

LIBOR Overhaul

LIBOR Overhaul

Banks + Gangsters = Banksters

It has been announced that the LIBOR rate will undergo an overhaul. Some of the changes I picked up were:

  • It will be administered independently, not by the BBA (British Bankers Association)
  • The admistering body will fall under regulation of the FSA (Financial Services Authority); therefore, future rate fixing  could result in jail sentences for the offenders
  • The rates will be audited, so banks will have to justify the rates put forward, based on actual transactions
  • The number of banks submitting rates will be increased
  • The number of currencies and interest rates involved will be drastically reduced so as to concentrate on the rates most used by investors and borrowers

The way in which the rate is determined, which had been thought may be changed will remain the same. It will be based on daily estimates by panels of banks, of the interbank borrowing rate. Although this method had been criticised earlier as not being objective, I guess the issue that was highlighted earlier is that in thin markets (e.g. in depressed economic conditions) too few or no trades take place, making it necessary to have an estimate.

This seems like a step in the right direction. I wonder if more reforms are to come to the banking industry. Many other questions are still worrisome. Are some banks too big to be properly managed? Do appropriate cultures of good governance exist within these organisations? Will the compensation structure be changed sufficiently to disincentivise ruthless risk taking? These concerns linger.

Quants, Risks and After-Work Drinks

Carpet at Marina Bay SandsI attended an after-work drinks event recently, attended mostly by quants. It was intriguing for me to enter this world for a while.

I am not a quant, though, given my background (science, finance, risk, business) there is some chance I might have gone that route, given the right influence, had I stumbled upon this world when I was choosing career paths a long, long time ago. Nevertheless, I’m not one now but it’s always interesting to discover new worlds.

There was no doubt, this was a bunch that were passionate about what they do, launching every now and again into discussions about various models, the gammas, thetas, vegas and the rest of the greeks. Contrary to popular belief, I didn’t find this group nerdy or geeky – they engaged in lively chatter with the very few non-quants, and had a genuine interest in travel, hobbies, education, volunteer work, and making the world a better place.

What I perhaps did find a little disturbing was that dealing with risks, to this group, seemed mostly about problems with the models, and improving the models. The risk management problems were about technical problems – market risk, credit risk etc, so the models needed to be improved. Hang on, but what about all the other contributing factors, I thought – compensation design, miscommunication, groupthink, thinking short-term (shortsightedly) to keep shareholders happy and the more commonsense stuff? These must be for other people to deal with, I gathered.

We all (quants or otherwise) love our comfort zones – after all we are all uniquely wired up, aren’t we? I enjoyed the evening – the company and the drinks – but couldn’t help coming away thinking risk management is still happening in silos despite all the talk about it needing to be all-encompassing recent years.

The Neuroscience of Risk Taking

It is good to hear that research is ongoing on the link between brain chemistry, biology and genes on risk taking behaviour (see “The American Banker”, 18 August 2012). I have often wondered why courses on risk management discuss models, complex mathematics, markets, operations etc. at length but stay silent on the topic of what, in an individual’s chemical make-up,  triggers extreme risk-taking behaviour and how to address this. (Surely this has to be among the most obvious and directly related of factors.) Perhaps the science has not been sufficiently developed to be made useful in practice – we hope some time in the future it will be.

In “The Hour Between Dog and Wolf” – by John Coates, reference is made to the question asked, “why do bankers (traders) take such stupid risks?”, and the reply was along the following lines – “we get a thrill from risk….a hot streak releases a chemical high….this is where the Master of the Universe feeling sets in. It’s euphoria”. It is quite the opposite of euphoria for those who suffer the widespread consequences when things don’t go so well. One suggeston put forward there is for more ‘biological diversity’ among traders – something we hope the ongoing research will help ascertain the benefits of. As alluded to in the ‘American Banker’ article, appropriate compensation design is also critical, to curb extreme risk taking for short term results.