U.S. and European regulators this week issued a report assessing the efficacy of risk management practices at major financial services firms during the recent period of market turmoil.

Observations on Risk Management Practices during the Recent Market Turbulence, released March 6, summarizes the results of a review done late last year of risk management practices. The review looked at 11 major global financial services firms, including banks and securities firms. It also reflects the results of a roundtable discussion that participating supervisory agencies held with industry representatives last month, noted William L. Rutledge, executive vice chairman of the Federal Reserve Bank of New York and chairman of the group that oversaw the review.

The 22-page report outlines regulators’ observations on the risk management practices that “may have enabled some firms to weather the financial market turmoil better than others through year-end 2007.” The report notes that regulators focused on the role of senior management in assessing and responding to the changing risk landscape as well as the effectiveness of each firm’s liquidity risk management practices in assessing its vulnerability to that risk and taking appropriate action. A third focus was the effectiveness of market and credit risk management practices in understanding and managing the risks in retained or traded exposures as well as in counterparty exposures, in valuing complex and increasingly illiquid products, and in limiting or hedging exposures to credit and market risk.

Participating regulators say the results of the review will support efforts of the Basel Committee on Banking Supervision to “strengthen the efficacy and robustness of the Basel II capital framework” by:

* reviewing the framework to enhance the incentives for firms to develop more forward-looking approaches to risk measures (beyond capital measures) that fully incorporate expert judgment on exposures, limits, reserves, and capital; and
*ensuring that the framework sets sufficiently high standards for what constitutes risk transfer, increases capital charges for certain securitized assets and asset-backed commercial paper liquidity facilities, and provides sufficient scope for addressing implicit support and reputational risks.

The report’s findings also “support the need to strengthen the management of liquidity risk,” which, regulators say, should be dealt with through an appropriate international forum (such as the International Organization of Securities Commissions), and for individual national supervisors to “review and strengthen, as appropriate, existing guidance on risk management practices, valuation practices, and the controls over both.” A final observation, Rutledge noted, is the need for support of efforts “in the appropriate forums to address issues that may benefit from discussion among market participants, supervisors, and other key players,” such as accountants. One such issue, regulators note, relates to the quality and timeliness of public disclosures made by financial services firms and the question of whether improved disclosure practices would “reduce uncertainty about the scale of potential losses associated with problematic exposures.”

Global regulatory agencies participating in the review included the French Banking Commission, the German Federal Financial Supervisory Authority, the Swiss Federal Banking Commission, the U.K. Financial Services Authority. The U.S. participants included the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Federal Reserve.