ERM frameworks [19]

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Bullet points include: Capital arbitrage increased ‘model risk’. Exposures parked into trading book if this produced a favourable capital outcome. Others (including other banks) ‘searched for yield’, over-relying on credit rating agencies to assess riskiness of resulting structures. Risk models overly focused on recent past (hence benign) short-term volatility. Basel II overwhelmingly focused on capital and not on liquidity, i.e. ability to fund resulting exposures. Philosophical flaw: perception by (many) regulators that market was generally right and bankers understood their own business

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