Black swan and Pillar 2: Difference between pages

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imported>Doug Williamson
(Expand for Black Swan is relative to knowledge. Sources: The Black Swan 2007, pp40-44, MCT Reading 4.1.2 p9.)
 
imported>Doug Williamson
(Expand. Sources: linked pages.)
 
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''Risk management''
''Banking - regulation.''


An apparently unusual event of very high impact.
(P2).


Particularly one which - before it happened - was believed in error to be highly improbable, or even impossible.
Pillar 2 is the aspect of banking supervision which addresses firm-wide governance and risk management, among other matters.


Additional capital requirements may be imposed by bank supervisors under Pillar 2, depending on their evaluation of banks' internal assessments of their risks and capital requirements.


The use of the term in finance derives from the widespread historical (and wrong) belief in the Northern hemisphere that black swans did not exist.  This wrong belief was held in the period before the common occurrence of black swans in the Southern hemisphere had been reported in the North.


The concept was popularised in a 2007 book by Nassim Nicholas Taleb - "The Black Swan".
=====UK Pillar 2 supervisory reviews=====
The UK supervisor is the Prudential Regulatory Authority (PRA).


There are two main areas that the PRA considers when conducting a Pillar 2 review:


Taleb summarises the problem in risk management as "the confusion of <u>absence of evidence</u> of Black Swans (or something else) for <u>evidence of absence</u> of Black Swans (or something else)". 
(i) Risks to the firm which are either not captured, or not fully captured, under Pillar 1 capital requirements, referred to as Pillar 2A; and


This means that the existence of financial "black swans" tends to lead to systematic under-assessment and <u>understatement</u> of financial risk.
(ii) Risks to which the firm may become exposed over a forward-looking planning horizon - e.g. due to external stresses - referred to as Pillar 2B.




<span style="color:#4B0082">'''''Turning black swans white'''''</span>
=====IRRBB=====
 
Most regulators treat Interest Rate Risk in the Banking Book (IRRBB) as a Pillar 2 risk.
:Taleb points out that black swan events depend on the observer, and the information and analysis obtained and applied by him or her.
 
:Being slaughtered shortly before Christmas is a black swan surprise for a turkey; especially following 1,000 days of consistent - apparently predictable - feeding and friendliness from humans.
 
:The slaughter of the turkey is not a black swan event for the human butcher.
 
:Turkeys need to gather more information and to analyse it.
 
:''How not to be a sucker - A Black Swan is relative to knowledge - The Black Swan, 2007 pp40-44.''
 
 
 
<span style="color:#4B0082">'''''Robustness not fragility'''''</span>
 
The key message from Taleb's work is about seeking robustness and avoiding fragility.
 
:"You have to avoid debt because debt makes the system more fragile. You have to increase redundancies in some spaces.
 
:"You have to avoid optimization. That is quite critical for someone who is doing finance to understand because it goes counter to everything you learn in portfolio theory....
 
:"I have always been very sceptical of any form of optimization. In the black swan world, optimization isn't possible. The best you can achieve is a reduction in fragility and greater robustness.
 
:"You may have heuristics, but not an optimization rule. I hope the message will finally get across because I haven't succeeded yet. People talk about black swans but they don't talk about robustness, which is the real lesson of the black swans."
 
:''Living with Black Swans - Nicholas Nassim Taleb.''




== See also ==
== See also ==
* [[Fat tail]]
* [[Bank supervision]]
* [[Guide to risk management]]
* [[Basel III]]
* [[Heuristic]]
* [[Capital adequacy]]
* [[MCT]]
* [[Interest Rate Risk in the Banking Book]]
* [[Portfolio analysis]]
* [[Pillar 1]]
* [[Probability]]
* [[Pillar 3]]
* [[Stress test]]
* [[PRA buffer]]
* [[Prudential Regulation Authority]]
* [[SREP]]
* [[Stress]]

Revision as of 13:33, 11 November 2016

Banking - regulation.

(P2).

Pillar 2 is the aspect of banking supervision which addresses firm-wide governance and risk management, among other matters.

Additional capital requirements may be imposed by bank supervisors under Pillar 2, depending on their evaluation of banks' internal assessments of their risks and capital requirements.


UK Pillar 2 supervisory reviews

The UK supervisor is the Prudential Regulatory Authority (PRA).

There are two main areas that the PRA considers when conducting a Pillar 2 review:

(i) Risks to the firm which are either not captured, or not fully captured, under Pillar 1 capital requirements, referred to as Pillar 2A; and

(ii) Risks to which the firm may become exposed over a forward-looking planning horizon - e.g. due to external stresses - referred to as Pillar 2B.


IRRBB

Most regulators treat Interest Rate Risk in the Banking Book (IRRBB) as a Pillar 2 risk.


See also