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  • As a point of reference the FSA backed tracked on principles based regulatory guidance soon after the 2008 financial markets collapse.  

    The main difference between principles based and rules based risk management is that principles-base risk management is focused on general guidance regarding risks inherent to an organization as well as approaches one may take to mitigate those risks.

    Rules-based risk management is more authoritative in nature.  As opposed to guidance, rules based risk management has specific mandates for actions to be taken to address a codification of risks.  The problem with principles-based risk management is the seriousness taken in addressing risks.  The fallacy of the FSA's principles-based regulatory regime was that the guidance was so vague as to apply no real steps to be taken to manage risks.  The lack of clear guidance left it up to the practitioner to decide what steps to take in order to "comply".

    On the other hand, rules-based risk management is too rigid.  The rules-based approach boxes one into a formulaic set of requirement that appear to address specific risks but instead mandates a "one size fits all" approach that is ineffective because it does not address the nuisance in each business and the types of risks one assumes.

    The more effective approach is a decision management based risk management approach.  This approach allows for flexibility and assesses how a firm chooses to manage risks based on the profile of each firm.  For example, Does the firm have a well defined risk profile?  How was the risk profile created?  Who is responsible for accepting risks and at what level or magnitude of risks is allowed at each level in the organization?  

    Understanding how risk management decisions are made and by whom allows regulators and business leaders to "manage" risks on both a granular level and at the 30,000 foot level.  Accountability for risk management becomes crystal clear and mistakes become learning opportunities not subject to finger pointing. 

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