April 2014 sees the beginning of a new era. An era of consequences, both intended and unintended, heralding a period of increasing centralized power, where understanding the strength of peers will determine success or failure. The month after the latest Comprehensive Capital Analysis Review (CCAR) results, as the Volcker rule becomes law and with single counterparty limits on the horizon, April will also reveal the much-anticipated fourth season of the fantasy HBO series, Game of Thrones (GoT).
Game of Thrones bears an uncanny resemblance to our real-world financial system. It contains a dominant central power (The Iron Throne), a small number of powerful houses, each of which rules over one of seven kingdoms, and then a large number of smaller houses. In case the metaphor was missed, GoT also includes a living reminder of a glorious past, and a growing external threat that demands a form of unity of the realm – or system -- to defeat.
The current regulatory drive in the U.S. (and globally) is very similar. Constructed around a Federal Reserve with increasing powers and dominated by several large global banks, it also contains of a numerous smaller banks. The U.S. financial system as a whole is also faced with external forces emanating from the euro zone, emerging economies, and demographic pressures from within. Finally, the Dodd-Frank regulations, including the Volcker rule, draw unfavorable comparisons to the Glass Steagall act of the 1930s, which is generally seen as heralding a boom time for the U.S. economy and its banking sector.
These similarities with GoT just scratch the surface. It is when we look at data and risk management that the world of Westeros, where most of the action takes place in the series, truly mirrors the U.S. banking system.
The first striking similarity is the application and use of data management and control. Current regulations put increased pressure on the already crucial data management systems. While the adage ‘garbage in, garbage out’ has long been the warning mantra of data managers, they are now faced with new demands, including:
- Reporting of trade details to the Fed
- Aggregation, calibration and reporting of data used for stress testing
The consequences of failing these data requirements could be significant, and as such, the pressure to get the data right is paramount.
In the past, failure to fully meet regulations has given way to fines and warnings, but failing the CCAR could result in constrained capital activity (M&A, dividends, etc.), and reputational risk. The reputational risk itself could extend to lower ratings for failing banks, within the internal rating systems that the Fed is requesting (in order to reduce a bank’s dependency on external ratings agencies).
The data used in GoT may not be yield curves and equity prices, but the penalty for wrongly calculating your peers’ or enemies’ strengths, weaknesses and leverages could be even more severe. It is a hallmark of the series that those in the know tend to survive the longest. The networks of spies throughout the fictional capitol city of Kings Landing and the message-carrying ravens flying throughout Westeros create a data-rich environment where management and prudent use of data determine the fates of lords and ownership of the Iron Throne itself. For instance, Robb Stark, the short-term King of the North, recognized that he could win every battle in combat, yet he was losing his war. Miscalculation of leverage and numbers ultimately led Robb to what became the Red Wedding – a scene any GoT fan could attest is a clear example of how mis-management of data and risk can be one’s downfall.
Data, while undoubtedly important, is just one part of the GoT/U.S. financial system metaphor. Banks could be described as organized structures around risk management, with that discipline being the real business of any bank. Fully understanding potential risks leads to appropriately setting risk appetites and risk-adjusted returns. The rules being pushed through when the specificities of these are encoded, and include:
- VaR-based margins
- Stressed VaR as well as standard VaR
- Stress testing and its associated data management
- Single counterparty credit limits management
- Liquidity measures and stresses
Even without the regulators forcing the new standards, risk should still sit at the heart of any financial institution. Good risk management ensures that any business being pursued is correctly priced, and incentivized. It is important to note that risk management is not risk elimination, but rather a process of exposing risks being taken, so that opportunities can be judged on equal terms, including the funding of potential losses. This improved bank strategy can even lead to more risky investments. As long as the risks are understood and priced into the profitability, this forms the basis for good risk management which directly adds value to the business.
In GoT, there are numerous examples of risk management being central to success and failure. But perhaps the best example is in the different approaches of Eddard (Ned) Stark and Tyrion Lannister (The Imp), who both serve as the ‘Hand of the King’ at different times in the series. There would appear to be no question as to who would be the most suited for this position, with Ned being one of the greatest swordsmen and well-respected lords in the realm, and Tyrion instead typically drawing ire or ridicule.
Tyrion’s acute awareness of his own weaknesses and strengths, his attention to detail and his own calculated risk management, sees him successfully defend the capitol city from attack. Remarkably, he achieves this success in spite of a lack of leadership from the throne itself during the war. Ned, on the other hand, fails to apply solid risk management techniques when he decides to confront the powerful Lannister family over succession rights when King Robert passes away. Ned’s badly placed trust and his failure to check his numbers leaves him in a poor position-- ultimately headless.
The world of Westeros, with its rich cast of characters, offers many examples of miscalculation and mismanagement of risk, contrasted with examples of excellent data utilization and smart risk management strategies. Is it surprising to think that the U.S. banking system, with its many players and pressures would relate so well to the story of Game of Thrones? One thing is clear, whether it’s banking or sword play, understanding and managing risk is a strategic keystone as the key players determine how they will win or die.
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