Bank Failures: The Limitations Of Risk Modelling

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Executive Summary

This paper argues that overconfidence on the part of bankers and regulators in mechanical risk management models is an important and distinctive driver of bank failures in the current crisis. Following an introduction which explains why this matters and how it is central to the crisis, Section 2 presents case studies of individual bank failures and losses in which this overconfidence and its consequences are illustrated. Each of the chosen cases illustrates one of the four distinctive failure categories in the early phase of the crisis: the diversified survivors; those too opaque to survive market doubts; those that gambled and lost; and over-leveraged mortgage lenders.

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