Supervision on Supervision

On February 1 2013, the Dutch Minister of Finance, in close consultation with the Dutch Supervisor 'De Nederlandsche Bank' (DNB), announced he nationalized the Dutch Bank-Insurer SNS Reaal.

Intervention was necessary to prevent grave threats to the Dutch financial stability and economy.

This intervention shows again that the European stress tests fail, as was already predicted in a Quartz article called "Forget the stress tests: Europe’s banks are a worrisome mystery" on October 2, 2012. Risk managers have to to a better job. Work to be done!

Role of the Supervisor
The intervention also raised the question about the role of the Dutch supervisor DNB in this debacle. Officially the (Dutch) Minister of Finance is responsible for the supervision on the national supervisor. In practice this role is delegated to the national 'Supreme Audit Institutions' (SAIs).

A special  European Committee Working  Group assessed the scope of the mandate of Supreme Audit Institutions (SAIs) and its proper functioning with respect to the main financial supervisor  (FSA)  for
prudential oversight on banks.

Thirteen (of the twenty seven) European countries participated in the SAIs research.

Three aspects were analyzed:

1. Mandate: Has the local SAI a mandate to audit the supervisory role?
2. Access:  Has the local SAI actually access to audit bank files of the supervisor\supervisor
3. Test: Did SAI successfully test the completeness of the bank files

Here are  that are disappointing results of the work group for the main 11 countries:

Yes* = Yes , with condition of confidentiality

Conclusion

Although a general approach of (SAI) supervision on (Supervisor) seems useless and even silly, it's clear that the current supervisory grip and transparency is undeniably inadequate.

In this case, we certainly need a strong supervision on national supervisors in Europe to prevent accidents like SNS. In other words: Back to the old 'Four Eyes Principle'...


Finally
In a letter to the Dutch  House of Representatives the Dutch SAI states:
"The Council of Ministers agreed to the introduction of a European supervisory mechanism for banks, with a central role for the ECB, on 13 December 2012. 

To safeguard the information position of the European parliament and the member states, the European Court of Auditors should be able to audit the supervision exercised by the ECB.

The European Court of Auditors' current mandate does not allow it to do so. This creates an audit gap at European level: arrangements are not in place for the independent audit of the ECB's organisation and exercise of its supervisory tasks and authority. "

Links
- State of the Netherlands nationalises SNS REAAL
- Forget the stress tests: Europe’s banks are a worrisome mystery
- Points for consideration in the Dutch House of Representatives
- Points for consideration in the Dutch House of Representatives (Dutch)
- 4 Eyes Principle Cartoon

U.S. Inflation 1666-2012

As promised, a nice Mathematica overview of U.S Inflation history.

View and play around with these inflation data to 'grasp' inflation long and short term behavior...

Download the Mathematica CDF player if you haven't already, it's well worth it....

If you can't load the application on this blog, or the panel range becomes wider than the width of the blog column, go here: Stand alone U.S. Inflation website

SMPLFCTN

As an actuary, you probably grew up with that famous quote of Einstein:

Everything Should Be Made as Simple as Possible,

But Not Simpler.

However, as 'Quote Investigator' shows, there is no direct evidence that Einstein crafted this aphorism...

Hmmmm.... Never mind.... as this quote is clearly redundant and therefore can be simplified....

So, it's enough to stick to the subjective concept of 'keep it simple'.....

'Simple', simply means 'easy to understand'.  

If we would try to present or explain something 'too simple', we are in fact making it harder to understand and therefore 'more complicated'.

Example

If we try to explain that we can estimate the area of a circle (approx. 3.14159...; radius=1) in practice by a n-sided polygon, a three year old child ;-) will buy your simplification in case of  a 12-sided polygon.

Oversimplified, or Worse: Desimplified
In case of a square (4-sided polygon), he'll probably raise his eyebrow, as you oversimplified the topic. And in case of a triangle you'll probably have lost him completely. You desimplified and thereby complicated your case to the opposite of what you untended : a clear understanding.

Simplification Criterion
Keep in mind that, like in the case above, you must develop a criterion when you simplify things. In the above example, a criterion could (e,g) be that the area of the polygon shouldn't differ more than 10% of the original circle and must have a relative simple (round) answer. This criterion would lead to a 12-sided polygon as an adequate simplification example.

And of course, we have to test this ex-ante 12-sided criterion in practice by means of a questionnaire.

Simplification is Complicated
However, 'simplification' as process, is not simple at all. In practice simplification can be used to reduce things that are:

1. complicated (not simple, but knowable) or 
2. complex (not simple and never fully knowable) 

In an article called 'Simplicity: A New Model',  Jurgen Appelo tries to simplify the complex world of simplicity linked concepts. He states that simplification means 'make understandable', which means moving it vertically, from the top of the model to the bottom in the following Appelo-illustration.

Anyhow, there's much to learn about simplicity related topics.....   

Let's finish with an excellent example of a need for simplification : 

Simplifying 'Complexity of financial regulation'
In an excellent presentation, Executive Director Financial Stability of the Bank of England,  Andrew Haldane, pleas and argues to simplify financial regulation.

It turns out that the growing number of regulation rules and principles (e.g. Basel III) has an adverse effect on taming the crisis.

Also the traditional Merton-Markowitz approach that assumes a known probability distribution for future market risk and enables portfolio risk to be calculated and thereby priced and hedged, offers no help to solve the current crisis.
Haldane concludes that "More simple regulation  based on 'Optimal choice under uncertainty' is necessarily. Haldane concludes:

"Modern finance is complex, perhaps too complex.  Regulation of modern finance is complex, almost certainly too complex.  That configuration spells trouble.

As you do not fight fire with fire, you do not fight complexity with complexity.  Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity, not complexity. 

Delivering that would require an about-turn from the regulatory community from the path followed for the better part of the past 50 years.  If a once-in-a-lifetime crisis is not able to deliver that change, it is not clear what will.  

To ask today’s regulators to save us from tomorrow’s crisis using yesterday’s toolbox is to ask a border collie to catch a frisbee by first applying Newton’s Law of Gravity."

Haldane's (2012) presentation called 'Ensuring Long-Term Financial Stability', or more popular 'The dog and the frisbee', is a breakthrough in managing, modeling and controlling Risk and financial future results. It's a MUST read for actuaries and board members in the financial industry.

Finally
From now in, actuaries can simply start 'helping' as a border collie!

Sources/Links
- The dog and the frisbee
- Risk models must be torn up
- Mathematica: Play with Polygons
- Einstein's Simple Quote Investigated
- Complex versus Complicated
- Complicated vs complex vs chaotic
- Simplicity a new model