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The Rise of Risk Management in Financial Institutions – Diminution of Legal Function

Business Law Today – The Rise of Risk Management in Financial Institutions and a Potential Unintended Consequence – The Diminution of the Legal Function By: Thomas C. Baxter, Jr.  After the global financial crisis, a highly respected group of financial supervisors from the industrialized world convened to consider what might have caused the worst financial crisis experienced since the Great Depression.  This group – aptly named the “Senior Supervisors Group” – concluded that a material contributing cause was what they characterized as a “colossal failure of risk management.”  The Senior Supervisors Group was not alone.  Many other bodies have taken up the same topic and reached a similar conclusion. In the 10 years since the global financial crisis ended, the financial community has responded to the identified causes of the financial crisis, adopting lessons learned and significantly reforming the financial system.  This work has resulted in a financial system with individual institutions that are demonstrably more safe and more sound than before, and a much more resilient banking system overall.  In contrast to what existed on the eve of the crisis – early 2007 – today’s financial system has considerably higher capital and liquidity, as government officials and other commentators have observed.  In addition, and perhaps even more importantly if we accept the conclusion of the Senior Supervisors Group, there has been a revolution in the discipline of risk management and in the “build-out” of processes and procedures for identifying, measuring, monitoring, and controlling risk.  In the United States, for example, one may witness the Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Obama signed into law on July 21, 2010 (the “Dodd-Frank Act”).  The Dodd-Frank Act introduced varied and different requirements for risk management, including a series of “enhanced prudential standards,” as well as governance directed at risk management requirements, like the requirement for a risk committee of the board of directors….

This article will discuss whether the rise of the risk management function has had one very specific unintended consequence – the diminution of the legal function.  To place such an important question in a proper context, this article will focus on the potential inverse relationship – it is not only that the legal function has declined in importance, but it is also that the decline has come as the direct result of the rise in risk.

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