February 15, 2009
Krawiec on the Rogue Trader
The Return of the Rogue, by Kimberly D. Krawiec, University of North Carolina at Chapel Hill - School of Law, was recently posted on SSRN. Here is the abstract:
The rogue trader - a figure that captured public attention in the 1990s - has returned to the spotlight, largely due to two phenomena. First, market volatility stemming from problems in the U.S. mortgage market spilled over into stock, commodity, and derivative markets worldwide, causing large losses at many financial institutions and bringing to light previously hidden unauthorized positions. Second, the rogue trader has returned to prominence due to domestic and international regulatory changes that have forced banks worldwide to focus more attention on operational risk, an important component of which is rogue trading.
Although critics have raised a number of objections to the Basel II operational risk provisions, few have examined those requirements as a species of enforced self-regulation. This Article contends that, of the many regulatory options for addressing operational risk available to the Basel committee, it arguably chose the worst - an enforced self-regulatory regime that is unlikely to substantially alter the success with which financial institutions manage operational risk. That regime also carries with it the threat of high costs, a false sense of security, and perverse incentives. Particularly with respect to the low frequency, high impact events - including rogue trading - that are the greatest operational risk concern to many, attempts at enforced self-regulation are unlikely to produce capital set-asides sufficient to avoid threats to bank stability and soundness. This is because those financial institutions with the highest operational risk are unlikely to credibly assess that risk and set aside adequate capital under a regime of enforced self-regulation.
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