jose manuel gonzalez - paramo : rethinking risk management – from lessons learned to taking action speech by mr jose manuel gonzalez - paramo, member of the executive board of the european central bank, at the risk and return south africa conference, cape town, 4 march 2011. * 1. * * introduction good afternoon, i was very pleased to accept the organisers ’ kind invitation to participate in this conference and to speak about a topic that at the european central bank ( ecb ) we consider of utmost relevance : how to adjust our financial risk management frameworks in the light of the lessons learned from the crisis. indeed, the ecb has always placed a great importance on the design, development and implementation of sound risk management practices. the financial and economic crisis that started in 2007 and that continues affecting the global economy has prompted us to rethink and further strengthen the risk management function at the ecb and within the eurosystem ( consisting of the ecb and of the national central banks of the seventeen countries that have adopted the euro ). therefore, it is a pleasure to have the opportunity to share our recent experience with distinguished professionals from the financial industry, such as those present in this room. my intention is to comment upon a number of issues that may have probably been already touched upon in the previous sessions. more specifically, i will first summarise some of the general lessons for risk managers that we have learned from the financial crisis. i will then discuss how the risk management function needs to be adjusted to the new economic and financial environment. finally, i will quickly describe some of the challenges ahead for central banks as risk managers. 2. lessons from the financial crisis so let me start by referring to some of the key lessons from the financial crisis. from the selection of topics for this conference, with its focus on innovations in risk management and reforms to the regulatory frameworks, it is clear that we have learned very valuable lessons from the crisis. however, the fact that we are drawing lessons from the crisis is not only illustrated by the novelty of the issues under discussion, but also by the different approaches taken to examine topics that were regularly discussed in risk and return conferences in pre - crisis times. as examples of topics that were “ usual suspects ” in past conferences, but are now presented in a different manner, let me mention two specific issues : ( 1 ) the broadening of investment universes, and ( 2 ) the advantages in terms of yield pick - up of investing

##balances. similarly to the pre - crisis situation, advanced economies ’ indebtedness would be financed with capital flows from emerging economies. this implies not only a massive misallocation of global capital, but also undermines the credibility of any initiative to rebalance savings and investments both within and across the main regions of the global economy. as a result, it risks creating – once again i should say – delusional expectations in financial markets about the sustainability of imbalanced financial and trade flows. policy discussions are likely to return to where they were a few years ago. the crisis has given us the opportunity to question their analytical and practical basis. there are concerns regarding the burden of adjustment on deficit countries and its impact on the world economy. if debtor countries adjust internal imbalances and raise national savings – thus avoiding the scenario of resurging global imbalances – which country would then act globally as the consumer of last resort? in other words, can we avoid a scenario in which there is protracted slow growth across all regions of the global economy until imbalances are eliminated? admittedly, this is not a new question, but it is more pertinent than ever. the typical answer is that, in order to avoid the slowdown, surplus and, in particular, creditor economies should rebalance growth within their economies by increasing domestic demand, strengthening non - tradable sectors and reducing reliance on export industries. thus the policy recommendation to surplus countries is to stimulate domestic demand, in particular through fiscal policies or structural reforms aimed at reducing the level of net savings. the problem is that surplus countries are in surplus in the first place either because they are fiscally more conservative, at least compared with the more profligate countries – and rightly so i should add – or are facing a situation in which private savings are very high and might even increase if public dis - savings were to rise. since surplus countries are reluctant to embark on expansionary domestic demand policies, the correction of payments imbalances is faced with some form of asymmetry, a situation that is often disliked by deficit countries. at the global level it has at times been used by the latter as an excuse for delaying adjustment. global imbalances are the result of a lack of policy coordination. it seems to me that we need better economic analysis in order to address this issue. first, we need to understand whether a given level of world growth, if achieved through unsustainable