What is missing in management of portfolio of credits?

The JPMorgan Chase & Co. announced $2 billion trading loss on credit derivatives on Thursday, 10 May. Financial institutions use sophisticated financial modelling methodologies those involve estimation of the market price of the derivatives, the derivatives impact on the institutions’ balance sheet and macroeconomic indicators to forecast trends and values of financial products. So what is still missing in management of portfolio of credits?

Credit derivatives are used in risk management to mitigate pressure on institutions' balance sheets. Derivatives help to manage differences in asset classes, maturities, rating categories and debt seniority levels. Thus, it might seem that once credit derivatives separate ownership of assets from the management of credit risk, the clients’ relationship management become more significant than due diligence and estimation of credit risk. However, derivatives transfer but not eliminate risks.

So if risks are determined through probability distributions the following consideration might be quite important. Widely used risk management systems or attempts to find a universal solution - standardized risk management methodologies narrow selection of possible decisions and transform firm specific risks associated with company’s unique decision making into the systematic risks those affect the overall industry.

Systematic risks are created once the majority uses the same risk management techniques – similar credit derivatives solutions, thus further losses are coming up.