Research: Hiring Chief Risk Officers Led Banks to Take on Even More Risk

Risk taking by big U.S. banks exploded in the years leading up to the financial crisis, much of it coming in the form of complex and opaque financial instruments like derivatives. But why did banks get in so deep with derivatives, particularly after Washington tried to crack down on risk in the early 2000s? The rise of the Chief Risk Officer (CRO). Many banks, it turns out, responded to new regulatory and reporting demands by appointing CROs as a way to show regulators and investors that they were serious about risk management. But CROs did not reduce bank risk-taking — in fact, they became part of the problem for three main reasons: CROs grew accustomed to optimizing risk instead of avoiding it; the mere presence of a CRO gave moral license to company-wide bad behavior; and many CEO and investor incentives actually benefitted from CRO focus on derivatives.