schoolchildren. This produced most comprehensive data on child obesity, revealing that:
● More than 40% of Arkansas children are obese or at risk of becoming so, and
● This 40% compares poorly to the national average, which hovers around 30%, which is in any case too high.
Moreover, children are not alone in obesity. More than 60% of Arkansas adults are overweight, adding to the state’s chronic health ailments, induced obesity and smoking – and from there to high health costs. This accounting led Mike Huckabee, the Governor of Arkansas, to a meta-investigation that is statistically an application of Pareto’s law: 5% of the state’s Medicaid cases use up 50% of the state’s Medicaid budget, standing at $3 trillion per year.
These references find a vast domain of implementation in accounting and in risk management. Applied to compliance, Pareto’s law assists in fine-tuning risk strategies within the letter of the law.
been authorized by the board, and if they conform to regulatory guidelines. Much can be learned on the origin of risks by data-mining years of:
● Balance sheets, and
● Income statements.
Available in real time, enriched with assumed risks and projected rewards, reflecting prevailing macroeconomic conditions, and incorporating selected mar- ket indicators, balance sheet and P&L data, as well as client and other counter- party accounts, have revealed lots of secrets. Successful efforts along this frame of reference have used cash as the pivot point, defining short term for cash in a way distinct from the short term for other investments.
Cash and cash equivalents include cash on hand, amounts due from banks, money market instruments, commercial paper and other investments having maturities of three months or less at date of acquisition; these are reflected in reporting cash flows. Cash equivalents are stated at a cost that (given the short term) approximates fair value.
Several banks have found that using the cash and cash equivalents account is a good way of exercising control over rogue traders. It is relatively easy for a trader to conceal a loss-making deal on paper, by faking the records or making up another position that hedges it. But it is much more difficult to come up with the cash to pay the counterparty to the trade.
● Cash enables risk management to detect from the cash outflow that some- thing is wrong
● This, however, requires the cash account to be re-established as the king of the bank, and its ultimate safeguard.
Nick Leeson sold options contracts to generate cash, but his losses eventually got to the point where he gave himself away by demanding huge sums of cash from headquarters. That pattern was repeated at the American-Irish Bank (AIB), where John Rusnak managed to keep his trading losses hidden until the end of 2001.
The head of treasury at Allfirst was then alerted by the big cash calls the trader was making.
As these examples suggest, the challenge is to increase by more than an order of magnitude the sensitivity of senior management to the institution’s cash pos- ition, by using cash as the messenger. Indeed, one of the crucial questions debated with participants in the research project that led to this book was whether top management should be alerted when traders offset their losses in cash markets with paper gains on other holdings.
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The majority opinion has been ‘yes’. Financial history shows that, in many blow-ups, people in positions of responsibility were not watching the cash. In other cases, accounting cash data were available, but management was too slow to react to danger signals. Both cases can lead to disaster.
Alfred P. Sloan, the legendary chairman of General Motors, gives an excellent example on the need to be ready and react quickly, when he describes how his company avoided the aftermath of the 1929–32 Depression suffered by other companies:
‘No more than anyone else did we see the depression coming … We had simply learned how to react quickly. This was perhaps the greatest payoff of our system of financial and operating controls.’8
The reader should also pay attention to Andrew Carnegie’s dictums on risk management: ‘Many men can be trusted, but a few need watching.’ On another occasion the well-known industrialist, investor and philanthropist stated:
‘Everything I saw tended to convince me that, on the Darwinian principle of sur- vival of the fittest, you have no reason to fear the future.’9The ‘need for watch- ing’ and the application of the ‘Darwinian principle’ correlate.
Notes
1 D.N. Chorafas, The Real-time Enterprise. Auerbach, New York, 2005.
2 European Automotive Design, September 2006.
3 The Economist, 9 December 2006.
4 D.N. Chorafas and Heinrich Steinmann, Expert Systems in Banking. Macmillan, London, 1991.
5 The Economist, 27 September 2006.
6 D.N. Chorafas, Economic Capital Allocation with Basel II: Cost and Benefit Analysis. Butterworth- Heinemann, London, 2004.
7 The Economist, 18 November 2005.
8 Alfred P. Sloan, My Years With General Motors. Sidgwick & Jackson, London, 1965.
9 Peter Krass, Carnegie. Wiley, Hoboken, NJ, 2002.
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