Rebuilding Trust Through Better Risk Monitoring

A recent op-ed article in the Financial Times by noted author and professor, Frank Portnoy, raises the question about the need to hold corporate managers personally accountable for gross negligence when they do not monitor risks. Mr. Portnoy proposes having senior executives at major banks certify that they are actively monitoring the risks taken in areas such as trading desks that have resulted in recent losses due to rogue trading activities. He summarizes his view in the following way.

Current rules permit directors and officers to avoid personal liability for gross negligence. That is a wise rule for most business decisions: courts are generally not skilled at assessing business judgment. But risk is different. Why should a bank manager who is grossly negligent in supervising risk avoid liability?

Shareholders might never be able to understand the risks of modern banks, and current regulatory approaches will not give them much confidence. But if they knew that senior managers had agreed to be personally liable for gross negligence in monitoring risk, they might trust the banks more. Without trust, it is hard to see how banks can recover.

Mr. Portnoy is correct to promote the notion of greater accountability for monitoring risk. However, attaching personal liability to executives may not necessarily be the best method. It would be very difficult to define what is an adequate level of risk monitoring since it really differs for every institution. That is why the industry is so heavily regulated. However, Mr. Portnoy is certainly on point in the fact that stronger risk monitoring is needed to rebuild trust in banks.

Now Is Not The Time to Reduce Investment in Risk Management

As we head into the second half of 2011, the economic recovery here in the US and abroad is taking hold much more slowly than most expected. Given the modest recovery, some executives may be looking to slash expenses to boost profitability and achieve their near-term goals. However, while tempting, cutting staff and investment in the wrong areas may prove to be a company’s undoing. For financial services companies, this is particularly true in the area of risk management because they are still mending their practices in the wake of the recent financial crisis.

According to the Financial Times, US regulators are keenly aware of what may be on the minds of bank executives and are issuing warnings to avoid cutting risk management budgets. According to Michael Alix, a senior vice-president at the Federal Reserve Bank of New York who heads the risk-management function within the regulator’s financial-institutions supervision group, the regulators are paying close attention to any plans to lower investment in risk management programs. “We haven’t seen it yet, but we’re vigilant,” says Alix.

Sacrificing the progress made in strengthening risk management programs at this precarious stage of recovery is certainly short-sighted and could lead to even greater problems for companies looking to weather the next storm.

FDIC Calls for Risk Management Improvements

This week, the Federal Deposit Insurance Corporation (”FDIC”) released a special edition of its Supervisory Insights publication focusing on the recent foreclosure crisis in mortgage banking. In the report, the FDIC provides additional perspective on the deficiencies in internal processes, staffing and control that resulted in a foreclosure moratorium by several of the largest mortgage servicing institutions in late 2010. The FDIC worked with the lead regulatory agencies of the fourteen largest mortgage servicers in the United States to conduct extensive reviews of current foreclosure practices.

The reviews uncovered many common issues among the mortgage servicers. The FDIC noted the following, “concerns included lax foreclosure documentation, ineffective controls over foreclosure procedures, and deficient loss mitigation procedures and controls. Many institutions failed to commit resources sufficient to manage responsibly the rapidly growing volume of mortgage loans in default or at risk of default. Weak governance and controls increased legal, reputational, operational, and financial risks while creating unnecessary confusion for borrowers.”

While the report focuses specifically on the foreclosure shortcomings, it can also serve as a reminder of the value of strong internal controls and risk management practices. As our business processes grow to be more complex and interconnected, the risks inherent in the processes grow exponentially. Unchecked, these risks can quickly propel a business into a full-blown crisis.

Viewing Risk in a Different Way

Several previous blog entries have explored the notion of approaching Risk Management in a new way. Rather than simply focusing on mitigating risk through various methods, companies and individuals alike should strive to seek a greater understanding of risk to improve their decision-making and maximize value to the organization. By doing so, an ever-present view of risk and opportunity will propel an organization from focusing purely on Risk Management to a new state of Risk Mindfulness.

David Spiegelhalter, leading risk expert and professor at Cambridge University, supports this view in a recent video (see below) that is both enlightening and humorous. Through his real-life examples, Professor Spiegelhalter provides a unique view of how we as humans typically view risk. His lessons are particularly relevant as we continue our struggle to emerge from the financial crisis of 2008. As he concludes, “One of the biggest risks is being too cautious.”

CNBC Profiles Internal Audit & Risk Management Practices

Earlier this week, the Institute of Internal Auditors’ Richard Chambers was interviewed by CNBC on the evolving nature of risk management practices in light of the recent financial crisis. Mr. Chambers emphasized the need for corporate boards to set the risk appetite and work with management as well as the internal auditors to monitor the level of risks. In addition, he noted that compensation programs still need to be improved such that risk metrics are included in pay determination.  To view the entire interview, click below.

Wheelhouse Advisors Joins the Business Finance Expert Network

Business Finance Magazine recently invited John A. Wheeler, Managing Principal at Wheelhouse Advisors, to join its Expert Network as a regular columnist for their online publication called the Big Fat Finance Blog. John will be contributing articles and thought leadership on issues in Finance & Risk Management in his own blog called the Risk Vortex. Along with the other columnists, the blog is intended to arm finance professionals with innovative ideas and best practices that help finance organizations create value. For up to date information on the events and trends that may impact your Finance & Risk Management organizations, be sure to subscribe to the Risk Vortex by clicking here.

The Human Element of Risk Management

Over the past decade, risk management became more about quantitative models and less about behavioral models. Unfortunately, as we discovered during the recent financial crisis, even the best quantitative models cannot predict the result of misguided behavior. In this week’s edition, Bloomberg Businessweek magazine provides a special focus on risk management with interesting viewpoints such as this:

As business has grown more complex, we have developed elaborate protocols, systems, frameworks, and approaches to manage risk. A consequence of putting science at the forefront of these risk management systems has been a stripping of human behavior out of the risk model.

The future of risk management lies in an ability to incorporate and inspire more of the behaviors we want, finding new models to map, monitor, intervene, support, and react to the behaviors of individuals and groups—both the behaviors we want to encourage and those we’d like to avoid. Critically, this taking account of behavior means we need a much sharper comprehensive strategy for corporate culture, so that our models are founded on the way “things really happen around this place.”

Examining the human element of risk management is a key part of Wheelhouse Advisors’ upcoming workshop, Navigating Risk: From Crisis to Innovation. To learn more about the workshop and enroll for this groundbreaking event, please visit www.oldedwardsinn.com/navigatingrisk.