Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 136

Good risk culture and how to recognise it

Risk culture in financial institutions has never been more important for their role of supporting steady economic growth. But how do you know good risk culture when you see it? We asked ten of the world’s leading experts what they think the most important signals are. It’s not always what you might think.

The trouble with risk culture is that you see it only when it fails. And even then it can be hard to be sure that the risk culture itself was in some way lacking, or whether it was just plain unlucky. Spotting good – and bad – risk management and risk culture before a crisis hits is even harder. For Crisis Wasted? Leading Risk Managers on Risk Culture, we asked ten global risk managers what they thought the hallmarks of good risk culture are, and what progress has been made since the crisis of 2007-09 to improve it. A revealing, warts-and-all view of how risk management decisions are taken in large financial organisations is the result.

While most agree that a strong risk culture is one that permeates the organisation, the overall verdict is that progress is decidedly mixed. Two questions stand out.

  1. Chief Risk Officers are commanding more status within organisations, but has this translated into influence and effectiveness?
  2. It is now commonplace to note the increased emphasis on risk culture, but has this given us better risk management, or just more regulation and longer risk reports?

A corner office does not guarantee good risk culture

The skill of the risk manager is a mix of art and science. Technical competence is a must-have, but so are common sense and street-smarts. John Breit finds that:

 “For me it was more about who’s making money, and why is he is making money, and can he explain to me in an intuitive way how he is making it?”

Yet, much new regulation emphasises risk measurement over risk management. Objective, uniform risk indicators have obvious appeal, but statistics can conceal as much as they reveal. Risk managers generally agree that some quantitative risk reporting is essential, but they also agree that it is only a minor component of the much bigger job of managing risk, and it can even have a negative impact on risk culture. The best risk management practitioners agree that people management, the ‘soft’ skills: behaviour, governance and accountability, are key to good risk management. Sir Michael Hintze is clear:

 “The point that I think has been missed is the fact that it is probity, it is to do with behaviour rather than models. And I think there is a transparency point that has been missed.”

But this is exactly the part of the risk management job that is being squeezed out. Worse, reducing risk management to a mechanical operation carries the danger of turning it into a box-ticking exercise – the opposite of any sensible understanding of a good risk culture. When statistics displace common sense, risk managers, despite their status, add less real value and can easily be ignored or even shown the door, for example because they voice disagreement with the firm’s strategy.

Regulatory reporting is not risk management

It is both unsurprising and understandable that investors and taxpayers, who pay the price when things go wrong, demand tighter regulation of risk-taking activities. But more regulation by itself is no panacea, and may even make things worse if it is not properly thought through.

Regulators and supervisors, for their part, do the best they can to guard against the worst outcomes. But with limited resources at their disposal, often the most they can do is to mandate more, and more detailed, risk reports.

Ever more extensive stress tests and longer risk reports are thus the most visible of regulatory reforms; and organisations are duly churning out ever more reams of risk data. But much risk reporting is mandated without thought to who will bear the costs of preparing and collating it, how it will actually be used, or indeed, if it is useful at all. Paul Bostok is sceptical:

“I don’t know how many pages of forms would give you the information that you get from meeting somebody face to face and asking some pertinent questions.”

Regulators, who receive the reports, struggle to keep up and make sense of them, often with resources intended for much more limited responsibilities. Richard Meddings sees this as a real weak link in the system:

“The regulatory world is full of very able people, though I do worry there are not enough of them for the scale, size of the agenda they have in front of them.”

One reason why regulators and supervisors rely so heavily on risk reporting is because they find it hard to quantify, and even harder to aggregate, things like behaviour, governance and accountability.

Meanwhile, organisations are devoting more resources to preparing risk reports, while the costs of doing so are inevitably passed on to consumers and investors in the form of higher bank charges and poorer returns. Worse, fewer resources are available actually to manage risk. This diversion of resources from risk management to reporting has real consequences for the economy, as Adrian Blundell-Wignall points out:

“… real investment and the productivity growth, that is needed to make bonds and equities worth something in 50 years’ time, isn’t happening.”

Risk culture affects regulators too

Regulators are doing the best with the resources they have, but to pretend that this is good enough to avert, or even dampen, the effects of a future crisis is to hold one’s head in the sand.

The evidence points to the need for regulators to deploy soft management skills in tandem with selective, targeted risk statistics and to ask pointy questions. Only by deploying that enlightened mix of art and science can they hope to understand properly the risk profiles of organisations.

The danger is that constructive risk culture gives way to risk reporting, which in turn can easily dissolve into box-ticking. The risk experts we interviewed agree that this does nothing to address the pressing issue of restoring the ability of the financial system to meet its social obligation of facilitating economic growth. Indeed, by engendering a false sense of security, it could be doing quite the opposite.

 

Frances Cowell is a specialist investment risk consultant working with R-Squared Risk Management in Paris and London. Matthew Levins is a risk consultant who directed risk practices for leading firms such as Commonwealth Bank of Australia and Bankers Trust Australia. More details on their website, www.riskculture.today.

 

banner

Most viewed in recent weeks

Meg on SMSFs: Clearing up confusion on the $3 million super tax

There seems to be more confusion than clarity about the mechanics of how the new $3 million super tax is supposed to work. Here is an attempt to answer some of the questions from my previous work on the issue. 

The secrets of Australia’s Berkshire Hathaway

Washington H. Soul Pattinson is an ASX top 50 stock with one of the best investment track records this country has seen. Yet, most Australians haven’t heard of it, and the company seems to prefer it that way.

How long will you live?

We are often quoted life expectancy at birth but what matters most is how long we should live as we grow older. It is surprising how short this can be for people born last century, so make the most of it.

Australian housing is twice as expensive as the US

A new report suggests Australian housing is twice as expensive as that of the US and UK on a price-to-income basis. It also reveals that it’s cheaper to live in New York than most of our capital cities.

Welcome to Firstlinks Edition 566 with weekend update

Here are 10 rules for staying happy and sharp as we age, including socialise a lot, never retire, learn a demanding skill, practice gratitude, play video games (specific ones), and be sure to reminisce.

  • 27 June 2024

Overcoming the fear of running out of money in retirement

There’s an epidemic in Australia that has nothing to do with COVID-19, the flu, or the respiratory syncytial virus. This one is called FORO, or the fear of running out of money in retirement, and it's a growing problem.

Latest Updates

Investment strategies

The iron law of building wealth

The best way to lose money in markets is to chase the latest stock fad. Conversely, the best way to build wealth is by pursuing a timeless investment strategy that won’t be swayed by short-term market gyrations.

Economy

A pullback in Australian consumer spending could last years

Australian consumers have held up remarkably well amid rising interest rates and inflation. Yet, there are increasing signs that this is turning, and the weakness in consumer spending may last years, not months.

Investment strategies

The 9 most important things I've learned about investing over 40 years

The nine lessons include there is always a cycle, the crowd gets it wrong at extremes, what you pay for an investment matters a lot, markets don’t learn, and you need to know yourself to be a good investor.

Shares

Tax-loss selling creates opportunities in these 3 ASX stocks

It's that time of year when investors sell underperforming stocks at a loss to offset capital gains from profitable investments. This tax-loss selling is creating opportunities in three quality ASX stocks.

Economy

The global baby bust

Across the globe, leaders are concerned about the fallout from declining birth rates and shrinking populations. Australia, though attractive to migrants, mirrors global birth rate declines, and faces its own challenges.

Economy

Hidden card fees and why cash should make a comeback

Australians are paying almost two billion dollars in credit and debit card fees each year and the RBA wil now probe the whole payment system. What changes are needed to ensure the system is fair and transparent?

Investment strategies

Investment bonds should be considered for retirement planning

Many Australians neglect key retirement planning tools. Investment bonds are increasingly valuable as they facilitate intergenerational wealth transfer and offer strategic tax advantages, thereby enhancing financial security.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.