Are You Ready for the Next Economic Downturn?
A cautionary tale for the relatively new risk managers who missed the Great Recession
Were you working in risk management in 2008 during the financial crisis and its aftermath?
If you’re like most attendees of a recent risk management conference, the answer is no. A casual poll there uncovered that a whopping 90 percent of risk managers weren’t in the field in 2008. That means the vast majority of risk managers at financial institutions have no experience in mitigating risk based on the lead up to a financial crisis or in steering an institution through a tumultuous economy.
Today’s risk managers are doing a lot of complicated work. Enterprise risk management involves coordinating all areas and levels of a financial institution and understanding the interplay of a variety of economic, internal and external factors on the ability of an institution to achieve its strategic goals.
These risk managers are smart and enthusiastic, but they are also relatively green. For them risk management to prepare for a financial crisis is more of a mental exercise than a real-world experience. It’s the difference between the thrifty grandfather who came of age during the Great Depression and won’t throw out anything and his daughter who knows she should be thrifty but doesn’t have the practical experience of living without to inform her actions.
That’s why it’s important to make sure green risk management teams have the right tools and expertise to properly manage risk. Having never been through a full economic cycle, they can benefit from added resources and expertise to enable them to leverage actionable ideas and knowledge of past events with the latest developments in risk management, including automation.
Another Downturn Is Coming
I’m not trying to be a pessimist, but it’s inevitable that another downturn is coming. We just don’t know when. It could be years or months, but history has shown us that the economy is cyclical. There have been 11 recessions (defined as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales”) since 1945, according to the Bureau of Economic Research. It follows that at some point we will face another recession and another crisis.
Some experts already see warning signs. Former FDIC Chairman Sheila Bair, who sounded the alarm bell about subprime mortgages before the most recent financial crisis, is concerned about credit card debt, subprime auto, corporate date, and cyber risk. She also compares student loans to the subprime mortgage market of the early 2000s. Bair told Barron’s earlier this year: “There are parallels to 2008: There are massive amounts of unaffordable loans being made to people who can’t pay them, and the easy availability of those loans is leading to asset inflation. In 2008, that was reflected in housing prices. Today, that’s tuition. It’s too easy to raise tuition because kids will borrow to pay for it. If the loan defaults, the primary beneficiaries—educational institutions—have no skin in the game, like in the mortgage crisis.”
Not every downturn is built the same. Some, like the Great Depression and Great Recession, are the type of events that will be spoken about for generations. Other smaller financial events are much easier to forget. The problem is that we never know which one is coming and the events that precipitate these crises are beyond our control. We can’t prevent them, we can only mitigate their impact on our institutions.
The Risk Management Lifecycle and Preparing for Another Downturn
There is no way to predict whether the next downturn will be small or large or when it will come. The only thing you can do to prepare is ensure that your risk management staff has the knowledge, expertise and tools to position your institution for success.
These tools should focus on the risk management life cycle.
1. Identify risks. What events could potentially impact your institution?
2. Analyze risks. How likely are these events and what’s the potential impact?
3. Mitigate the risks. Develop controls to limit the likelihood or impact of the risk.
4. Monitor. Pay attention to key risk indicators (KRIs) to understand whether your controls are successfully mitigating risks or whether changing circumstances require new or modified controls.
5. Report. Make sure those in charge, including management and the board, are aware of any significant developments.
Whether your risk management team is bright and new or experienced veterans, make sure they are equipped with the tools to oversee the entire risk management lifecycle.
Want to be prepared for the next economic downturn? Talk with us about Nrisk, Ncontracts' enterprise risk management solution.