Creating Value with A Culture of Risk Management
Many bankers think the concept of a “risk management culture” is thought exercise. It’s the kind of psychobabble that takes up time that could be dedicated to more important business activities.
That couldn’t be further from the truth.
A strong risk management culture is all about leadership, and that leadership creates value. Financial service companies perceived as having good leadership can increase their value by as much as 37 percent, according to a Deloitte report. Institutions where leaders regularly demonstrate the core value of stewardship should fare much better than one where people know it is merely lip service.
What is a Culture of Risk Management?
A culture of risk management is a commitment to the core values of an institution. It is both a top-down exercise in developing policies, procedures, messaging, and compensation that supports the institution’s long-term goal, but also one where front-line employees take an active role in managing risk.
Some institutions are risk averse while others take a more aggressive stance. Neither is necessarily right or wrong as long as the institution has carefully considered the potential impact of its decision. For instance, a mortgage bank is more likely to have a conservative approach to risk than an investment bank that trades derivatives. Similarly, what one institution views as a risk, another might view as an opportunity. What’s important is that the institution has carefully aligned its goals, mission, and vision with its risk tolerance for long-term success.
3 Keys to Building a Risk Management Culture
The Federal Reserve Bank of New York has spent years studying how to improve the culture at financial institutions and holds an annual culture conference. It has distilled it into three key issues:
- Defining and clarifying purpose to create clear goals for assessing performance. A bank’s purpose should “emphasize sustainable success, not short-run profit.” Customers should be at the center of business decisions. Stewardship should be a value of the institution.
The Fed isn’t the only one to draw this conclusion. As a research cited in a report of how culture contributed to Barclay’s manipulation of the LIBOR rate in 2013 points out, “Groups of people require (in a sociopsychological sense) that sense of purpose (what they are there to do). In this way, purpose is a foundation of culture. Culture then gets determined by the way the group shares and acts upon its collective sense of purpose. The research also shows that cultures defined by overly commercial and competitive features, with little regard for other elements, lead to poor outcomes.”
This purpose needs to be clearly communicated by the board, which needs to follow up with management to ensure they are leading in a way that supports the institution’s purpose. There must be consequences for those that stray.
- Measuring how firms and the industry are performing. A bank needs to know if it’s achieving its purpose and how it compares to its peers. Standardized metrics can be useful tools that assess behavior and culture while including behavior in performance reviews can help influence behavior.
William C. Dudley, president and CEO of the Federal Reserve Bank of New York, thinks the industry would benefit from a “common culture survey” to benchmark behavior. Taking inspiration from an annual review of the United Kingdom’s Banking Standards Board, he’d like to see banks ask whether employees agree with statements like:
- “I believe senior leaders in my organization mean what they say.”
- “In my organization we are encouraged to follow the spirit of the rules (what they mean, not just the words).”
- “I see people in my organization turn a blind eye to inappropriate behavior.”
- “If I raised concerns about the way we work, I would be worried about the negative consequences for me.
- Determining whether incentives encourage behaviors consistent with goals. Incentives need to align with behaviors that will support long-term business goals.
The benefit of this is twofold, according to an article in the Delaware Journal of Corporate Law. There is the obvious problem we’ve seen before where employees put their own careers and monetary gain ahead of customer and institutional needs. The other problem is that incentives and policies that encourage employees for look out for their own interests instead of the institution can attract “individuals with anti-social traits” which can then rile up others and spread across an institution.
Now that you know what to look for you can assess how successful your financial institution’s efforts to build a risk management culture have been. If you’re on track, give yourself a pat on the back. If you’re falling short, it’s never too late to change and improve.