Risk management in Banks: a question of standards or culture?

Risk management is a key performance element for financial institutions. The recent examples show that risk management through standards and processes is not enough.

In the post financial crisis period, banks are trying to maximize their risk-adjusted profit under the constraints of equity and costs. Therefore, a bank profitability lies, by nature, in the balance between the risk appetence, source of profit, and risk aversion (that we could call the non-risk appetence), source of security.   

Les acteurs qui cherchent la profitabilité ajustent en permanence leur business mix pour trouver des zones de profit, donc de risque. Le contrôle des risques ajuste en permanence sa perception et sa capacité de mesure pour s’adapter aux évolutions des activités de la banque. D’une certaine manière, plus il est efficace et encadre la prise de risque, plus il pousse les acteurs à évoluer rapidement vers de nouvelles zones d'activité risquées.

Actors looking for profitability adjust permanently their business mix in order to find profit zones, thus risk zones. Risk control adjusts permanently its perception and its measuring capacity to adapt to the evolution of the activities of the bank. In a certain way, the more it is efficient and manages the risk-taking, the more it pushes the actors to quickly evolve to new risky activity zones.

That raises the question of a different approach by talking about culture.

Therefore, the FSB (Financial Stability Board) recommends the banks to define and put in place a risk culture in a company.

The P-Val approach consists in defining a Risk World: the objective is to define how individuals, whatever their service could be (Risks department, Back Office, Middle Office, Front Office, etc.) think, decide and act when dealing with risks problematics.

After the breakthrough of daring to talk about culture for such a topic, from now on, it is necessary to clearly define the bases of a relevant risk culture. 

The World approach brings a strong methodological frame, validated on hundreds of contexts, around four items:

·             Greatness: the answer lies in the capacity of an organization to implement the decided strategy with a defined risk appetence. It is the integration of the risk constraint into the company strategy and the very definition of performance. Regardless of my service, the risk is not next to quest for performance: it is in the heart of the strategy formulation.   

·             Recognition: in terms of financial recognition, the banking system introduces a well-known bias as single individuals taking the risk for the institution are only carrying a small personal risk. The game between profit and loss is asymmetrical. That is why the recognition loop must be strongly embodied by the management. The management plays a role of an identification model around a collective project that must be promoted and supported. 

·             Collective interactions: the exemplarity without any ambiguity of the top management is the key element of the reducibility of risk culture. Simultaneously, the middle management must be recognized in its ability to act in a responsible way. The more the delegation escalades back, the less front line actors learn to use their judgment. The middle management must be held responsible more strongly, with appropriate escalation processes. 

·             Decision making: decision-making processes must be organized on a 360° spirit to prevent a group of single individuals to « vampirize » the subject to their own advantage at the expense of the institution as a whole. Simultaneously, the appreciation should not use indicators taken one by one but reason globally, based a converging indication beam.

Define the desired World of Risk culture helps, at the minimum, to create the basis for a consensus within the company and helps decision-makers to stay on course in the storm and bring a viable economical answer to strategic risk management.  

Laurent Dugas