Change, culture & risk: a primer for financial services executives with agendas

RMA Journal, The, Dec, 2003 by Thomas R. Hofstedt

"Oh, no! Not another article about culture!"

In sympathy with that reaction, three precise questions are posed. If you answer yes to all of them, then read on. Otherwise, get back to what's on your desk or look at the other articles in this magazine.

1. Are you in charge of anything that affects the institution's risk level?

2. Do you believe there is a dysfunctional lack of understanding about the institution's core values for risk appetite and risk taking?

3. Do you want to address and narrow that risk vision gap?

This article is motivated by three strongly held and perhaps controversial views. The first is that financial institutions need to pay more attention to understanding and communicating their collective values around "risk." There can never be enough attention or dialogue on this topic. The second observation is best put as a question: Have financial services companies approached the point where our reliance on mathematics, models, and markets has led to a dangerous lack of attention to the softer, less quantifiable variables that drive risk? A philosopher once observed that "the last thing a fish would discover would be water." Could bankers have the same perceptual failing around risk? This seems particularly true at this moment in history, as our technological and marketing sophistication perhaps has outstripped an instinctive prudence that was embedded in our risk management genes. The third and least controversial conviction concerns the inevitability of change. Ironically, there is widespread agreement that banking has changed enormously in a relatively short time and that, on balance, those changes have been highly positive. Banking is not only different: It is better, safer, friendlier, faster, etc. On the other hand, that very change has accentuated the need for a focus on the "soft" variables one more time, particularly our core values around risk appetite and risk taking.

The Contemporary Setting

Clearly, all is not well in the world of financial services. The recent business press (and public consciousness) is littered with incident after incident in which a financial institution has tested the limits both of its risk management infrastructure and the public trust. Just consider these recent and disturbing Wall Street Journal headlines:

* "Freddie May Have Understated Profits by Up to $4.5 Billion" (June 26, 2003).

* "BofA Sought Assets, Got Troubles" (Sept. 12, 2003).

* "Home Loan Bank's Woes Increase" (Oct. 1, 2003).

* "AIG Is Charged by SEC With Fraud" (Sept. 12, 2003).

* "Scandal Scorecard" (featuring Merrill Lynch & others--Oct. 3, 2003).

* "Home Loan Bank's Woes Fuel Debate on Risk" (Sept. 29, 2003).

* "Mortgage Hedges Have Big Impact on Rate Changes" (Sept. 25, 2003).

* "Mizuho Holdings Expects to Post Widest Net Loss Ever" (Jan. 22, 2003).

* "A Banking Success Story Draws Questions" (May 12, 2003).

What's going on? Are these events--as the new crop of enterprise-wide risk management practitioners might intone--merely Six Sigma VaR anomalies? Or do they signal genuinely systemic problems? We can only acknowledge that each incident is different and that context is important, then resort to platitudes like "time will tell" (although managers, shareholders, and regulators do not have that luxury).

Some Scenarios

Assume that you are the newly appointed CEO of a mediocre financial institution, strongly motivated by a conviction that the company can become truly great. You are determined to make it so. Alternatively, perhaps you are the head of a perfectly fine operation--a leader in its industry--but you foresee massive change just over the horizon, a coming tectonic shock for which your firm (partly because its success has made it smug) is ill prepared. Or consider yourself a surviving CEO of two merged institutions, forced together by market necessity but with incompatible styles, marketplace strategies, and value systems. Or you are a brand-new board member and Audit Committee chair of an "intervened" bank, one snatched from the brink of insolvency by a regulatory agency. Or you've just taken on the newly created position of chief risk officer.

Are these enviable career opportunities? Or are they an organizational graveyard for well-intentioned leaders? These apparently disparate contexts have three important commonalities. The first and most obvious is that change is mandated. Perhaps more than almost any other sector today, banking is about anticipating, adapting to, and managing continuous change. These are the critical (and scarce) skills in managing financial institutions. The second bur slightly less obvious reality is that the changes will require a deliberate intervention into the culture of the organization, particularly those elements dealing with risk-taking attitudes and behaviors. The third common element is that there will be massive confusion over the best way to manage that intervention. This confusion has spawned an entire subculture of "culture consultants" and has (arguably) led to more wasted money than any nightmarish loan portfolio ever did.