We should celebrate risk reporting, not censure it

In a recent article published in the FT Adviser, Dr Robert Webb - Associate Professor of Banking at Nottingham University Business School - argues that the financial service industry needs to rethink its attitude to risk.

According to Dr Webb numerous disquieting events, the global economic crisis foremost among them, have prompted this bout of collective reflection.

As a result, terms such as ‘operational risk’ and ‘risk management’ have become buzz-phrases. The expert consideration of risk is now stressed in consumer-facing literature and risk-escalation frameworks are found here, there and everywhere.

In tandem, regulatory controls are growing more demanding. Basel III may yet succeed where its predecessors failed, genuinely laying the foundations for bank solvency around the world in the face of intensifying complexity.

Basel III does, for the first time, attempt to constrain balance-sheet excesses by placing checks on concentrating assets in one place. But at the same time it is vital to remember that risk comes in various forms and, in many instances, it boils down to the (sometimes hidden) actions of individuals.

To illustrate, consider the following exchange. It was central to the case against City traders caught manipulating Libor, which came to light in 2012:

Trader 1: “What’s the call on the Libor?”

Trader 2: “Where would you like it?”

Trader 3: “Mostly I’d like it all lower so the world starts to make a little sense.”

Trader 4: “The whole HF [hedge fund] world will be kissing you if Libor moves lower.”

Trader 2: “Okay, I’ll move the curve down one basis point – maybe more if I can.”

It is increasingly accepted that a key feature of incidents such as this is that they can be traced to internal hierarchies that permit major errors of judgment to remain undetected, overlooked or concealed. Even the crash of 2007-08 fits the bill. The trajectory is one of sustained recklessness and eventual catastrophe.

Those who work in financial services cannot be expected to act with unerring rationality in relation to risk events unless they are helped to understand the choices that might arise and the potential repercussions of their decisions

Crucially, one person has the power to make a difference in such circumstances. One person can take a stand or let the situation endure. Consumers have become familiar with the consequences that almost inevitably ensue when ignorance is the preferred course and risk is allowed to go unreported and unchecked.

The fundamental problem is that for too long the financial services sector has been built on a system in which fears over risk are stifled rather than voiced. What is required is an environment in which the reporting of risk is celebrated – maybe even rewarded – instead of censured.

Research into what has become known as ‘people risk’ still represents a comparatively new area of study, but one point that is clear is the importance of appropriate training. Those who work in financial services cannot be expected to act with unerring rationality in relation to risk events unless they are helped to understand the choices that might arise and the potential repercussions of their decisions.

The recent history of aviation provides surprisingly neat parallels. Although air crashes tend to be high profile and costly, it was only in the last quarter of the 20th century that the industry at last acknowledged that to err is human. Accordingly, its response to calamity is now routinely encapsulated in the following process: recognise the mistake, learn the lesson, solve the problem.

This is in marked contrast to the culture that dominates so many other sectors – financial services arguably included – where disaster is more likely to be met by denial, buck-passing and an unhealthy determination to ‘draw a line’ and ‘move on’.

Few passengers would board a plane whose crew is so un-schooled in risk management that a flight attendant would hesitate to alert the captain to a sudden drop in cabin pressure. Why should investors entrust their wealth to organisations in which the same needless uncertainty might be rife?

The introduction of Crew Resource Management in the early 1980s transformed aviation safety. Significantly, it followed a series of tragedies that were caused by people.

Financial services is long overdue a similarly seismic shift. With the industry at last starting to appreciate the role of individuals in creating and preventing risk, maybe now is the time to give real thought to how to ensure truly meaningful change.

This article first appeared in the FT Adviser on Monday 19^th September 2016