Saturday, 25 January 2014

Risk Culture in Financial Services

One of the many issues that seems to puzzle some academic researchers seems to be the multiplicity of risk management approaches and, by implication, risk cultures.  One implication is to urge caution about codifying risk management.  The hope is that over time experience will accumulate, which will help us understand the need for this variation (here). 
I recently came across an interesting research report from Michael Power, Simon Ashby and Tommaso Palermo (here).  It seeks to explain this variation based on some field work covering UK banks and insurance.  
The report doesn’t look at risk culture by identifying instincts, attitudes, habits, and behaviour.  Rather it focuses on a number of observable building blocks that are associated with the design of risk management structures and identifies the underlying trade-offs, which I have summarised in the table below.

Building block
Design of oversight structures
Business partner and independent advisor
Enhance the organisational structure of risk management
Informal network and formal processes
The real organisational life of risk appetite in the form of limits and tolerance
Risk and control
The openness of organisations to outsiders in progressing change
Internal change and the use of advisors
The extent of the footprint of the regulator on organisation processes
Own risk and regulatory culture
Choices in designing leverage over behaviour
Ethics and incentives

I found the section on risk appetite particularly interesting and, in particular, the articulation of the trade-off between risk and control.  The difference between the focus on the choices within the risk appetite limits and the focus on the enforcement of the limits.
The report considers the above building blocks in the context of the three lines of defence governance models.  The trade-offs also suggest that any current model would be built on tensions and that the lines of defence would be likely to be less than ‘straight’ lines.  
The report has helped me make sense of my own observations.  I am sure it will help you too.

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