Leaders must step up to avoid excessive risk taking in financial institutions
Bank reforms will not stop banks from taking excessive risks in the future according to an academic report by Professor Simon Ashby (i), released today. He says that, without a cultural change, excessive risk appetite will continue.
Twenty senior risk professionals from the banking industry took part in the study. They placed much less emphasis than external experts (who have predominantly reported before) on economic and market factors, such as low interest rates or the growth in securitisation, and much more on human and social aspects of the crisis within the institutions and the regulatory machinery. Instead, they saw inappropriate risk cultures, poor risk communication and an over-reliance on mechanistic (model-driven) approaches to risk assessment and control.
Nevertheless, the official investigation into the financial crisis commissioned by the Government and chaired by Sir John Vickers of the Independent Commission on Banking is expected to concentrate on structural reforms and capital requirements for banks when it releases its final report on 12 September.
Ashby says that financial institutions, especially those whose failure would cause excessive market turbulence or economy-wide disruption, should promote the principles of so-called high reliability organisations (that is to say those that have succeeded in avoiding catastrophes in an environment where normal accidents can be expected due to risk factors and complexity).
Wyke and Sutcliffe (ii) studied such organisations and concluded that they all have a culture of collective mindfulness which is characterised by a preoccupation with failure, reluctance to simplify interpretations, sensitivity to operations, commitment to resilience, and deference to expertise.
Eastern wisdom helps to illustrate the concept of mindfulness. Niskar (iii) gives a great example. Imagine going to the cinema. When we are watching the screen, we are absorbed in the momentum of the story, our thoughts and emotions manipulated by the images we are seeing. But if just for a moment we were to turn around and look toward the back of the cinema at the projector, we would see how these images are being produced. We would recognise that what we are lost in is nothing more than flickering beams of light. Although we might be able to turn back and lose ourselves once again in the film, its power over us would be diminished. The illusion-maker has been seen. Similarly, in a culture of collective mindfulness, we look deeply into our own movie-making process. We see the mechanics of how our collective story of the world gets created, and how we project that story onto everything we see, hear, taste, smell, think, and do.
The challenge in becoming a high-reliability organisation is to build a culture in which everyone is mindful. Leadership builds cultures. Structural reforms and capital requirements, though important, are just not enough.
i.Simon Ashby, Associate Professor in financial services at Plymouth Business School: Picking up the pieces: Risk Management in a Post Crisis World
ii.Weick, K. E., & Sutcliffe, K. M. (2001). Managing the unexpected.
San Francisco: Jossey-Bass.
iii.Niskar, W. (1998). Buddha’s nature: Evolution as a practical
guide to enlightenment. New York: Bantam Books