Researching risk in financial organisations

Choice road sign5 December 2012

The global financial crash of 2008 is regarded by many economists to be the worst crisis since the Great Depression of the 1930s. Post-mortem reports into the causes of the crisis have highlighted the destructive cultures of many large banks as a key underlying factor. Since then many financial organisations have attempted to rein in the more dysfunctional elements of these cultures and their implications for risk-taking and control. However, a new report has found that there is still no clear consensus on how such risk cultures can be effectively managed.

A preliminary research report on Risk culture in financial organisations by the Centre for Analysis of Risk and Regulation, based at the London School of Economics, and Plymouth University looks at how banks and other financial firms have begun to address the problems of risk culture identified in the fallout of the financial crisis.

The authors began their project by interviewing 15 chief risk officers (CROs) and senior managers from nine major financial organisations. They found that although risk culture is difficult to define precisely, change programmes and other experiments in managing risk culture are underway.

"We found that organisations differed in their approach to risk management, which in turn highlighted differences in their risk culture," says Dr Simon Ashby, an author of the study and Head of the Accounting and Finance Group at Plymouth University.

"For example, some organisations have responded by formalising their risk management arrangements, writing everything down and creating lots of documentation. Other organisations rely more on social networks to inform them of risks and have more informal controls."

Banks and financial organisations also differed in their responses to risk, with some organisations exercising more control over risk-taking than others. However, controlling risk is not always a good thing.

"You may think that a company that is very controlling of risk is a good company, but this is not necessarily true," says Dr Ashby.

"Some building societies were on the verge of crisis before the financial crash because they were too cautious in their lending. Being overly cautious is as much of a problem as taking too many risks. Financial institutions are in the business of taking risks within acceptable parameters."

The authors also found that in contrast to the public debate, which has often tended to focus on the ethical issues surrounding excessive risk-taking, banks saw the problem as being more to do with the failure to connect up disparate sources of risk information.

"In contrast to public debates which emphasise values and the need to change mindsets, we found that banks and other financial institutions appear to be focusing less on these matters and more on improving management practices and information structures," says Professor Mike Power, co-author of the report and director of the Centre for Analysis of Risk and Regulation.

For example, many of the CROs and senior managers interviewed felt that there was a need for clear authorities to set limits and boundaries. There was also an emphasis on the need for effective communication across organisations, and many interviewees said that their organisations wanted to centralise risk management.

The research project's final report will be published next year, and the researchers are currently conducting surveys in financial institutions in order to explore these themes further.