Latilla's Blog: Operational Risk related thoughts and discussions

According to Wolters Kluwer Financial Services the amount of fines issued for the first quarter of 2011 amounts to nearly £14 million. Is this a lot? Of course winning the lottery and walking away with £14 million (about £9 million after tax) would truly be classified as a windfall to say the least. But statistics are always a bit of a bug bear to me when in the latest Operational Risk and Regulation issue, Norwich & Peterborough Building Society agreed to pay customers £92.3 million for mis-selling a product and Credit Suisse settled a lawsuit for £70 million due to improper business practice. These are just two of the litany of loss events that occur on a continual basis, yet the FSA lauds a fine total of £14 in three months. At this rate the total fines issued would be £56 million, less than two settlements for fraudulent practices by just two organisations.

FDR wanted to go to war against Nazi Germany way before 1941. Didn’t know that? It’s true. He saw as clearly as Churchill that Hitler had to be stopped and better to do it in Europe than Maine or even Ontario. He also did little to nothing to determine the future of the free world. Don’t believe that either? It’s true too. Much to the chagrin of Cordell Hull, his Secretary of State, the beloved FDR preferred to trust to a roll of the dice to save us all. Brinkmanship? Luck of the Dutch? Karma for contracting polio? Take your pick, but if Japan didn’t have an defensive pact with Germany, if the Luftwaffe had been victorious in the Battle of Britain, if Japan had gotten a fair shake as they saw it, from the Treaty of Versailles, and if Hitler wasn’t as mad as a bag of hammers, then America may never have joined the fray. Now there’s a thought to mull on. Hull was badgering FDR to declare war and go in but try selling that idea to Congress while surrounded by isolationists and with the fighting over 3000 miles away was not the easiest of jobs. Japan was closer and expanding its influence but still thought Hitler the greater threat.  So he decided that better part of valor was to do nothing.  He trusted to luck and if luck is the right word then his horse came in on December 7^th. In a colossal game of risk management he bet that someone would enable him to enter the war. He allowed global and murderous events unfold so that he might have the chance to manage events in the future the way he wanted. How would history look upon America if they declared war on Germany in 1939? How would history view a preemptive bombing raid on Tokyo in 1940? He wasn’t about to go pick up a rifle so he was safe and sound, but he was responsible for millions of people and billions in capital that all of a sudden became highly personal and intimate.

For days now I have waited expectantly for my monthly issue of Operational Risk & Regulation, conjuring up contented childhood memories when the Valiant and Lion comics would arrive. Wednesday morning, seven am and my internal clock would have me wide eyed in anticipation of the next installment and then I would hear the rattle of the letter box and the electrifying “phlumph” as they hit the mat. Oh joy, oh expectant, rapturous joy! Up I would spring, tossing aside my blankets and hurling my frame downstairs to gather up the latest editions of fantastical adventures. Did the Captain get out of the trap? Was it curtains for the hero this time? What fascinated us when we were ten about reading the next installment? Who was it we were drawn to among the tales of derring-do and expansive adventures? Oh sure the good looking guy to see if he escaped, but wasn’t the evil villain so much more magnetic with his rapacious appetite for wickedness?  

The UK Financial Service Authority (FSA) has just published its paper covering risk management. It is titled Enhancing Frameworks in the Standard Approach to Operational Risk, not a gripping title for sure but illuminating nonetheless. Ruminating over the very first line i thought, why just the TSA firms? Surely risk evaluation should apply right across the board from Basic Indicator Approach (BIA) to Advanced Measurement Approach (AMA). Again, I thought, the whole industry has missed the opportunity for wholesale reflection and reform and I stormed about the office in a tirade of piety and accusational epithets aimed at the big guys who seemed to have once again dodged the conscience bullet. We, as a company that, see this day-in and day-out; the constant excuses for inaction. Either the big boys, the AMA firms, do everything in house so don't see the need for outside scrutiny or the smaller guys say they cannot afford to purchase the systems to be as competitive, and therefore diligent, as the power hitters. Result: stagnant responses and little real progress. Then I read on. Yes, the paper is focusing on the TSA firms but it strongly advocates what we have been banging on about for years.

The Asian Wall Street Journal reported this weekend on South Korea's intention to tax foreigner's purchases of their government's bonds for fear of a potential mass exodus of capital should things go pear shaped in the future. Not an unreasonable thought bearing in mind recent events in Greece and Ireland. Money scuttles for safety in gold especially when the risk in more liquid markets is less attractive. Again, not an unreasonable act. Companies work under the caveat that they do what they do for the benefit of their shareholders and individuals say that their family comes first. But to hunker down, to panic in the face of financial uncertainty has traditionally been the worst option when things go pear shaped. But I slightly digress when I talk about strategy. I am talking about the human component for self -preservation above the greater and noble good.

I read an article by Tom Donohue, the CEO and president of the U.S. Chamber of Commerce today posted in the Huffington Post and had to wonder if he ever sits with the banking community or sees what is around him. He said one thing in particular that made me scratch my head in view of the recent elections and the fact that we are each and every day in touch with the mechanics and thinking of the financial industry. He said "the American People don't want status quo, they want their problems solved."

There are to be another round of stimuli from the U.S. Treasury this time to the tune of $600 billion, though I have heard that with other incentives it may well be approaching the trillion dollar mark. Now I am a Keynesian. Call it my benevolent nature or my love of history but I cradle Keynesian theory close to my chest when I harken back to the dour days of the thirties. But if I let the historian in me come to the fore then I have to be pragmatic and say that the New Deal didn't bring about the U.S. recovery, far from it. In fact I hasten to add that Adolf Hitler had more to do with the American economic recovery than John Maynard Keynes. What deficit spending did do was buy time, alleviate the pain of the immediate effects of the Depression and make it seem as if the government was trying something, anything, to prevent the complete collapse of the American Dream.  In the thirties, deficit spending offered hope but in reality did little to effect real change. Spending was up slightly, but there was little substantial growth and long term unemployment had languished in the mid to high teens for most of the decade. Keynesian economics was an untested theory and a leap of faith with little immediate data to prove the hypothesis.

Last week as reported in the Wall Street Journal and by Reuters, there was the universal condemnation of the efficacy of Basel III by the IMF and the U.S. Treasury. The IMF experts considered it not far-reaching enough to offset another global recession and view the practicality of a global body imposing levies on individual nations as unworkable. The U.S Treasury has dropped the notion of an imposed levy for its larger banks just prior to the Congressional elections and has always viewed a levy as a way to pay back the American taxpayer rather than as a buffer for future disasters. It is the GRC vs. ERM and the qualitative vs. quantitative argument all over again. The IMF and EU want to impose an overarching regulation from without to compel financial institutions to tow the line and change its way of thinking and the U.S wishes to see risk management taken care of from within by seeing results as vindication that it has improved its compliance procedures without external pressures.

My football team lost 5-0 last weekend. Crystal Palace, the dream team of the eighties, the moderate overachievers of the nineties and heartbreakers of the noughties lost horribly to fellow strugglers Derby County. With the same team that scored four just two weeks ago and a creditable draw last weekend, they (I) went down with a thud. Excuses abound. Well they were traveling to Derby and never play well away from South East London, the ref was biased, the linesmen missed a bunch of calls, the air was too thick and the weft of the grass was not conducive to their style of play. All well and good but what now? I am sure they have had their team meetings and had the regular post mortem film reviews- but really, what now? Dare I bet that there will be no changes to the line up next week? There is a good reason for this and plenty of history to back up my prediction. Who doesn't get a pang of coziness when a Spitfire flies overhead and why is the Tea Party so appealing in its name alone? We get a safe and fuzzy feeling when we look back but ahead, well, there be dragons!

There seems to be a certain amount of buzz going around about GRC versus ERM. It appears that two camps seem to be evolving that perceive GRC as a spectre looming over the industry stifling individuality and progress with ERM as a lone guardian who boldly defends the rights of organisations to work prudently, if largely unfettered. However there also seems an atmosphere of myopia with the jolting days of 2008/9 becoming hazier as the days roll on and the now is once again becoming more important than the months or years to come. As a result GRC, not long ago seen as the saviour of western civilisation and the last bastion of humanity in the heartless world of commercialism, is being demonised and replaced by rationalised risk. Enterprise Risk Management even has a noble ring to it as it battles for the rights of the free thinker and the progressive, balanced mind. However, I might remind you, dear reader, that GRC (Governance Risk and Complaince) were established by the industry, yes us, and not governments in a vain attempt to win votes even though it sounds very much like a cabinet white paper. ERM has long been with us, but to be honest has failed in its duty to curb the excesses of our industry but this is also not a reason to alienate ERM as a wild child that needs a serious grounding. ERM is a natural state of business. It is the assessment that considers whether the cost of preventing loss is more than the loss event itself. However, I do not consider them mutually exclusive; to accept ERM is not to reject GRC and unfortunately that seems to be the road down which we are heading...again. I have heard and read, for example, that for individuals to bend or even break the rules is an abhorrence, one offs, and too difficult or expensive to protect against or even monitor effectively, and therefore it is more cost effective to allow these infractions to occur than to stop it in the first place. To rationalise so callously is not only damaging but also unnecessary. In some areas technology is ahead of the curve in combining GRC and ERM satisfying the calls for morality and practicality.  We all have a golden opportunity to assess not just the industry but how we work within it to the advantage of all. ERM gives us this practical ability immediately not GRC. It is ERM that dictates what systems to update and/or implement but it is GRC that gives us the impetus to do it, even if reluctantly. If GRC is the stick and the carrot is ERM and profitable progress then operational risk managers have the perfect opportunity to direct their respective organisation not to be stubborn, intractible mules.