Battling national risks

This may seem to be the wrong time to ask such a question. After all, these have not been good times for risk managers in the West. Many of them have been rapped on the knuckles for their failure to prevent mounting losses in the trading rooms that they were meant to police. Some have met a worse fate. Banks such as Citigroup, Merrill Lynch and Canadian Imperial Bank of Commerce have asked their chief risk officers to leave because they could not prevent the build-up of bets that eventually backfired.

Yet, central corporate risk offices do help top management get a grip on what the various decisions taken across the company mean for overall corporate resilience. Individual traders and managers usually assess the risk of their individual bets, or at most of the total investment and business portfolios they are managing. They have an incentive to take large risky bets to pull in the mega profits that will ensure a handsome bonus at the end of the year. They have little immediate interest in what this could do to the entire company they work for. Corporate risk officers are in-house regulators: they try to keep the risk faced by the entire organization under control and minimize potential losses.

This edifice has been shaken with the subprime and derivative tremors in the US and elsewhere. So, it is interesting that the World Economic Forum (WEF) has recently reiterated a suggestion it had made a year ago—that national governments should have a country risk officer who would be the “public sector equivalent of corporate risk officers in the private sector." Why? Because “managing risk on a portfolio basis is as important in government as it is in the private sector," says WEF in its new Global Risks 2008 report.

So, should governments think in terms of national risk? And try to manage it?

The idea seems alluring. Countries face risks—geopolitical, economic and environmental. Many of these risks are correlated. For example, consider the current rush to give subsidies for ethanol production in a bid to cut dependence on imported oil. Ethanol subsidies try to manage one type of national risk—energy insecurity. But they worsen another. Ethanol subsidies have put food security in some countries at risk, as corn, grain and sugar cane are diverted for fuel.

How should energy security and food security be balanced in public policy? There are two ministries and two sets of stakeholders involved. Is there a useful framework to sort out the tangle?

Then, some are global and outside the control of any single government: avian flu and climate change, for example. How does a government negotiate with others on these issues? These risks should ideally be quantified so that the trade-offs are more transparent.

Could a national risk officer do the job?

However, there are some important differences between risk management at the national and corporate level. The WEF report points to a few. For example, business is all about taking risks while governance is often about avoiding risks. Also, companies have a clear mandate to maximize profits and shareholder returns and their risk management can be designed with these clear goals in view. Governments, however, have to satisfy a far broader group of stakeholders and policy goals. And the trade-offs in public policy are far more complex than in corporate policy.

Britain has already taken a few baby steps towards setting up a national risk management office. It set up the Civil Contingencies Secretariat (CCS) in 2001. It sits at the heart of the British government, in the cabinet office: the stomping ground of the Sir Humphrey Applebys of the world. This group started off trying to improve post-crisis management, but has now taken on a more forward-looking role “in identifying and assessing potential risks to national resilience." While the CCS website suggests that terrorism is the chief concern, it does mention other threats as well: flooding, outbreak of disease, failure of key utilities such as power and water, industrial accidents and even public protests.

It is not yet clear whether initiatives such as CCS will evolve into Orwellian nightmares. Or what risk management techniques national risk offices would use. Or whether the state will clamp down on private business and individuals in the name of protecting national resilience. It is always preferable if the financial markets evolve further and provide ways to buy insurance against large nationwide shocks. Bonds that insure against natural catastrophes such as floods and earthquakes (the so-called cat bonds) have already become popular.

That said, evaluating public policy from a risk manager’s viewpoint could be a useful route to follow.

Your comments are welcome at cafeeconomics@livemint.com

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