The recent recall of cars by Toyota Motor Corp. highlights how market share pressure and shareholder demands can lead even the best to dilute standards, and sometimes result in a gradual erosion of the best practices that underpin a company’s culture. The incident is not dissimilar to the weaknesses in organizational culture that resulted in irretrievable losses in the banking sector two years ago. The culture of a financial services company is driven in large part by its approach to risk.
Although all companies have to cope with risks, those faced by financial services firms in lending capital are fundamentally different. Lenders deal with adverse selection and moral hazard all the time. Not surprisingly, risk management is central to the financial services business. In undertaking their remit, risk managers in financial services firms must frequently throw sand in the wheels of commerce that their colleagues bring to the table, and therein lies a tricky balancing act—one whose success depends on the inherent culture of the company.
All the forces of large corporations are aligned to push revenue through the system. The risk function in financial services is an unusual exception to this rule, often existing in a shadowy land where it assumes some responsibility for the business while also reining in its animal spirits. Given that the forces of a corporation are generally aligned to do business, risk managers can be really effective only if the organizational culture supports them. Senior managers and boards have to work hard to institutionalize such a culture. At the same time, it is difficult to pin-point precisely how such a culture gets built.
Getting this balance right can require some subtle footwork on the part of the senior management. In many companies that went under during the crisis, the status of risk management was subservient to its business counterparts. While undoubtedly all businesses exist to sell something, in financial services, failing to achieve parity in status between business and risk can place organizational survival at stake.
It is possible for signals about risk culture to be sent both implicitly and explicitly. In an implicit signal, it is not uncommon to find large risk management teams are structured in the form of outsourced operations located far from corporate headquarters where business decisions are taken. Such actions in themselves can create an undesirable caste system of sorts, sending a silent signal about the importance of risk.
As KPMG has pointed out in a well-reasoned report on the culture of risk, even where risk management is generally well regarded, it is possible to dilute its efficacy if the culture of an organization is such that the messenger of bad news is frequently shot, if explicit discussions on the risks of particular transactions are uncommon and where risky behaviour is allowed to get away with little accountability.
It is also unarguable that the status of a function is very closely aligned to mundane organizational elements such as position in the hierarchy, the size of the budget as well as remuneration. Although sometimes deemed to be exclusively human resource-related issues, these elements have strong symbolic implications for the culture of a company.
The status of risk management can also be tested against the touchstone of the resources placed there. A survey by KPMG has also shown that risk is perceived as a compliance function and it rarely enjoyed a seat at the top table. Goldman Sachs survived the crisis in part because its influential chief financial officer David Viniar also had oversight of its risk function. Moreover, keeping in view that most of the critical risk decisions take place at mid-levels in the organization, we need to go the extra mile to ensure that the right incentives exist at these levels. Even today, despite the relative increase in their prominence since the US subprime crisis, in most organizations there are relatively few career paths available for specialist risk managers.
Finally, even boards need to recognize that they can inadvertently push companies onto the path of risk by the innocuous act of benchmarking their company against others in the same industry or indeed their own past performance.
Companies such as JPMorgan Chase and Co. and Goldman Sachs would have been poorly served by their boards if they had been continually pushed to match the returns of Lehman Brothers Holdings Inc. at every point in time. Given that the real level of risk on the balance sheets of other companies is likely to remain unknown, caution must be applied in making comparative performance measurements.
Boards, therefore, need to recognize that it is in their interest to ensure that a risk management culture is deeply enshrined in the companies’ vision, strategy and behaviour. This is particularly important because as economic recovery accelerates, there could again be a temptation to lend carelessly. As many banks recognized not long ago, the road to bad assets was paved with good intentions and only those with the right risk culture survived in business.
Govind Sankaranarayanan is CFO, Tata Capital Ltd. He writes on issues related to governance. The views expressed in this column are personal.
Write to him at email@example.com