Balance is a term we frequently hear to describe something worth achieving: work/life balance, a balanced diet, balance of power, a balanced budget. Right now the financial industry is seeking balance, particularly when it comes to risk.
While risk management has become a higher priority for financial services organizations, a recent report by Ernst and Young and the Institute of International Finance (IIF) shows there is still room for improvement. The survey found that even though companies are increasing the number of employees dedicated to their risk management roles, infusing the amount and type of risk they are willing to take across all levels of the organization remains challenging.
Rick Waugh, president and CEO and vice chairman of the board of directors of the IIF, spoke about balance in a press release regarding the report’s findings, “The proper risk culture, understanding the right balance of risk appetite, and the right balance of risk/reward, are essential to mitigating future crises, without which, no amount of capital or prospective rules will hold us safe.” The motivation to improve risk management clearly exists, however it is not an easy fix. The critical need for balance lies between the central and departmental risk groups.
There will always be differences across lines of business concerning the amount of risk each assumes. As long as there is an enterprise risk strategy in place these differences should not upset the overall balance. There are challenges both internally and externally to achieving the appropriate amount of risk exposure across the organization.
Establishing risk tolerance is tied to both industry risk factors and the amount of capital your bank has to absorb risk. When economic conditions change banks need to see the early warning signs and adapt quickly. Therefore, regular loan review is essential to ensure a bank’s portfolio remains properly risk rated. Additional external pressure comes from remaining compliant with the increasing number of new regulations.
Many institutions are restructuring their risk governance to be more transparent across the institution. For this to succeed, there can’t be risk committees operating independently of the enterprise risk team. The bank’s chief risk officer must be aware of all risk being taken so it can be assessed as a whole.
For example, if the investment group is planning securities trades that are too great a gamble against the bank’s overall risk limits that decision should not be solely in their hands. This is where the importance of balance plays out. If risk is too centralized, risk won’t be sufficiently engrained in line employees’ work and unplanned risk will likely emerge. If it’s too distributed, different departments could expose the institution to unknown risks. The key is to find a balance where central and distributed risk groups each assume responsibility to protect the enterprise.
It’s definitely a time for change in the industry. The bottom line is there has to be a consistent approach and accountability for risk management across the institution. This requires a balancing act. The critical element is having the foresight to set appropriate risk parameters and employing an enterprise risk strategy that is embedded in daily operations.
Eric Lindeen is the marketing director for Zoot Enterprises, located in Bozeman, Mont.