Banks and banking appears to be very crisis prone entities. There were 88 banking crises over the last 40 years, according to the International Monetary Fund. Precisely, this fact makes the strongest case for tighter risk management regime for banks.
Banks are custodians of people’s savings. Banks are providers of credit. Banks are the vehicles of economic growth and also economic well being. Therefore, it is necessary that well-being of the banks is given top priority.
The World Economic Forum’s latest report prepared in collaboration with the Boston Consulting Group – “Rethinking Risk Management in Financial Services: Practices from Other Domains,” is quite interesting. It analyzes the risk management strategies of seven unexpected domains well outside of the financial services sector: aviation, fisheries, immunology, infectious disease control, pharmaceuticals, telecommunications and wildfire fighting.
In looking at these diverse industries, the report makes nine proposals.
1. The report sites Chilean salmon deaths to advocate diversity as homogeneous systems are less resilient than diversified ones.
2. Financial Institutions should put more emphasis on creating and rehearsing contingency plans for large systemic events, as per the example of WHO which helps nations to develop action plans for pandemic situations.
3. Noting that forest eco-systems need fire to rejuvenate, the report advocates limiting of government guarantees and says it will be desirable to accept failures of some financial institutions.
4. Looking at the aviation industry’s constant efforts towards improving safety by gathering and analyzing data on all accidents and near misses, the WEF suggests those in financial services could do the same by identifying any indications of threats to the system, analyzing the information and acting accordingly.
5. The report advocates “unintended consequences” studies for the regulators siting the pharmaceutical industry which conducts in-depth studies to analyze the efficacy of new drugs.
6. By examining immunology, the WEF suggests that financial firms should “innovate transparently,” meaning firms and regulators should be weary of rapidly “mutating” products and carefully monitor those instruments with the possibility of exceptional growth and variation.
7. By examining the World Health Organization and its approach to pandemic prediction, the Forum suggests that financial services could create similar early-warning tools and indicators, helping the industry become more proactive instead of reactive.
8. Report advocates documenting lessons learnt from past crises to train new generations, as is done in airlines, fire-fighting and flood control.
9. Advocating empowerment of the front-line, the report sites pilots, firefighters who are empowered to take decisions on spot.
“Drawing inspiration from unusual quarters, the report makes a compelling argument for finance to break from its somewhat insular approach to risk management,” said Duncan Martin, partner and managing director at The Boston Consulting Group.
Though the Forum states that its report is merely food for thought, it is obvious that the financial services industry could benefit from the ways in which other industries handle risk. Many hope that the report will, at the very least, initiate a constructive dialogue between those in the industry with the aim of making the financial services field as a whole more resilient and risk-aware.