In recent weeks, several banks have revamped their Boards. Some new Directors even have the word “risk” feature in parts of their Resumes. That’s very nice. Now what?

The current crisis has revealed that many banks’ boards (and executive management) failed in their risk oversight responsibilities. Not only do many lack board-level risk committees, but those that have risk committees do not meet regularly nor do they have the functional feedback necessary for meaningful governance.

It is time Boards of Directors become pro-actively committed to risk management. It is time Regulators focus keenly on risk governance in their analysis of the health of banks. And it is time investors and shareholders and customers differentiate banks on this basis.

So, with so many stakeholders looking over its shoulders, what’s a Board to do?

• Start with a holistic approach. Align practice with strategic objectives by issuing a well developed top down statement of risk appetite. It is high time we moved away from cliché in this regard. Risk appetite need not be all quantitative. And it is unlikely to be static. And it is always relative. Boards must not only understand current business risks but assess the changing marketplace, identify new risks, monitor the business and be prepared to respond rapidly.

• Transparency is crucial. Set the trend by actively disclosing risk appetite and tolerance to all stakeholders for critique and comment.

• Mandatorily disclose the available risk architecture that reconciles bottom-up business and risk management practices and output, with target appetite, tolerance, and results.

• ‘Stakeholders’ necessarily includes the internal organization. Are all employees aware of the statement of risk appetite, can they find it, have they read it? Does the statement of risk appetite describe what is expected insofar as the unusual, the unintended, and the unacceptable? Does the firm have a meaningful way to aggregate, understand, and respond to risk? Are all staff able to articulate the parameters of their own risk responsibilities?

• Define a meaningful relationship between the risk function and the Board. Equip and empower the CRO and the risk management organization, with clarity in culture, role, and accountabilities.

More on this soon

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Posted by Jaidev Iyer, MD, GARP at 9:27 AM 0 comments

Compensation has been brought to task as a major contributor to the global financial crisis. Chasing short-term positive results, failing to implement a robust internal control environment, not fully understanding the risks of financial instruments being sold, or, in many cases not caring, simply to pad personal compensation resulted in a major disconnect between company and shareholder interests and the interests of the individual whose contracts provided for incentives tied to profit making. Government initiated “thinking” such as that set out by the Sir Warren in his recent report issued in the United Kingdom , many in the United States Congress and various other country legislative bodies suggests compensation should be more highly controlled, directly or indirectly by the government.

The problem with dealing with compensation and incentives is obvious, it goes against most all notions of capitalism and free markets, and having the government involved in setting compensation policy is generally not considered a positive move in the right direction.

But the way forward is not at all clear. If compensation controls are implemented, or “suggestions” made by regulators that cannot go ignored, e.g., governments providing disincentives through taxation policies mitigating against personal wealth creation, one result is that individuals will simply forum shop, moving to another location to practice their craft. Of even greater concern is that a wrong policy or incentive structure will stifle innovation and initiative will diminish - not a good thing. Regulators have a tendency to overreact in times of stress, and may not necessarily look at an issue as volatile and complex as compensation in a forward thinking and objective manner.

An approach to this issue would be for companies to proactively establish compensation policies tied to long-term incentives and other risk-based compensation methodologies. The financial industry taking a proactive approach would keep governments out of the highly personal compensation issue.

Questions:

1. Is there really a compensation solution that is politically viable and commercially acceptable?
2. How can compensation policies be linked to the risks a person takes?
3. Is this really much to do about nothing in that the problems we’re now dealing with were really only marginally linked to banking compensation and because it is perceived to be generous it has become an easy target?

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Posted by Rich Apostolik at 11:46 AM 6 comments