(This blog post comes from our colleague Benjamin Weldon, Archer Business Manager for Financial Services with RSA in Australia. He offers a unique perspective into the connection between risk culture, profitability, trust, and sustainability.)
A few weeks ago I went to lunch at one of my favourite local Chinese restaurants near our head office in St Leonards. The round tables always provide a great opportunity to laugh with friends and enjoy the spicy Sichuan food as it spins around on the lazy Susan. At the end of the meal the host always leaves fortune cookies and chocolates.
With the snap of my cookie, I was curious as to the significance of the little note I discovered inside. The note read: “Decision is a risk rooted in the courage of being free”. I knew once I read the note that the meaning of this simple sentence would soon emerge in my daily activities and interactions.It was only a week later that I had the pleasure of meeting an individual responsible for managing risk across a financial services organisation in a highly competitive market segment. This meeting provided a good opportunity for strong debate about the complex issue of risk culture. We discussed how like most challenges in the world of risk, there are no simple solutions to improving risk culture and conduct risk in organisations. It got me thinking… is it true that we have been dealing with the issue of risk culture for several years but it has not been improved in any measurable way?’ Have we simply just come up with a new name for an existing and long-term problem?
During the conversation we discussed how last year several large banks were investigated for their financial advice businesses. This year we have seen possible bank bill swap rate manipulation. The banking industry has even seen its own bribery incidents. As these organisations get bigger and more profitable, it becomes more difficult to embed a balanced culture of core values and principles with increasing revenues and profitability. We have seen these events occur for years, but there has been very little done to address them. Fines are given, warnings issued, regulators speak about the challenges and companies apologise, pay out and move on.
Is it cheaper to take risks and suffer the consequences than to proactively manage risks and ‘do the right thing’? The figure below from Kit Sadgrove’s book The Complete Guide to Business Risk Management simplifies this point well. It is evident from events we have seen in Australia and around the globe that the balance of risk and reward from the left to the right is clearly difficult for many organisations.
I’m a firm believer that risk management, like a map and compass, exists to help organisations steer the right course. It is about striking the balance between profitability and ‘doing the right thing’ by your customers, shareholders, partners and employees. However, if I go back to the little note inside my fortune cookie, I am drawn to the possibility that good and bad decisions are rooted in the courage of being free and perhaps it is human nature to test the boundaries and take seemingly necessary risks for the possibility of significant rewards. After all, it’s risky decisions that have led to advancements in technology, human adventure, travel and exploration.
I decided to do some research and get my own balanced view on the effects a risk-aware culture has on an organisation’s profitability and longevity. I focused my attention on risk management within financial services and the arguments for and against.
How risk management shapes financial organisations
1. Organisations that invest in risk management are more profitable.
A recent PWC study has shown that “companies that put a premium on risk management are seeing better growth and increased profit margins”. “Risks are increasing dramatically and executives are constantly faced with making decisions to protect their businesses, while also trying to improve their financial performance,” says Dean Simone, leader of PWC’s US Risk Assurance practice. The facts are clear: “55 per cent of risk management leaders recorded increased profit margins and 41 per cent achieved an annual profit margin of more than 10 per cent.”
Marcus Vaughan, regional lead of the Aon Risk Maturity Index for Australia said of the findings: ‘The evidence is clear: there is a direct positive correlation between advanced risk maturity, an organisation’s understanding of risk management practices, and enhanced financial performance when considering key metrics such as Return on Equity and Return on Assets. This in turn speaks directly to directors’ obligations to maximise shareholder value. The report found that companies with the highest rating on the risk maturity index, a 5.0, experienced share price volatility 34 per cent lower than those with the lowest score available, a 1.0.’ This is represented in the graph below:
‘The highest rating also resulted in a 42 per cent return on equity performance compared with a negative return of -23 per cent for companies at the lowest end of the spectrum.’
It is clear from these studies that there is a direct link between investments in risk management to profitability.
2. Organisations that embed risk management into the corporate culture generate greater ‘trust dividends’.
Last week when addressing a lunch to celebrate Westpac’s bicentenary, Australian Prime Minister Malcolm Turnbull said that ‘banks are built on trust’ and I couldn’t agree more. The greatest difficulty, however, is measuring ROT (return on trust). In his book The Speed of Trust, Stephen Covey discusses the concepts of ‘Trust Tax’ and ‘Trust Dividends’ when building credibility and long-term success. Consciously or not, we make decisions every day using our own trust barometer.
It is clear from the diagram below that the c-suite and risk managers are both concerned about risks that impact their public perception or reputation, particularly in the face of competition and economic slowdown. What is most interesting is that many of these risks seem interrelated, as many are by-products of the others.
Embedding risk management into corporate culture is not an easy task. There are several factors that contribute to its success. Here are a few that may help you:
- Risk scorecards: Scorecards assist in selling risk to the organisation. There is no better example of the power of simplicity than boiling down risk into a manageable and digestible format for executives and business units to make decisions around appetite and action.
- Tone from the top: Organisations that have a positive risk culture have a consistent and strong tone from the top as to its importance. Acceptance from the head of the business that risk management is key to profitability and sustainability goes beyond the scope of what risk management teams can do on their own. Just like corporate social responsibility, risk needs airtime from the top.
- Job descriptions: Set the expectation early. In his book Good to Great, Jim Collins says that successful companies first got the ‘right people on the bus’. The right people are those who understand that risk management is an important part of their job role and there is no better place to discuss this expectation than during the hiring process.
- Success stories: Internal marketing of examples of good risk management in action is a way to create a competitive environment, and highlight and reward good behaviour as an example to others. Highlighting success stories has the dual purpose of selling the value of the risk management team in helping the company avoid all types of risks.
- Regular training: Employees are expected to complete regular training for ethics, compliance and security. Risk management training should simply be another module of regular training and awareness.
- Linking directly to remuneration: From my research, of all the factors attributing to the better integration of risk management into corporate culture, directly linking risk management to the payment of bonuses is by far the most successful. Should a breakdown of values occur due to the attractiveness of revenue and profitability, the fact that the individual themselves could not be remunerated is often reason enough to prevent the wrong behaviour from taking place.
3. Organisations that invest in risk management have stronger long-term sustainability.
Share price is not a sole indicator of long-term sustainability, but it is an important part of the picture. Future sustainability is as much about year-on-year growth as it is about weathering events and market volatility. The graph below represents the comparative share price performance of organisations with low risk maturity to those with a higher rating. As you can see, those organisations with higher maturity had a higher share price performance overall, showing us the direct correlation between advanced risk management and market perception.
There are several factors that help organisations survive a financial crisis. One of the key areas is risk management, as it involves several forward-looking models to minimise the impact of external and internal risks. As represented in the graph below, mature risk management assisted these organisations in maintaining a strong share price position during the Greek financial crisis.
My simple truths
Will we continue to see companies in the financial services industry fall victim to the decisions of a few individuals who lack the values and beliefs of the broader organisation? Of course we will. However, resting on the belief that this will never happen to us is not a strategy.
- Investing in risk management is about steering the right course and standing by the duty of care you have to your customers, stakeholders, partners and employees.
- It is true that we can’t stop all risks, but with technology we can encourage the right reporting behaviours.
- With the right culture, we can inspire everyone to own risk.
- With the right funding and engagement, we can develop a solid business strategy that embeds risk conversations into everyday business practices.
I hope you enjoyed the article. If you have any questions or would like to discuss any of my beliefs, opinions and recommendations, please feel free to reach out. I am always interested in broadening the discussion and getting more views. You can reach me at benjamin.weldon
(The opinions expressed here are Weldon’s personal opinions. Content published here is not read or approved in advance by EMC and does not necessarily reflect EMC’s views and opinions, nor does it constitute an official communication by EMC.)