Market Digest

Technology and risk training are key to mitigating future meltdowns

According to Michael Welles of EdWel, a risk management training corporation, businesses should take home the lesson of risk management from Black Monday, September 15, 2008 to avoid their own meltdown by understanding that risk does not go away if it’s ignored. If the most sophisticated financial companies in the world are prone to failure can regular businesses guard against a similar downfall? Comments made by New York Times editor David Leonhardt indicate that we’re more focused on putting out fires than preventing new ones, “The Bush administration, the Fed and Congress, meanwhile, continue to focus on the immediate crises, with little attention paid to the underlying reasons that economy has gotten into this mess … ” (NY Times September 17, 2008).

“The answer to minimizing risk exposure is to not ignore it. Everything is a risk … customer relationships, financial controls, back office operations and product development practices could all pose problems for an organization. It’s getting the company to focus on the right risks. Sure you should worry about disasters (like Hurricane Ike or the stock market crash), but sometimes too much emphasis is put on these ‘sky-is-falling scenarios’. Instead, be sure to focus some attention on the risks that cause ‘death by a thousand cuts’. These risks slowly erode your competitiveness, and leave you in the same spot as a disaster,” says Welles.

When new banking rules allowed investment banks, such as Lehman Brothers and Bear Stearns, to not only create a debt-based instrument (mortgage backed securities), but also facilitate its sale, it appears the motivation to understand exactly what risk was buried within the debt instrument was lost. The new rules shifted the industry’s risk posture from cautious to aggressive.

“With a disciplined approach to risk management any business can understand the risks that lie just beneath the surface and develop a layer of protection from their own “‘Black Mondays’,” advises Welles. “The key rests in recognizing the dynamic nature of risk — and watching out for those risk triggers that hint at where things stand,” he adds.

According to Welles, every company can take these steps to minimize risk:

1. Review existing risk policies. Do the policies stop at disaster recovery or do standards exist to manage the dynamic nature of day-to-day business risks?
2. Assess your company’s attitude toward risk: Is your company a risk averse culture or does it live by the mantra — the greater the risk the greater the reward? How do your risk practices fit with this attitude toward risk?
3. Use new technologies to your advantage: Automated risk assessment and tracking tools, such as prediction markets, exist that can get you beyond ‘just trusting your instincts’.
4. Change the culture: The long-term goal should be to get every employee involved in managing risks. Developing a common risk language among the employees and training a disciplined approach to risk management prevents minor risks from morphing into disastrous challenges.

Source: EdWel