Financial Inst. Look To Diverse Industries For RM Lessons

"In the run-up to the recent crises, risk management in finance had taken a back seat. We need to make it a part of the way we do business again," said Lazaro Campos, CEO of SWIFT and co-chair of the report's steering committee. "The industry has a responsibility towards itself and to wider society to not let this crisis go to waste."

Simon Levin, Moffett Professor of Biology at Princeton University, welcomed the fresh perspectives in the report. "Developing a deep understanding of the context of complex systems outside of finance and accounting for the differences between the environments are key to drawing the right lessons to successfully implement change in finance," he said.

The report analyzes seven domains outside of financial services: aviation, fisheries, immunology, infectious disease control, pharmaceuticals, telecommunications and wildfire fighting are all examined with the belief that their risk management techniques might hold lessons for finance.

"Risk management has many dimensions," said Axel Lehmann, chief risk officer at Zurich Financial Services, and co-chair of the report's steering committee. "This report shows how risks are successfully absorbed in situations and under circumstances entirely different from those faced by financial institutions. There are vital lessons to learn from these findings, particularly the ones that deviate from the conventional wisdom proffered in our industry."

The findings were grouped into three non-mutually exclusive areas of focus: system-wide perspective, transparency and information flow, and governance and culture. It illustrates points with examples from various industries.

The report makes nine proposals, including:

o Innovate transparently: In immunology, pathogens that mutate before the adaptive immune response can kick in are particularly dangerous, because the immune system perpetually lags the pathogen's invasion. Similarly, financial institutions and regulators should be weary of rapidly "mutating" products by carefully monitoring instruments with exceptional growth and variation.

o Aggregate system-wide data: Aviation has become one of the safest human endeavors. Yet it makes efforts towards improving safety standards by continuously gathering and analyzing data on accidents, near misses and unexpected incidents from all industry participants.

Along these lines, actors in financial services could identify critical indicators of threat to the system; aggregate and analyze data that exists on these within individual banks, regulators, international organizations; and act on the insights generated.

o Look for trouble: The World Health Organization is continually watchful of the next pandemic, using its customized search engine and human networks. This has improved its ability to detect outbreaks earlier and respond to them more effectively. Financial services could create similar early warning tools and indicators and a culture that proactively looks for trouble.

The report's findings are presented as "food for thought" and are intended to spark a broader discussion, with a deliberate choice not to provide concrete prescriptions or off-the-shelf solutions for the industry.

In the area of transparency, the report said the financial industry lacked transparency and had insufficient consideration of complex interactions that prevented virtually everyone from fully comprehending cascading effects at the systemic level.

Regulators did not see the need to intercede earlier or knew how best to address the situation when they did react. Also, adaptations in regulations, along with the processing of information relevant for supervisors, significantly lagged behind innovation and industry evolution.

The report cited the aviation industry as an example. As accident rates began to plateau in the 1990s, the industry looked for new methods to continue to improve safety in the new millennium.

Now in the U.S., many agencies collect aviation safety data, including, for example, the Federal Aviation Administration (FAA)'s Aviation Safety Action Program (ASAP) and NASA's Aviation Safety Reporting System (ASRS).

These programs rely on voluntary reporting of incidents and near misses by commercial airlines and by individual aviation professionals; they have processed around 1 million incident reports to date. To encourage reporting, all reports submitted are de-identified so that names of individuals and carriers are secure.

"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, The Boston Consulting Group.

"We hope that the suggestions and insights in the report, while potentially controversial, will initiate constructive engagement between the various stakeholders towards making the financial system more risk-aware and resilient," he added.

The Steering Committee was comprised of industry partners of the World Economic Forum as well as noted academics and experts.

You can access the report at //www.weforum.org/pdf/FinancialInstitutions/RethinkingRiskManagement.pdf