As changes in regulation, technology and customer expectations accelerate, Swiss financial institutions are confronted with a highly complex risk landscape. To what extent does your organization still rely on backward-looking methods that frame risks as static, isolated objects? And how well do you tackle cognitive biases in assessing risks and spotting upside potential?
Volatility, uncertainty and ambiguity are hardly new to business leaders. An increasingly critical part of a Chief Risk Officer’s role is to make sense of them, identify the ‘flywheels’ to act upon and indicate the best course of action. This presents a great opportunity to create genuine, lasting impact, as long as you take necessary steps to improve the effectiveness of your function.
Moving away from a silo mentality
While many risk professionals engage in endless semantic discussions around boundaries between risk categories, the risk landscape for their organization becomes more and more interconnected.
Traditional risk assessment methods allow comparisons between risk categories based on their impact and probability. This helps to set priorities but falls short of identifying how risks interact and how quickly they might affect the organization. Further, they provide no insights into the compound effect of risk clusters, potential chain reactions and options to thrive in uncertainty.
The past is no predictor of the future
Here lies the biggest challenge. Extrapolating based on experience to predict what might happen tomorrow is common practice in financial forecasting. Yet, the recent financial crisis demonstrates how highly sophisticated mathematical models are of little help when structural breaks kick in and change the rules of the game. When all assumptions that made sense before need to be redefined and scenarios that seemed unthinkable suddenly become the new norm. How many institutions faced severe profitability challenges once their assumption was proved wrong that favorable monetary policies would last forever? How many underestimated the pace of technological progress and assumed their back-office operations and distribution strategy remained good enough to compete in the market?
The psychological dimension of risk assessment
Several studies on behavioral economics warn us about our intrinsic limitations when it comes to risk perception. The World Economic Forum’s Global Risks Report 2018 acknowledges that “…our brains play tricks that make some risks appear to be more or less likely than they are in reality”. Moreover, depending on the structure of the expert process to bring out risks, one or more cognitive biases such as groupthink, anchoring, confirmation bias and framing effect are likely to significantly influence the end result.
Enabling better decisions: mission possible
Recognizing the above challenges is the first step for any Chief Risk Officer towards finding a solution. While it is may be unreasonable to suggest that traditional backward risk models are without merit, it is advisable for CROs to focus their attention on forward-looking tools such as Key Risk Indicators. Doing so will help the organization shift its focus from ‘what went wrong’ to ‘what might go wrong.’ And to master cause-effect relationships by enabling preemptive actions.
In order to make sense of complexity and gain competitive advantage, a truly enterprise-wide approach to risk management needs to be adopted. This should include the use of tools that help identify non-obvious interconnections between risks and differentiate treatment based on velocity – thereby optimizing the risk response and providing management with crucial insights into the ‘make or break’ factors for the organization’s future.
While efforts to improve risk culture require years to produce results, the use of technology and the application of appropriate ‘nudging’ techniques can deliver immediate benefits in terms of the quality and relevance of risk insights. And can go some way to delivering on that crucial success factor for reaping the benefits of enhanced risk assessment tools – the countering of cognitive biases.
 “Nudge: Improving decisions about health, wealth and happiness”, R. Thaler and C. Sunstein, 2009
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