We need a fresh approach to risk

IN LATE June, beginning of July, someone pressed the emergency malfunction switch again for the UK’s banks. The reputational fallout has been toxic.

Even Mervyn King, the governor of the Bank of England said: “[something] went very wrong with the UK banking industry and we need to put it right.”

In just two short weeks, we witnessed RBS’s computer failure, leaving customers of Natwest, Ulster Bank and Royal Bank of Scotland floundering, despite staff trying their hardest to clear backlogs. In quick succession, then came the fine for Barclays for Libor fixing, followed swiftly by another reprimand from the FSA for high street banks mis-selling interest rate hedging products to small and medium-sized businesses (SME).

This was followed by a flurry of activity in Canary Wharf, with Marcus Agius’s resignation followed by Bob Diamond’s resignation, followed by Agius’s non-resignation. The Treasury select committee has been kept very busy.

And it doesn’t stop there. Looking globally, we saw the JP Morgan Chase credit trading derivative losses – some $2bn (£1.2bn) and mounting. The London trading desk of JP Morgan was identified as the source of the loss, with Jamie Dimon telling the US House of Representative’s financial services committee that the desk had embarked on a “complex strategy.”

UNDER THE MICROSCOPE

The banking industry wasn’t standing alone in the spotlight. We also learned recently of GlaxoSmithKline’s $3bn fine for admitting it bribed doctors. And all this is topped off by the Leveson inquiry, which is taking a break from its investigation into phone hacking.

2012 has been a testing and trying time for the professions, from journalists to bankers. Auditors and accountants have had their fair share of issues to face in recent years too. We are not immune from controversy ourselves. The world of finance clearly needs to heal itself.

Even some four years after the original banking crisis, questions about risk, reward, trust and confidence remain, such as:

How do we balance risk with profit?
How do we ensure that the global financial system and business play by the rules?
How do we make sure that numbers are trusted, that the financial products we get as consumers and customers meet our needs and instill trust and confidence?
How do we work in the public interest?

GREATER SCRUTINY
Serious failings – words used by the FSA in its news release about the sale of the aforementioned interest rate hedging products to SMEs – have “had a severe impact”. Their words again. And while the banks are looking to provide redress, it was also clear from the FSA that poor sales practices were at fault, with rewards and incentives being a driver.

And whether it is desk traders or the chief executive, risk has to be managed and balanced with the financial rewards that come with it.

A survey conducted by ACCA in January of this year was almost prophetic in its findings. Conducted among its global membership, the results showed that risk greatly concerns accountants. It found that businesses do not always achieve the right accommodation between risk and reward. Respondents reported very high levels of bad behaviour around risk management – with examples including frequent gaming of forecasts, providing optimistic versions to avoid criticism or pessimistic ones to reduce expectations.

And it also revealed clear differences in the perception of a company’s exposure to risk between those at board level and those accountants working below board level, suggesting a worrying lack of appreciation of risk among decision makers.

Risk and its implications have not been addressed with sufficient respect or understanding by institutions. The risk function itself seems to remain undervalued, and too far down the corporate pecking order to be effective.

As the fallout continued for banks in July, Ifac – the International Federation of Accountants – published its latest position paper called A Definition of the Public Interest. It aims to present a practical definition that identifies the public interest and enables accountants to assess the extent to which actions, decision, or policies are made in the public interest.

This paper addresses the issue of the public interest from one specific perspective, namely how standard setters and regulators incorporate such concerns into their various procedures. But it is helpful in a wider sense since it seeks to explain how the process of developing financial and non-financial reporting creates benefits for society generally.

It talks of how an assessment is to be made of whether an action, a decision or a policy reflects the public interest. This assessment should consider net costs and benefits, and also whether the action is being conducted transparently, accountably, with independence, competence and adherence to due process – among other measures.

Some of these considerations will be relevant to the assessment of any large organisation’s risk profile and strategy.

As a result, businesses need to make sure they give risk management the strategic importance it deserves and integrate it appropriately into their systems. They also need to think about public interest implications and take the mirror test a bit more often.

The on-going financial crises highlight the disastrous consequences of senior management ignoring risk management. But the big question is: “what can be done?”

POLICY CONSIDERATIONS
It’s time to reset the switch, to reboot and rewind. We need to take on the Vickers proposals and separate retail from investment banking. After all, the banking you and I do on a day-to-day basis is very different to the inherently risky and specialised world of investment banking.

Businesses also need to work harder to spread responsibility for risk management across the whole organisation. Risk management needs to be something which is woven into the culture of an organisation, so it is fully integrated into what everyone does. Consumers of financial products need to understand risk better too.

While the accountancy profession has had its own share of controversies, we believe that accountants have a big part to play in the wider context of delivering public value and instilling trust.

After all, no one wants a business world – banking or otherwise – that does not inspire trust and confidence.

John Davies is head of technical for ACCA.