Sunday, 26 April 2009

The Failure of Risk management

'"Well then, how will our state supply these needs? It will need a farmer, a builder, and a weaver, and also, I think, a shoemaker and one or two others to provide for our bodily needs. So that the minimum state would consist of four or five men...." (The Republic, Page 103, Penguin Classics edition.)

"When every individual person labours a-part, and only for himself, his force is too small to execute any considerable work; his labour being employ’d in supplying all his different necessities, he never attains a perfection in any particular art; and as his force and success are not at all times equal, the least failure in either of these particulars must be attended with inevitable ruin and misery. " (David Hume, A Treatise of Human Nature" (1739)):

These are two views on the division of labor. One speaks to its necessity for a wealthy and productive society, and the other to its destructive impact. I think the creation of Finance as an industry is an example of the former, whereas the creation of Risk Management as a sub-industry of Finance is an example of the latter.

Why do I think this? Well, it is to do with the separation of decision making, reward and responsibility.

Investors often talk about 'taking risk'. We choose to either 'take risk' or 'not take risk'. And responsibility for making a good decision lies with the decision maker.

To seperate the measurement or management of risk, from the decision to take the risk itself, not only confuses the responsibility, but dis-empowers the actors in the decision.
And creating adversarial environments between risk and profit (as most banks do) only puts risk in the junior position.

Therefore I think risk management is a discipline, not a profession. And as with mathematics, all should be literate and responsible in its practice. Risk cannot be delegated like Law, or Carpentry...

But worse than this is the scale such a division of labor between decision makers and 'professional reviewers' allows. Partly because it requires less training to reach 'competence' in one of the divorced skills, but also because of the sense of safety that such an organised and professionalised environment creates.

The failure then of risk managers (and I count myself very much in this) is that they, as individuals, submitted to, and encouraged this organisational slight of hand.

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