“Risk management is a systematic process of identifying and assessing company risks and taking actions to protect a company against them.” (Reference for Business)
In his previous blog post “Anticipating risks in 2011… but can we?” bravenewloock emphasized how important it is for businesses to identify their risks. Following up on this post, I will take a look on how the attitude towards risks before the financial crisis played a major role in the latest economic downturn.
Being the first step towards risk management the identification process leads to anticipating the possible impacts some of these risks might have. As a last step, a company needs to find some measures of protection against those impacts. (Müller, 2010)
What did particularly banks do to reduce risks or “hedge” their business?
Let’s go back to the year 2007: In January a similar global risk map, as introduced by bravenewloock in his previous post, was published by the World Economic Forum.
As you can clearly see, one of the biggest expected risks was the Asset price collapse.
This should have had the banks thinking of how to prepare for the worst, to survive it.
The article “Eggheads and long tails”, published by the Economist on May 17th in 2007, describes – despite being a bit skeptical about their functionality – some of the great risk management systems put in place by the big investment banks.
This is all nice and it seems the banks did actually prepare for some of the risks they might face.
But not the occupation of some risk managers or mathematicians who calculate the risks were the biggest part of the banks risk management system.
Instead, they just introduced new financial vehicles, as described in this article on stock-market-investors.com.
Banks pooled the highly risky mortgages into securities, which have been sold to investors, who then could resell them, and so on. The clue about this system is, that through the pooling of many mortgages into one security, these securities were highly diversified and could come clean on their Risk rating. Additionally, the risk has been spread through the whole financial system.
A British Banker “compares the process of transferring risk around the financial system to spreading butter on toast. With luck, he says, the butter will not be rancid.” (Economist)
Now, in 2011, we know how high these risks have been. In my opinion, the attitude towards rather earning more money with taking more risks than securing their business is one of the most important triggers for the current economic (not only financial) crisis.
The question is: Did the world learn to take risk maps more seriously, try to assess the possible impact of those risks and anticipate to them?