Jeff Judy

Jeff's Thoughts - May 16, 2007

Is Your Worst Case Scenario Bad enough?

Figuring out the "worst case scenario" is routine for bankers who want to identify and manage risk. I spend enormous amounts of time, in the classroom and in the boardroom, helping banks and bankers think about anticipating problems and devising mechanisms to mitigate them.

Unfortunately, I frequently discover that the people I'm working with aren't really thinking about "worst case" situations. They are thinking about "bad cases that are reasonably probable," which isn't the same thing at all. And merely "bad case" scenarios don't give you the same protection from risk that true "worst case" thinking does.

This seems odd to me, because most of these people watch or listen to the news, and read newspapers. They talk to their neighbors, co-workers, and customers. And a lot of that news, and that conversation, is about surprising, catastrophic events!

We all remember 9/11, and its impact on the economy. In the last decade, we've seen different parts of the world hugely impacted by the SARS epidemic and hoof-and-mouth disease, not to mention Katrina. We know about hurricanes, earthquakes, wars, terrorism, disease and more. Any and all of these can suddenly and dramatically change the way we do business, because they can completely alter the way our customers live and work.

On that scale, the "worst case" stories I hear from participants in exercises and boards devising, say, loan policies, or relationships with dealers and distributors are pretty weak stuff. They tend to be "one-offs" -- something that is bad for a customer, rather than something that could be bad for an entire market. And they rarely include something that could be bad, directly, for the company itself.

Perhaps you're saying, "I understand this, but there are an unlimited number of disasters that could befall us. We can't have a plan for every one of them." I agree. But the impact of these disasters is channeled through the inputs to business, and we could do a little more thinking about core requirements for our, and our customers', businesses.

Take energy. We have to have it to do business. We have seen energy costs affected by hurricanes, wars, pipeline shutdowns, grid failures, and, increasingly, worries about climate change. Yet we only include concerns about energy when a business is in that industry, or extremely dependent on energy costs.

If a major disaster prevents any additional fuel from reaching your local market for a week, or ten days, do you have any customers whose income or revenue will dry up in that time? If travel becomes exceedingly difficult, due to disease or terrorism, where will that have an impact in your market, besides the obvious travel agencies and similar businesses?

Pessimism can be a very healthy trait in a forecaster, and we can all aspire to practice being just a bit gloomier in our "worst case" predictions.