Jeff Judy

Jeff's Thoughts - December 23 , 2009

Risk and Response: Avoiding Potholes or Adapting to Conditions?

One thing we grow really well here in Minnesota, besides corn and soy, is potholes. Weather in this part of the world eats holes in our roads of such depth and ferocity that by the end of winter, major highways and side streets alike offer Swiss cheese surfaces that snap at your wheels, hoping to pop off a hubcap and ruin your alignment.

Strange to say, some deep potholes are regulars -- they appear in the same place year after year. If you live here, you get used to driving around those, almost without thinking about it.

And all of them produce a lot of last minute swerving and braking. I mentioned in the last issue of Jeff's Thoughts how some drivers look only a few feet ahead of their hood ornaments. These are the ones who are jerking the wheel at the last second.

It's not good driving, but it is usually good enough. They avoid most of the potholes, with a little minor jarring, but it gets the job done.

In the past, managing risk for your bank has been a lot like that. The risks in question were fairly specific, they tended to pop up in the same old places from one borrower to the next. Bankers took a fairly narrow view of the road ahead, very often responding rather late to an increase in risk in a particular relationship, but most of the time managing to get through it with minimal damage.

But in the decade ahead, as we crawl out of this recession, we have to be more concerned with broader road conditions, not with just a few potholes here and there. We have to look all around us, and well beyond our front bumpers, in a world where we face a broad spectrum of risk.

Not only are there more sources of risk, there is the possibility that several small risks will combine to create major problems. The troubles in our industry have certainly made lower returns, if not more common defaults, facts of life in our business. But as I mentioned in a recent issue, they have also significantly changed the legal risk most of us face, increasing the risks we can encounter when we get entangled in litigation. ("The New World of Legal Risk")

Similarly, new regulations, and the application of old regulations to smaller institutions, will require changes in reporting and processes, and in the systems that support them. And with those changes come risks of mistakes, crashes, and confusion as some employees adapt to new ways of doing things better than do others.

So we end up with a whole set of road conditions to monitor and respond to, not just potholes, but gravel, or rain, or snow and ice, or accidents (and strings of gawkers stopping traffic), or construction zones. While a single deep pothole can damage your wheel, a little ice on a rough road combined with a sudden traffic slowdown can take out the whole front of your car. In the same way, combinations of risks of different kinds pose new threats that are much more challenging to assess, and respond to, than those neatly packaged risks we managed just a couple of years ago.

These issues of the broadening spectrum of risk we will see in the coming decade, and the responses that make sense to manage that risk, will get plenty of attention in Jeff's Thoughts throughout the coming year. I'll also write more about Enterprise RIsk Management (ERM), which is increasingly applied by businesses of all kinds as a framework that helps ensure important sources of risk are not overlooked.

For now, though, get used to the idea that, as the economy improves, just settling back into your old patterns of risk management won't protect you from many of the hazards that are lurking out there. Prepare to develop new responses to a new world of risk that you can't "swerve" your way around at the last moment.