Jeff Judy

Jeff's Thoughts - October 8, 2014

Eternal Risk Management

"ERM" is an acronym heard more and more often around banking circles these days. Those letters officially stand for "Enterprise Risk Management", a broader, more comprehensive approach to risk management than has historically been applied by most organizations, whether in financial services or other business arenas.

Now, I understand why I sometimes see bank management roll their eyes when they hear suggestions that they diligently apply the ERM approach to their own institutions. The full blown Enterprise Risk Management approach is very complex. "Credit risk" seems reasonably intuitive, but ERM breaks familiar risks into many components, and adds new areas of risk to monitor and manage.

That means that having the staff resources and processes to manage default risk, interest rate risk, liquidity risk, legal risk, reputation risk, regulatory risk, and more is very challenging. And since there is no single universal interpretation of ERM, you could be dealing with even more items on your risk management menu.

Of course, I do not have space here to lay out ERM in much detail. But I do encourage you to look beyond the details of any given ERM implementation scheme, the letter of ERM, so to speak, to embrace the spirit of ERM.

Think of the "E" as standing for "Enterprise-wide" and "Eternal"!

The real contribution of ERM has been to raise awareness of risk factors beyond the usual default on an individual credit. First of all, ERM suggests that everyone in the institution can contribute to risk management, even of specific credits. After all, almost anyone could notice a relevant item in the news, or a change in behavior of the borrower (Does the usually friendly owner suddenly seem to be trying to get in and out of the bank as quickly as possible?).

Second, defaults are not the only challenge to your success. The recent economic downturn had lots of financial impacts on you and your borrowers. But it also had a huge impact on the reputation of the entire banking industry, and smart banks adapted how they talked to their prospects and customers to reflect that new reality.

Risk management also has an eternal aspect to it, we might say. By this, I mean that risk management is not an event that occurs on a quarterly or annual basis. It is a daily activity that never stops. While certain milestones come and go on the calendar, what's needed is constant enterprise-wide vigilance to detect any significant change -- within a borrower, within the marketplace, within the broader economy, within the legal and regulatory environment, within the media -- that could have an impact on your business.

Eternal and Enterprise-wide vigilance is the cost of truly effective risk management. Whether or not you formally adopt a specific ERM approach, adopting the ERM philosophy can do a lot to improve your fortunes as you ride the business cycle, year after year.