Risk Averse & Risk Managed

In Seeing Culture, I introduced the idea that a culture is “Risk Averse” or “Risk Managed”. It has been pointed out to me that I did not explain what I meant by these terms. I come from an investment banking background and that’s where my understanding comes from. Please shout out if the terms I use are unclear, it’s probably because of the finance language and that I never went to a public school to learn the propa meanin of werds.

Risk exists. Regardless of whether we are risk averse or risk managing, the risk is there. The difference is our approach to risk.

Risk Averse means that we attempt to ignore risk or get someone else to own it for us. Often risk averse individuals will feel powerless about risk and will attempt to hide it or deny that it exists. Risk Averse refers to our intent rather than our behaviour. The irony is that people who intend to be risk averse engage in very risk behaviour. When risk averse individuals take risks, they gamble. They make big bets and they take a punt. They ignore the risk and hope that everything will turn out OK. Sometimes it does, often it doesn’t. Managers get promoted because they are lucky. In fact, in a risk averse culture, the way to get ahead is do nothing and wait for those who do try something special to fail.

Risk Managed means that we manage the risks around us. There are many strategies we can adopt to manage our risk, which include:

  1. Do nothing.
  2. Monitor the risk.
  3. Make the risk transparent.
  4. Hedge the risk.
  5. Get an expert to manage the risk.
  6. Sell the risk.
  7. Buy insurance.

The point is that a risk managed culture attempts to make risk transparent and visible so that it is managed, whereas a risk averse culture will attempt to hide risk, ignore risk, or off lay it on someone else. Risk managed cultures attempt to understand risk so that they can manage it.

I recently ran a session on the role of the IT Project Manager (They are there to manage risk funnily enough). We ran an exercise where each group would pick a process point, and identify the risk it was meant to mitigate. Then they could suggest an alternative process to manage the risk. One group picked “Production Sign-off”. This was where the team got senior management to sign off that the software was fit to go into production. When we discussed what risk it mitigated, the answer was “The manager will get sacked instead of us in the event of a serious fail in production” The reality is that the manager would still sack you and is unlikely to be sacked themselves. The risk they are trying to address is a complex one “Failure in Production” and they are trying to address it with a Complicated Strategy, by going to an “Expert”, “Hippo” or “Authority” to cover themselves in the case of failure. They are NOT mitigating the risk of failure, only the impact on them…. And it does not do a good job of that either. The real risk was “How do we handle a production fail after release?” This is an outside context problem as we do not know what might cause the failure. We were then able to start developing options to manage the risk. A “Roll back strategy”, “Monitoring and failure detection”, “Phased roll out”. In effect, we need to develop systems that are resilient and robust. Sign offs are a sure sign that people are being risk averse.

Years ago I worked for a large multi-national. It came up that they did not insure employee’s laptops. “Why not I asked?” “It cost more to insure them than it does to replace the ones that are lost/stolen/broken” The risk was not ignored, it was quantified and the company decided it was cheapest to do nothing. This is why “Catastrophe Insure” exists. Some companies find it cheaper to not insure business as usual risk, but they do insure against existential risks. This was a sign that the organisation was risk managed.

The interesting thing about risk is that we can have a different risk preference for different types of risk. A company may be amazing at managing its business risk but then have a “Vendor assumes the risk” attitude to IT investments. They are blind to the fact that the vendor does not assume all the risk, and they are ignoring significant risk. Risk aversion often has to do with our understanding of a subject and the risk associated.

Most people are risk averse when it comes to their financial investments related to their retirement. They consider finance to be a scary and risky world. As such they will tell their financial adviser to invest in the safest or least risky investments. They will then gamble or have a flutter with some small proportion of their investments. So most of their pension goes into investments (Government Bonds) that will provide a return just above or just below inflation. A small proportion will then be invested in a start up. A more balanced approach might see someone investing in an equity pension. The great thing about equity pensions is that they go up when the market goes up, and they go down when the market goes down. People check their pension performance once a year when they get their statement. Most people investing in a pension do not know the track record of their financial adviser, and they do not know the name of the person managing their pension fund.

Risk takers invest in hedge funds. They know the name of the trader running the hedge fund. They probably know the trader personally. In fact, they were probably the trader’s manager when the trader worked for an investment bank learning their trade. Each day they will check the price and risk profile of the fund. The hedge fund will be expected to make money when the market goes up AND when the market goes down. The investor will expect an appropriate level of return for the level of risk they are taking. They do not ignore risk, they learn about it.

So here is the punch line. ALL cultures should be risk managed. There is no excuse for being risk averse. As companies, the risk most people are concerned with is “Will I be fired?” as they think the company is big enough to survive on its own. Most employees do not think “Will the company go bankrupt?”. The reality is that large companies now go bankrupt. Fifteen years ago investment bank made money out of “over-supply” in a market through juicy merger and acquisitions fees. Companies did not go bankrupt because banks did not make money out of bankruptcy. The problem with M&A revenues was that they were lumpy and were not predictable. Fifteen years ago an innovation called Credit Derivatives came into being. Investors pay Investment Banks an insurance premium to protect them when companies go bankrupt. Now investment banks can make money out of bankruptcy. Not only that, but is a steady predictable income stream. A few bankruptcies now and then are good for business.

It also explains why smaller companies tend to have a culture that manages risk. The biggest threat to your salary is that the company goes bankrupt.

Sorry its a long blog post, I did not have the time to write a short one.

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About theitriskmanager

A IT programme manager specialising in delivering trading and risk management systems in Investment Banks. I achieve this by focusing on risk rather than cost. A focus on costs can lead to increased costs. View all posts by theitriskmanager

2 responses to “Risk Averse & Risk Managed

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