How far can risk management be taken? For example, should a company with a superstar risk manager have been able to predict, two years ago, a recession so deep that it was marked by the implosion of Wall Street investment banks, massive layoffs, and plummeting consumer demand?
Risk managers on a panel at the CFO Rising West conference in Las Vegas Tuesday agreed that some outlying events cannot be predicted. But they didn’t relieve risk departments of responsibility for making sure companies can respond well to those events when they do happen.
Bill Bojan, former chief risk officer at United Health Group and now CEO of consulting firm Integrated Governance Solutions, said he always tells company executives and boards that “risk management is not a silver bullet and not a crystal ball.” While he pinned part of the blame for the financial crisis on a lack of checks and balances and poor governance at the top of many financial-services firms, he added that no risk-assessment process could have actually predicted the crisis.
But while some elements of risk management help prevent bad things from happening, Bojan said, a good risk-management culture also helps companies respond when the unforeseeable does happen.
Even in the recent economic climate, when most companies were taking few chances, some opportunities that involved risk presented themselves. That, to Bojan, is the key to a good risk culture: cultivating an awareness at the top levels of the company that businesses are in business to take risks intelligently, and that opportunities can either be leveraged or missed. Organizations that managed risks with that in mind “are responding better right now — they’re agile and adaptable, as opposed to being on their heels trying to figure out what to do,” said Bojan.
Gary Germeroth, chief risk officer at Calpine Corp., a big power company, agreed that he didn’t believe anyone could have predicted the broad economic meltdown. But the same wasn’t true, he added, for some of the risks that contributed to the crisis.
“You have to be really careful not to be too much in love with your own math. When you’re looking at an event like [the financial crisis], it’s really scenario testing that could have given you some heads ups.” — Calpine Chief Risk Officer Gary Germeroth
Before Bear Stearns collapsed in March 2008, Calpine was supplying energy to a subsidiary of the investment bank, Bear Energy, a natural-gas distributor and broker. Calpine, Germeroth claimed, was the first supplier to cut off credit to Bear Energy. Other parties, including rating agencies, were relying on complex mathematical models that concluded Bear Stearns never would go under, he noted. Calpine, however, factored in some additional market information on Bear Energy and saw a huge risk in continuing credit.
“You have to be really careful not to be too much in love with your own math,” said Germeroth. “When you’re looking at an event like [the financial crisis], it’s really scenario testing that could have given you some heads ups. Scenario testing is mor common-sensical than high-powered math, and people at all levels of the company can get their head around it more easily.”