ABA Banking Journal - April 2013 - (Page 30)

cover story Risk management RAROC architect says banks can’t ignore risk managers anymore Financial risk discussion often comes wrapped in arcane terminology and methodology that can render the subject opaque, at least to the neophyte. But not when you speak with Dan Borge. Here’s an example from his 2001 book, The Book of Risk, on the concept of leverage: “When you leverage a risk, you magnify all of its potential outcomes, good and bad. If you can lift a 500-pound rock with a 3-foot lever, you can use the same force to lift a 1,000-pound rock with a 6-foot lever. A 6-foot lever has twice the lifting power of a 3-foot lever. It also hits you in the face twice as hard if you lose your grip at the wrong moment.” The engineering analogy comes naturally to Borge. He was part of a 5,000-person team designing the Boeing Super Sonic Transport (SST). When the SST got cancelled, Borge went to business school, and New York’s Bankers Trust snapped him up in the late ’70s. Charles Sanford, then a division executive and later head of the bank, wanted his help formularizing an idea completely new to the industry: Not all risks are alike. What he and Sanford cooked up, and developed with a willing team and an often-unwilling banker cadre, became both an industry standard and the foundation of much that came later: Risk Adjusted Return on Capital, known as “RAROC.” Sanford’s intent was to devise a system, with controls, that gave a bank the means to accurately measure risk, “so he could argue to the regulators that we didn’t need as much capital as they thought we did.” The first job wasn’t convincing the regulators, but the company’s bankers. Says Borge: “They thought we were nuts.” By 1986, the bank felt it not only had something that worked, but something beyond what many competitors did. Risk management had had its vindication. In discussing the evolving riskmanagement function, Borge believes 30 | ABA BANKING JOURNAL | April 2013 many banks still haven’t fully embraced what it can do. “Before the crisis,” he says, “the chief risk officer’s primary duty was to take a bullet in case of trouble.” During much of the pre-crisis, crisis, and post-crisis period, Borge served as a risk-management consultant with large consultancies—he’s independent now—and felt risk managers too often did their thing off to the side, producing analyses, charts, and graphs that top executives gave short shrift when business kept booming. “I think we still have a long way to go” — Dan Borge Here’s where the “bullet” came in. “A bank would report a big loss for a quarter,” says Borge, “and people would ask, ‘How did that happen?’ Management would reply: ‘Our (former) risk guy, well, he really screwed up, and we had no idea what was going on’,” To Borge, that’s an unacceptable answer. Accountability is essential to riskmanagement culture. Many institutions have the tools and the people in place, but adopting a risk-management culture takes an organizationwide commitment, Borge says. “I think we still have a long way to go.” Building, and living, risk culture Once the industry found itself enmeshed in the financial crisis, risk management and risk culture were overshadowed. “Everybody, under- standably, went into fire-suppression mode, and they could only fix things that they saw as immediately compelling,” says Borge. “Building a risk culture is more of a long-term, slow, and difficult process.” Actually, if a bank approaches this correctly, he says, the task never ends. The central challenge to building, and using, risk management, says Borge, is that “Managers don’t understand what risk managers do, and risk managers don’t understand what managers do.” “This is a very hard problem to solve,” says Borge. “It’s not just a matter, at times, of ill will or stupidity. It’s a matter of very different roles.” Borge faced that when implementing RAROC, and learned that simply imposing an approach wasn’t always the best solution. A standard response evolved: “We’d rather fix the airplane in flight than wait for it to crash. And if you’ve got a better idea, we’re open to suggestions.” This worked, he says. Building a risk culture begins with the board. Borge stresses that he’s not encouraging an adversarial relationship with management, but a questioning one. The board must ask questions, get answers, and ask more, digging down into a view of what’s going on in individual business units. Board members must insist on reports that provide understandable analytics, not just a pile of indecipherable data. Ultimately, he says, “you need the reports and the rules. But you’ve got to make sure the CEO and board are on the hook for changing the organization’s approach, so you can trust them to not do something stupid or reckless. And that’s a cultural effort.” (Read more of Borge’s advice to boards in ABA Bank Directors Briefing at www. ababj.com/BDBsample) Risk management and regulators Bankers are worried about Basel III, and Borge says they should be: “It’s way too complicated. You could spend http://www.ababj.com/BDBsample http://www.ababj.com/BDBsample

Table of Contents for the Digital Edition of ABA Banking Journal - April 2013

ABA Banking Journal - April 2013
Contents
Chairman’s View
Editor’s Column
The Economy
Bank Notes
Picture This
ABA COMMUNITY BANKING Negotiating better contracts
Pass the Aspirin
Tech Topics
COVER STORY: Focus on risk Regulators raise the bar—big time!
RAROC architect’s views on risk
Top-performing big banks
Compliance Inbox
ABA At Your Service
Legal Issues
First Person

ABA Banking Journal - April 2013

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