Risk Awareness and Acceptance

My first slide and its opening bullet points—"this can happen to us, this does happen to us"—has always caused consternation and disapproval. I have argued that to say you have "No Appetite" for such bad behavior is simply living in denial, burying your head in the sand, defaulting to hope and prayer, not accepting the realities of bad and good people in your midst. It’s essential to recognize that bad behaviors and critical times necessarily have post-hoc ergo propter hoc ("after this, therefore because of this"; i.e. if A precedes B, A must have caused B). A non-zero appetite is implicit in being open for business with people as a resource. Perfect storms do not happen; they are carefully assembled and implemented. When your unpreparedness meets the right opportunity, and your people are game for it, even as your structures, systems, and governance mechanisms have swiss-cheese elements with the holes neatly lined up to let anything through.

So What?

Start with explicitly acknowledging that bad things will sometimes happen, even if your mechanisms are best-practice and robust (or so you think). Prevention is entirely correct and mandatory for top-down messaging and policy dictates; however, it behooves the operating part of the organization to embrace and act on the "Catch it Early and Keep It Small" goal. Once you accept this, defining and putting structure to Risk Appetite follows quite easily.

Go back through every major accident and event in financial market history—from the Titanic to various natural and man-made disasters. Prevention in some cases was not possible, and in others simply did not happen. Yet, organizations that proved resilient possessed the fundamental ability to catch issues before they festered and snowballed into something beyond what balance sheets and capital (and the system as a whole) could sustain. They had the detective and forensic abilities that provided the safety-net, quickly catching smelly stuff, unusual p/l, conflicts of interest, trade tickets in the drawer, fudged accounts, system accesses, fake reports, collusions, violations of confidentiality, doubling down on bad debts, unwillingness to accept smaller losses, disregard for limits and boundaries, and cooking client books—all of which help to conceal and exacerbate the original problem, retrospectively small and simple if the culture allowed for early recognition and acceptance.

Without early intervention, it becomes too difficult to camouflage and conceal the issues. The lid of the pressure cooker blows. For want of nails, kingdoms are lost, and the rest becomes history.

A Final Point

There’s a tendency not to ask questions when things are going well, even too well. Conversely, there is a tendency to slump and withdraw when things are going badly, even too badly. When someone makes large and unusual profits, ask how they achieved it. When someone has made a large loss or fallen well behind budget, ask what they might do to try to make it up. Watch the large gains and the large losses—bad behavior is lurking there, waiting for the opportunity to manifest.

Amen.