Despite the worst recession for decades, apparently Brits went on a serious shopping spree in the build-up to Christmas. Retailer Tesco reported its best performance for three years and John Lewis reported record sales, while the British Retail Consortium reported a total sales rise among its members of 6%.
But rather than playing the fool, have consumers actually demonstrated an awareness of the need for risk management and mitigation?
VAT reverted to 17.5% on January 1 and may increase further this year. Pundits are forecasting a rise in interest rates. Perhaps many of us decided to apply a little risk management and buy while goods were still affordable.
Consumers are clearly conscious of their individual circumstances and are taking steps to mitigate the negative impact the risk of future unemployment could have on their finances.
Figures from the British Bankers’ Association at the end of 2009 showed that consumers are concentrating on saving and paying off debt in the downturn. Total consumer credit contracted by 2.2% in the past year.
In November people paid back £300m more in total than they took out in credit and the household savings ratio rose to its highest level since 1998.
So if risk is top of consumers’ minds at the moment is it also top priority for financial institutions?
Latest figures show the UK economy has emerged from recession but it would be a fool who believed that 2010 would be anything but a challenging year. While there are improvements in many key indicators a number of critical measures are still in negative territory and recovery is likely to be protracted.
The events of the past couple of years have underlined the importance of properly understanding the risks financial institutions face, and of having the appropriate systems in place to respond to changing circumstances.
Arguably, the credit crunch that led to the recession was not caused by a failure of the business models of banks. Rather it was a failure to properly understand the risks involved, to adequately stress test the assumptions underpinning these models and to consider the effect on business.
It would also seem there was a failure to ensure management information included the lead and lag indicators available to monitor and manage deviations from expectations. Lack of this critical information could stop a firm taking timely corrective action.
But it is unfair to just point an accusing finger at banks. It is true to say that many financial services businesses, including insurers, have failed to adequately use risk management as a practical tool to drive business decisions in recent years.
Risk management is all too often seen in isolation and only analysed when something goes wrong, at which point risk mitigation strategies may no longer be appropriate or applicable.
Only by understanding all the types of risk a business faces from strategic and operational issues to financial and market matters – and understanding what drives each area – can a business determine its risk appetite. This should form the basis for all business decisions in the future.
A shift in attitude
Rather than being a backward-looking exercise this should involve a fundamental shift in attitude. Financial companies need to look forward to identify the inherent risks they face, see what can be done to mitigate and transfer risk, then pin down trigger points to implement action.
This does not mean the process should be internally focussed. Yes, it is important to understand internal processes, quality controls and checkpoints but firms must also understand the impact of their decisions on product development, distribution channels, client relationships and customers.
Product design and distribution choices can result in unintended risk to firms if they fail to properly understand the risks they face in the markets in which they operate.
Adopting a silo view – whether looking internally rather than externally or from an individual department, product line or geographic base – can lead to a business failing to identify the potential for cumulative risk.
One area that often falls outside risk management frameworks but should not be ignored, particularly in the current climate, is that of people.
It is a sad truth that job cuts are a natural outcome of an economic downturn. While companies strive to retain talent the strain of seeing colleagues leave and absorbing additional workload as well as the stress as staff manage their own personal circumstances can lead to behavioural change. This can result in a desire for a job change as the economy improves and the job market picks up.
It’s all very well having assessed prudential or liquidity risk, created and stress tested scenarios and pulled the trigger at the right point to implement an identified mitigation strategy but if a business faces a brain drain as markets recover it could suffer.
Strong personnel management practice in areas such as motivation, training, reward and staff retention should be an integral component of a risk management framework.
Sound risk management frameworks, whether imposed by a regulator or internally, provide the discipline required to help firms ride the economic storm and protect their competitive position once markets recover.
In the coming months I plan to take a closer look at some of the strategies that financial institutions can implement and how insurers can support them. There is a great deal of synergy between lenders and insurers and the closer we can work together, the stronger we will be.