"Personalizing Risk Management"

An article I read titled "Personalizing Risk Management" by Julian Birkinshaw and Huw Jenkins, gives a unique view into risk management, somewhat similar to what we have discussed in class thus far.

The article described risk management for a large firm with three complementary approaches, each with positive and negative aspects:

• The first is called formalization, which is basically just following all the formal procedures, rules, formulas, etc. to evaluate and decide what risks should be taken within the company.
• The second is called externalization, which is depending on the expertise and skills of third parties (such as auditors, regulators, credit ratings agencies, etc.). I discussed possible problems with this approach in my previous post.
• The third is called personalization, which involves giving the responsibility for evaluating and judging risk to those individuals who are making the decisions within a company.

I think that the switch of a company's risk management approach back to focusing on personalization is a great idea to make risks more effectively understood and controlled. For example, if you think about a company's management, it doesn't make sense for them to have sole control over risk management decisions, like they would get if the company followed formalization. Management doesn't always know all the information about what is going on in a company, and by getting input from lower level employees, or employees from various divisions in a company, they would have a wider view and be able to make better decisions. Personalization would allow this to occur, by giving more people input on risk management decisions and providing as much information as possible to make good decisions.

Personalization is also a good thing, because sometimes managers may be too focused on personal goals and not the overall good of the company. They may get bonuses or benefits for short term profits, so they will focus on this, rather than the long term status and future of the company. Making risk management decisions in this manner could be detrimental for the future long term good of the company simply due to a greedy manager. Personalization would reduce the sole power of these managers, and also refine their personal accountability. It seems to me that reorganizing their rewards would be a great way to fix part of the problem. It should be more focused on long-term behavior, rather than short-term profits. Companies need to make sure that those people who are making the key decisions are genuinely responsibility, and not too far removed to see what is really going on.

To me it seems that a supportive culture would also help out with this personalization of risk management. For example, if you look at those few companies that have been successful even during these difficult economic times, such as JP Morgan Chase and Goldman Sachs, you will see that they have a high level of team-based decision processes, open debates, intellectual honesty, and sufficient self confidence to make decisions. This way information is not hidden from any level of management or employees. It also helps manage risks better because employees see how their actions impact others, and have a clearer picture of the company, and everyone looks out for each other.

Though I think it is evident that all three types of risk management - formalization, externalization, and personalization - can be beneficial at times, but after reading this article I see the many benefits that come from personalization. It seems like a pretty intuitive thing that responsibility for evaluating and making a judgment on risks should be given to those individuals making the decisions, rather than pushing it solely upon top company managers or outside organizations with no real accountability.

Financial Times - "Personalizing Risk Managment"