1.1 Increasing Importance of Risk Management Competency Development
The 2007–2009 Global Financial Crisis is the largest single economic upheaval since the 1930s Great Depression. Barely a decade earlier, the US property prices had reached dizzying heights and seemed to defy gravity. Many, lured by the property frenzy, borrowed heavily to supposedly invest. Many others rode on the property boom to refinance their homes with even larger loans. Meanwhile, banks were adding fuel to the fire through lucrative but complex products called exotic financial instruments. These exotic financial instruments attracted investors worldwide, and hence, the subsequent US property market crash would subsequently have global reach (Lund, Manyika, Mehta, & Goldshtein, 2018).
Furthermore, securitization accelerated the transmission of the property market crash. Securitization is the process of pooling together loans which are in turn repackaged into smaller units of securities. These securities are sold to investors who hope to receive future cash flows which emanate from the originating loan principal repayments and interest income. The proceeds from the sale of these securities effectively provided the banks with an easier alternative source of funding. In other words, the banks were able to pledge these securities as collateral so as to borrow more to fund their incremental lending activities. While loans extended to better credit quality borrowers had tapered off but with balance sheets still expanding, banks compromised their lending standards. They gave out increasingly more subprime loans, that is, to borrowers of lower credit quality. These subprime loans eventually entered the securitization process. In other words, banks went to the extent of ‘borrowing by pledging bad loans as collateral’ (Shin, 2018, p. 2). Hence, the effect of the subprime and bad loans was magnified and transmitted more quickly in the banking system.
Moreover, mortgage brokers who originated the mortgage loans were quickly churning fees by selling mortgage-backed securities to investors. But often, these brokers did not properly assess a borrower’s underlying creditworthiness. This is because these brokers were incentivized by sales volume rather than the borrower’s creditworthiness. They wanted to quickly sell off the securities rather than really having the investors’ interest at heart. These brokers were also encouraging households to unduly stretch their borrowing capacity to take up mortgage loans, a problem compounded by lax regulations on the originator brokers (Mishkin, 2016).
When the US property prices crashed, many people lost their jobs because of the depressed economy. Many could not repay their loans and banks took possession of their homes. As a result, ‘millions lost their jobs, their homes, and their savings’ (Lund et al., 2018, p. 1). Banks became more cautious and it became harder to obtain loans. Consequently, the economy suffered a liquidity crunch and went on a downward spiral. The Global Financial Crisis also led to the fall or near-failure of once highly respected global financial giants, such as Lehman Brothers, Bear Stearns and Citigroup (Bloomberg, 2012, p. 516). The effects were far-reaching, and the US government alone spent some USD 475 billion in bailouts (Pizzani, 2012; U.S. Department of the Treasury, n.d.).
Despite the lessons learned and regulatory reforms, leading global banks still hog the headlines for the wrong reasons. Over the ten years following the Global Financial Crisis, regulators worldwide fined banks more than USD 375 billion for various misconducts (Wright, 2017). Some examples include Barclays and HSBC being charged for manipulating interbank rates reporting and money-laundering financing, respectively. Further, JP Morgan Chase, widely regarded as a global role model for risk management, suffered a USD 6 billion trading loss and was fined USD 750 million for engaging in securities fraud (Hurtado, 2013). In fact, Gordon Brown, the former British prime minister during the Global Financial Crisis, laments a decade later that the British banking system ‘has failed to learn many of the lessons from the 2008 financial crisis’ (Arnold, 2017).
Drawing from the above discussions, we see many reasons for the banks’ woes. These include the unprecedented property market crash, mismanagement of complex exotic financial instruments and the securitization of bad loans—all of which point mainly to the banks’ lack of risk management competency. And this lack of risk management competency persists even after the Global Financial Crisis. Banks find it hard to source suitably qualified risk management professionals because (1) the demand for risk management professionals has increased very sharply, (2) university curricula have not kept up with the changing needs of risk management and (3) the compensation packages are unattractive (Arnold, 2017; Tadros, 2018). This is both ironic and disturbing since risk management lies at the core of banking business. Today, in the midst of global economic uncertainties and challenging global banking regulatory requirements, banks are cutting back on investment banking operations but desperately scouting for good risk management professionals. But such knee-jerk reactions in the form of recruitment frenzies are by themselves insufficient for at least three reasons. First, relentless staff pinching leads to increasing demands of an increasingly scarce resource. This causes risk professionals to demand skyrocketing pay packages which are not sustainable for the banks. Second, increasing staff turnover may shorten the risk management professionals’ stint with each bank. Shorter stints may in turn mean that these professionals at the junior and middle management levels may have inadequate depth in skills or knowledge when other banks desperately poach them for more senior positions. Third, even if good risk professionals are recruited, they would be ineffective if they have wrong attitudinal traits, such as being overly individualistic rather than being team players. This would result in the recruiting bank being unable to properly integrate such risk management professionals.
The foregoing discussions suggest that banks need a more deliberate, proactive and sustainable longer-term solution to develop their risk management competency instead of a knee-jerk short-term reaction. A widely accepted definition of ‘competency’ is that it refers to the appropriate knowledge, skills and attitude to perform a job well. In short, competency refers to the right traits of the head, hand and heart. Competency relates not only to abstract head knowledge. Knowledge without skills (i.e. taking appropriate action in an organizational setting) is not of much use. Likewise, if one has the right skills to perform a job but has a bad work attitude, this may not benefit the firm. Finally, if one has the right attitude but does not have, or is not given, the opportunity to acquire the right knowledge and skills, one may not perform well too. Hence, all three aspects of competency, namely, the right knowledge, skills and attitude, are needed. Indeed, banks need an integrated approach to competency development—one that is more overarching, comprehensive and sustainable—which is what this book endeavors to discuss in a more granular, user-friendly and practical manner.
1.2 Can Banks Have a Sustainable Risk Management Competency Development Approach?
The ongoing debates over the banking debacles seem to cast doubts as to whether banks will ever learn from their mistakes (Aitken, 2014) or can regain public confidence. If a bank needs an integrated or a more comprehensive approach to competency development, where should it begin and what should it do? Would a bank be caught up in overwhelming details such that it misses the forest for the trees?
Perhaps, three examples of unlikely sports heroes may offer some indicative guidance, hope and motivation. The first is Croatia’s soccer team’s amazing exploits at the 2018 World Cup soccer tournament. Croatia, a small, young and previously war-torn country, created shock waves at the world’s largest sporting event, the World Cup soccer tournament. It did not have much funds, infrastructure and long-term plans for sporting prowess. Yet, Croatia defied the odds by beating highly ranked teams before losing to eventual champion and seasoned campaigner, France, in the finals. Croatia’s remarkable achievement is attributed to several reasons. Most of its players play in top foreign clubs across Europe. These players sharpen their skills by learning from good foreign coaches, practicing and competing alongside some of the world’s best players. Moreover, they demonstrated tremendous teamwork. Its captain, the gifted Modric, led by example as evidenced by his widest field coverage during the tournament, often taking on roles beyo...