Answer:
Of the issues currently bedeviling financial services firms, risk culture is one of the foremost. The buildup in risk exposures preceding the financial crisis forced boards and regulators to question weaknesses in risk governance. Since the crisis, the numerous cases of “bad behavior” in the banking industry, such as the Libor and forex manipulation scandals, have intensified focus on the broader concept of risk culture.The Financial Stability Board, which sets international standards for the financial services industry and provides advice for national regulators, released a paper, “Guidance on Supervisory Interaction with Financial Institutions on Risk Culture,” in 2014 that defined risk culture as “the norms, attitudes and behaviors related to risk awareness, risk taking and risk management.” The FSB considers risk culture effective when it promotes sound risk-taking, addresses emerging risks (beyond risk appetite), and ensures employees conduct business in a “legal and ethical manner.” The FSB paper highlights the importance of subcultures across the organization adhering to consistent high standards and values.Lack of focus on known but unlikely risks – Failure to give sufficient weight to potential extreme events or poor outcomes was one of the characteristics in the run-up to the financial crisis. Stress tests were not sufficiently rigorous, and considerable anecdotal evidence suggests there was pushback when more severe tests were suggested. The pendulum has now swung in the direction of conservative risk assessment.
Trade-offs leading to too much risk – All organizations have to make trade-offs. Goals have to be set, whether it is to increase profits, reduce costs, or increase efficiency. The effect on risk must be fully recognized in order to avoid risk creep. A number of individually sensible decisions may be made, but the overall effect could be an excessive buildup in risk. This is true of all industries. A study of risk and safety culture failures across a range of industries found different physical causes but similar root causes: “mindless cost cutting, incentive schemes that divert attention away from safe operations and failure to see the safety implications of organizational changes.” (Hopkins, A. (2009). Preface, Learning from High Reliability Organizations) A clearly defined risk appetite, against which decisions can be measured and aggregate risk tested, is essential to counter these causes.
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