We all face risks; how to manage it

The Real Matter - A column by Pankaj A. Kumar

WE all know the saying that there are only two certain things in life – death and taxes. While one cannot deny the facts of life and that all of us will have to face the realities of life, not many, I believe, are prepared to accept that risk or risk management is the third element of life.
Ignore it and you will be cursed, embrace it and you’ll find a new meaning to life and it will change your perspective of life itself. Let me illustrate how risk or risk management determines our journey in life.
Many readers would have watched the movie Titanic – an epic 1997 American romantic drama film directed, written, co-produced by James Cameron about the sinking of the RMS Titanic. Twelve years ago when I watched the winner of 11 Academy Awards on the silver screen, I could relate to it only as a wonderful love story.
It was only recently when I attended a course on risk management that I watched the movie with a different perspective. The fact that it was her maiden voyage, untested in speed, the story offers many lessons to managers and corporates.
On hindsight, Titanic had insufficient number of lifeboats in case of emergencies and at the same time she was pushed to the limit in order to surprise everyone on her arrival in New York. She only had two lookouts for possible icebergs on calm waters and worse, warnings of iceberg were ignored as non-essential. By the time she hit a large iceberg, Titanic was travelling too fast to alter her route and to avoid the inevitable. The rest, as we now know it, is history.
How does the Titanic relate to the real world? As we now enter nearly 21 months into the second worst recession in history, there has been a lot of finger pointing to all sorts of market participants – the blame game – as investors try to find the root cause of the mess that the global financial institutions created.
From the bubble created by the US housing market to the subprime loans that came along with it, to the rating agencies responsible for the so-called AAA ratings assigned to these dubious instruments, to the regulators for allowing these transactions to take place, to the greed of investment bankers and sales persons responsible for pushing these products to the market, to even Fed chairman Alan Greenspan for creating the perfect environment of low interest rate environment, which made it even easier to create the mother of all bubbles – the credit market.
The reason markets went frenzy with the credit and housing market bubbles was that people were driven by greed and profits rather than best practices in terms of ensuring that whether it was an individual or a corporate, its balance sheet remained healthy despite additional bets taken on more products/services or transactions.
It is really funny that when we look back over the past two years or so, we hear how traders and sales persons were so well paid in the western world as they were measured based on the amount of deals they did and the amount of products sold, irrespective that the size of some of these bets could in actual fact, paralyse the whole institution.
Without these greedy traders or sales people, we would not have seen the demise of Lehman Brothers, neither would AIG be operating like a hedge fund. And, where was risk management in these institutions?
I am sure it was there, but totally ignored as business owners focused on profitability rather than ensuring that the firm’s position is not compromised. I believe that not many senior management staff of some of these large institutions had any idea that if things got out of hand, it would be equivalent to the Titanic hitting the iceberg.
There has now been a lot of debate in the marketplace of more regulatory enforcement, not only in areas related to governance but also on the issue of executive compensation. While it is really difficult to attach conditions of compensation – if regulators do really want to see changes in how a financial institution is run – risk management has to play a more prominent role.
It is not the traders or sales persons that these institutions should be focusing on in terms of rewards but risk managers as they are the true key drivers of profitability. Reward them well as they act as lookouts and ensure that a ship arrives at its destination on time, not earlier and definitely not later.
As humans, while death and taxes are certain, risk management ensures that we have a trouble-free journey and hence, we must embrace it.
Life itself is risky and as we journey on, we will be faced with many choices and changes. With risk management as a guiding tool, the journey of life becomes more fulfilling although it may not be all that satisfying.
● Pankaj C. Kumar is chief investment officer at Kurnia Insurans (M) Bhd.