Extend Your View and Sharpen Your Focus
Enterprise risk management helps you anticipate the unexpected and seize opportunities.
The key to success for any organization (or demise, for that matter) rests on its ability to continuously learn and adapt to environmental changes. Mistakes in the financial services industry are no longer just financial losses.
Measuring and managing risk is central to competitiveness and survival. Success depends on your ability to identify, quantify, price, and manage risk better than your competitors do.
Adaptability to existing and emerging situations is paramount and remains the central role of credit union leadership.
It’s not about perfectly predicting the future but rather quickly identifying environment changes (internal or external) that pose risk to current strategies. It’s about continuously nudging your organization toward more appropriately aligned strategies and tactics. It’s this ability that creates strategic advantage.
World-class leaders advance this concept, establishing a culture and systematic processes. They implement enterprise risk management (ERM) programs to increase their view of potential risk events that threaten their strategic direction and tactical operations.
In the wake of the economic crisis, ERM receives a lot of attention, and for good reason. It is, after all, unanticipated risks and ignorance that shut the doors of many organizations.
ERM represents a set of systematic processes designed to create a culture of proactive identification, measurement, and management of risks. It enables credit unions to universally seize opportunities and quickly adjust to negative events.
Rapid adoption of ERM programs throughout the financial services industry is expanding the breadth and depth of risk management capabilities. This evolution brings a global perspective of an organization’s risks that go beyond the traditional concerns: credit, interest-rate, and liquidity risk parameters.
And as financial institutions implement more rules resulting from the Dodd-Frank Act, they’ll also need more robust risk management programs. These programs will monitor strategic, reputation, operations, information technology, and regulatory risks.
NEXT: ERM implementation
Proactive credit unions have already begun this important transformation to bring about real change within their strategic and risk management processes. Employing an ERM program has significant strategic value and financial results for credit unions, although the full financial results might be as yet unrealized.
During the first year of an ERM program, credit unions, on average, improve the risk-return relationship more than 20%. They also report enhanced abilities to:
But it’s important to do it right. Credit unions must beware of shortcuts and avoid creating superficial and non measurable programs aimed merely at appeasing various constituencies. Make sure your ERM program builds capabilities to drive competitive advantage through improved decision making.
Evaluating an ERM program is simple. Every leader and volunteer must understand your credit union’s significant risks and the threats those risks pose both qualitatively and quantitatively to your credit union’s strategies.
This requires proactive and transparent processes that challenge current assumptions, measure potential events against the impact to your credit union, and clarify the parameters established within its risk appetite.
In other words, a risk program that doesn’t unearth real information to vet decisions across your entire credit union isn’t an ERM program at all.
Credit unions working with The Rochdale Group in 2012 enhanced the risk-return relationship, increasing risk-based returns more than 25% for those with more than $1 billion in assets and more than 12% for those less than $1 billion in assets.
These credit unions also average more than a 2% economic capital ratio—meaning they can withstand a worst-case scenario twice before depleting capital.
Their average total risk equals 43% of assets. And after taking into account the likelihood of events and risk mitigation efforts, their unmitigated annual risk is approximately 3.5% of assets and 31% of capital.
This brings to light key organizational questions. How much risk should a credit union take? And what is the return for that risk?
The table at the bottom of this page illustrates where risk currently resides across the industry, based on the credit unions that Rochdale works with.
The significance of risk within the credit, transaction, strategic, and reputation categories are of particular interest. Credit unions are adept at calculating and measuring credit risk (although this area continues to surprise financial institutions), but the other three—compliance, reputation, and liquidity—are largely neglected in current risk management efforts. This is a sizable weakness or, conversely, opportunity.
Holistically, these credit unions do a good job maximizing returns (12% to 25%), while maintaining a fairly conservative risk-to-capital position (two times economic capital). The point is not to eliminate risk, but rather to leverage the risk taken for added opportunity.
NEXT: Strategic planning
Key questions for credit unions to ask include:
Strategic planning, by definition, is the advent of strategies to accomplish the organization’s goals while taking into consideration outside influences. Risk management is the ability to identify, measure, and manage those outside influences.CHART
Strategic success depends on your credit union’s collective ability to understand and address disruptive events. Thus, a strategic plan must be part and parcel to risk management.
During strategic planning sessions, your credit union should discuss these risks that are most urgent today and will be for the next 12 months:
NEXT: Potential "black swans" and opportunities
Potential ‘black swans’
A “black swan” event is an unexpected surprise that has a major impact on society. Black swan events that might occur during the next couple of years include:
The other side of the equation is opportunity and improved performance. Current trends reflect growing gaps/opportunities within the credit union landscape. The following are key opportunities for credit unions:
The biggest risk
Hope, complacency, and doing nothing are not strategies. Inactivity isn’t an option, regardless of obstacles such as a lack of capabilities, budget concerns, regulatory roadblocks, or misaligned traditions.
Credit unions must undertake a thorough process of self-discovery and put in place the programs necessary to compete over the long-term. A culture that values learning is essential. Require transparency, discovery, and the challenging of yesterday’s best practices with tomorrow’s opportunities.
Adapted from CUNA’s soon-to-be-released 2013-2014 Credit Union Environmental Scan.