Manage Risk for Success
Succeeding in a competitive, dynamic environment requires CUs to take risks and continuously evolve.
A ship is safe in harbor, former Rear Adm. Grace Hopper once said, but that’s not what ships are for. Correspondingly, a credit union exists for the betterment of members, not itself—or to appease skittish regulators by avoiding all risk.
During the past century, credit unions have provided members with an exclusive value proposition by leveraging the collective whole of their membership. Looking forward, however, many are calling that value proposition into question.
Strengthening your communities, building a large member base, providing support to members in their time of need, and building the financial reserves to carry you forward have left many credit unions white-knuckled, holding tight to the past while facing a tumultuous future.
That’s why it’s important to challenge the thinking and actions your credit union takes, especially during its strategic planning process. Doing so involves thinking about the decisions you make—and how you make them—in pursuit of the organization’s vision.
The goal: Create value through the development of a world-class risk management culture.
Uncertainty can leave many leaders stationary and cautious. And historical successes and failures oft en leave organizations stagnant and risk-averse.
Even personal life lessons reinforce leaders’ propensity to guard against losing things of value, whether it be your hearts, wallets, or egos. The unfortunate reality is that situations change—organizations and industries go through life cycles just as humans do.
Transformation faces us on all fronts: social, political, technological, and economic. The question is, how do you respond to change? Do you see and understand it? Do you admit that it’s taking place—and are you willing to take bold action?
These lessons weren’t lost on the credit union movement’s founding fathers.
As credit union pioneer Roy Bergengren once said, “All human progress is made in spite of the opposition of the set majority who react almost automatically against every new idea.”
The point is that in the face of risk, early credit union leaders forged ahead knowing that only through taking risk could they create value. Given the era, these principles were revolutionary.
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Today, however, many view risk in one context: bad. But risk drives learning, opportunity, and prosperity. And organizations often fall prey to their own success.
James Collins’ book, “How the Mighty Fall,” depicts the life cycle of most organizations, even those once thought unstoppable.
The common thread centers on the need for organizations to be relentlessly critical of their successes and abilities, and to act boldly.
In sum, this is risk management. Risk management has the capability to provide a sustainable competitive advantage. Namely:
- Knowing more about your own risks than your competitors do allows you to better manage them and go on the offensive, considering both risk and return together.
- Knowing more than your competitors about the risks in the market and industry allows you to better see adversity on the horizon and take advantage or react more quickly.
- Embedding enterprise risk management (ERM) into strategy and business planning allows organizations to make more proactive, risk-informed decisions, improving the chances of meeting financial and operating goals.
Risk is required
ERM recognizes that credit unions must take risk. Your role as financial intermediaries is to intermediate risks your members can’t or won’t make. Successfully competing in a dynamic environment demands that you take risks to continually evolve and innovate.
But despite the overwhelming evidence, credit unions often elect the path of least risk until it’s too late. While some credit unions undertake new and unique directions, most favor a benign approach.
Credit unions tend to carry considerably more conservative investments, loans, and capital levels than their competitors. Industry outsiders regularly criticize credit unions for the excessive capital they maintain (aggregate of $44 billion in excess capital above the regulatory minimum to be classified well-capitalized) and for their level of credit risk.
This isn’t due to a lack of passion or effort, an analysis by The Rochdale Group shows. Rather, it’s a function of risk process and culture that starts at the top and cascades through the organization.
But the answer isn’t simply to take more risk. It’s about understanding how much risk you already have (residual risk level), how much risk you can take (risk capacity), where you want to take risk, and what types of risks you can leverage in pursuit of organizational goals.
This can’t be done in isolation but through careful consideration and deliberation of the credit union’s mission, values, and vision. And your entire organization must view risk holistically.
To remain focused, credit unions must tie together operational risks, risk appetite, and strategy. Risk appetite is a tool to shape organizational performance and manage your approach to achieving organizational goals and strategies. It represents the amount of risk you’re willing to accept in pursuit of organizational value.
As you venture through the risk appetite process, you’ll try to decipher and articulate those actions and activities you’re willing to pursue—and those that you’d rather sidestep. If you’re unwilling to assume certain risks in pursuit of your objectives, you should revisit where you want to be or find alternative ways to get there.
The process of defining and understanding the risk you assume and setting established boundaries helps to align performance activity and shape actions and decisions. It also aids in prioritizing resources, and identifies inconsistencies within strategies and organizational initiatives.
In the broadest sense, risk appetite serves as a governance and performance set of filters helping to ensure you meet the credit union’s goals.
NEXT Minimize lost opportunities
- Enterprise Risk Management Certification Institute: events.cuna.org/erm15
- Enterprise Risk Management for Directors & Executives: events.cuna.org/ermdirector15
- Environmental Scan resources: cuna.org/strategicplanning
The Rochdale Group: rochdalegroup.com
Minimize lost opportunities
You must understand the risk you’re asking your credit union to take to achieve your goals.
Risk and return are inseparable. Every action and decision you make—from the minute to the strategic— carries a risk/return trade-off.
Organizations that understand this dynamic drive value for their members. Imagine the credit union that desires more sales from front-line staff but never achieves a real lift in numbers.
Imagine a credit union board that seeks first-class online and mobile tools but continues to lag the industry. Why?
The “why” is oft en the same: risk aversion and a lack of understanding.
It’s human nature to avoid risk because you don’t want to feel stupid and you don’t want to make mistakes that may count against you. We perceive (and, quite frankly, receive) no real recognition for the effort, or we receive confusing messages from the organization.
If a board focuses heavily on budgets, it will influence the types of investments management makes even at the expense of better investment opportunities because no one wants to disrupt the operating budget— or because you want to see short-term results that are more closely aligned with performance incentives.
Many employees will try to protect their jobs at all costs, even to the demise of the organization. They’re reluctant to try new things for fear of failed attempts that come with some element of scrutiny.
Most will avoid bringing up problems for fear of retribution—or simply having more work loaded on them.
A survey by the Harvard Business Review indicated that out of several hundred professionals in self proclaimed innovative organizations who were asked what would happen if they developed and tried “new and untested ideas,” only 17% said the behavior would be rewarded or approved. Nearly half (47%) said the reaction from their superiors would be unpredictable.
In another study, a survey of 1,500 executives in 90 countries demonstrated that executives are extremely risk-averse regardless of the size of investment.
Executives turned down opportunities even when expected net present value was positive at a 75% loss level.
Instead, they only accepted projects when the chance of loss was lower than 20%, regardless of investment size, area, and type.
Risk management and risk appetite involve so much more than looking for downside events. These concepts are really about the total collection of our governance, managerial, and organizational performance attributes.
In this context, think of all the decisions that are made annually and all the ideas and questions that go unspoken. Organizations miss out on substantial earnings potential due to fear of risk, according to an analysis by The Rochdale Group.
While this is unquantifiable and large-ranging, think about all the things you didn’t say or do—and where returns may have been muted because doing nothing was the easier option.
Organizations never live up to their potential due to this phenomenon. ERM more fully understood and more fully engaged and rewarded helps to minimize this lost opportunity.
Luck doesn’t drive great organizations. What does drive them is alignment and a relentless questioning of what they do and why they do it.
ERM and risk appetite will cause your ship to take on water or make adventurous voyages. Will you dock your ship in the relative safety of the harbor or make sail?
Adapted from CUNA’s soon-to-be-released 2015-2016 Environmental Scan.
Tony Ferris is managing partner of The Rochdale Group, a CUNA strategic partner. Contact him at 800-424-4951 or at email@example.com.