Saturday, April 25, 2009

My correspondence with Alan Peachey on Financial Crisis

Alan Peachey is a good friend of mine. He'is a former senior executive of Barclay Bank, London. He wrote the book entitled The Great Financial Disasters of Our Time.The following is our latest correspondence. Alan has given me permission to publish this on my FB and blog (deddyjacobus.blogspot.com). Hope it will benefit you.

Dear Deddy.

Thank you for your email.To answer your second question first (and please forgive me for being cynical) "The History of Financial Disasters - What can we learn" - I am afraid the answer to this question tends to be "not very much". As far as individual banks are concerned, the problem arises when those members of staff who experienced a particular disaster have retired, and a new generation of staff have come into the bank. Those who have retired will have taken their knowledge with them, and those just arrived will be trying to prove themselves in the bank and may well fall into the same trap as their predecessors who caused the losses originally.

For example, there are plenty of examples of what works well in the UK does not necessarily work well in the United States (two nations divided by a common language). Some years ago, Midland Bank in the UK brought Crocker Bank in the US, and wound up writing off some USD 760 million (chicken-feed by today's standards). More recently (in December 2002), HSBC brought Household International Inc for some USD 14 billion.Just four months later, Household paid a fine of some USD 484 million on charges that it had been tricking customers into paying higher rates of interest than it had promised.Six years later (in 2009) HSBC is now trying to sell the bank but, guess what? It has been unable to find any takers thus far!!!

As far as I can tell, Indonesia appears to be on the fringes of the financial tsunami which is travelling around the world at present. Not all countries have been affected by the banking crisis thus far, but the problem for developing countries and for those producing commodities (iron ore, copper, aluminium, etc) is that demand is falling away for finished goods as people try to hold on to the money they have left, and therefore demand for the materials required to make those goods is also falling away.The countries which have (or will) experience difficulties are those whose citizens have a high level of debt (UK for example), or which have invested heavily in eastern Europe (Austria) or which have in vested too heavily in commercial property (Germany) or which have invested too much money in speculative building projects for the private sector, and have discovered that demand has collapsed (Spain). As you well know, Japan has been in trouble for the past ten years (mainly due to a property bubble, I believe) but by and large, the rest of Asia appears to have escaped the worst of the problems. This is because banks have pursued conservative lending policies and have not encouraged their customers to over-extend themselves by borrowing too much. Traditional banking values do have their advantages!

China has USD coming out of its ears as a result of their export boom, which has now more or less dried up, but Uncle Sam is creating money at such a vast rate (just as the UK is doing) that the value of the USD is rapidly diminishing. (see attached article). As a result, it appears to be stockpiling commodities (paid for in USD) for when demand once again increases and as a hedge against USD devaluation.

I look forward to hearing from you further in due course.

With kind regards,
Alan Peachey

ERM Defined

There are quite many definitions on ERM, but worth noted here is that defined by COSO (2004): “… a process, effected by an entity's board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risks to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.” (COSO Enterprise Risk Management – Integrated Framework. 2004. COSO).


ERM is:

1. a process -> which has to be embedded into the business process
2. effected by the board and management -> after all this is a strategic initiative and must be set and monitored by them
3. applied in strategy setting -> thus the concern shifts from risk limit to risk strategy; it should align the statement of mission, strategic objectives down to tactical and operations objectives and activities
4. applied across the enterprise -> say good by to silo and partial approaches; risk is now everyone's business is designed to identify potential events that may effect the achievement of an entity's objectives -> define your goals/objectives first. set the criteria and performance measures, and then identify the potential risk events that may hindered (threats) or strengthen (opportunities) your organization capability to achieve its goals/objectives.
5. risks should be managed within an entity's risk appetite -> find the right balance between pursuing expected gains and taking appropriate risks. no risk no gain but excessive risk is a truly dangerous adventure.
6. reasonable assurance -> not absolute assurance. you can override the risk management process. you can deny the adverse facts. if that's the case, ERM dooms to fail. it's then also about modal and ethical standard not only data and calculations.

About Risk

Risk and reward/return are two sides of a coin.

Risk in terms of Enterprise Risk Management concept basically comprises of three important words: chance/probability, impact, and objective.

Chance or probability refers to events that may occur in the future. These events may present threat or opportunity. Probability of the occurrence should be identified by ERM officers using the most relevant analytical tools available. These events are called as risk issues or risk events.

Impact refers to our exposures towards the risk events describe above. Impact could be positive or negative depends on the objective. Without exposures, any events are no more than events. But with the present of exposures - means we are being exposed to certain risk events, than that events should be anticipated. Especially if they potentially threaten or strengthen the achievement of our objectives.

Objectives are those goals or targets that are well formulated by our organizations. No goals no risk. No destination no risk. If an organization does not have clear formulated goals, it essentially does not have risks. But without goals or targets they are going nowhere. It will face total failure.

Based on the above understanding, good ERM officers should be able to identify and predict what might happen to the achievement of an organization objectives based on their analyses of the internal and external context of their organization (financial, customers, people, management, information technology, partners, and regulators).

Risk Management is About People

Through my constant contact with my clients, there are 5 factors that cause a problem in an organization which in turn triggers operational risks, e.i.,:

1. People
2. Precedures
3. Information and system
4. Organizational issues: policies, other functions
5. External factors: economic, politics, nature, other parties, etc.

The most frequent factor of the above is people. Talking about people in organization, we may refer to them on individual basis such as their lack of competencies and knowledge and the possibility of their engagement in fraudulance acts or on organizational basis such as misplacement, inappropriate performance measurement, lack of appropriate rewards and punishment system, inappropriate culture, etc.Thus, enterprise risk management must also means managing your people well. HRM department becomes very critical when we talk about ERM.

Just as James Lam wrote in his book enteprise risk management is about people. Couldn't agree more with him.