The last fifteen months have challenged us from both a physical and financial risk perspective. The term resiliency has been used to both boost us up and describe what our overall goal is. But what do we mean when we say we want to be or are resilient?
“A good half of the art of living is resilience.” – Alain de Botton
In that quote, de Botton was talking more about the traditional definition of “resilience,” the concept of resilience at the interpersonal level, as the ability to recover from difficulties. While that idea can be important in having a good personal quality of life, it’s not quite what we’re talking about today. Maybe somewhat predictably, we’ll be looking at the concept of “resiliency” in the sector of risk management, a term which has certainly risen in usage over the last four or five years as the organizational need for it has risen.
The concept of resiliency within the space of risk management is not altogether different from de Botton’s meaning. In a 2012 paper by Dr. Tom Mitchell & Katie Harris for ODI, it was defined as “a concept concerned fundamentally with how a system, community, or individual can deal with disturbance, surprise, and change.” Particularly in financial risk management in the modern era, this tends to deal with the ability of an institution to bounce back after a downturn or crisis event. When we adopt the concept of resilience, it forces us to define what failure, just getting by and what success is. The ever-growing uncertainty in the economic space around us, especially when viewed in the space of the last year and a half, is emblematic of the need to prepare to not only mitigate risk, but to be resilient to them.
How to Be Risk Resilient
Risk resilience isn’t particularly easy, but then again, you probably didn’t expect it to be! The main ideology behind it focuses primarily on two major goals. The first of these goals is to make your system resistant to shocks, and the second is to prevent any problems from turning into full-blown crises.
Our definition of a “system resistant to shocks” has certainly had to shift since the pandemic started, however. Even with the historical information we received during the recession in 2008, the brand new set of uncertainties and concerns that come with a post-coronavirus world require an additional group of precautionary, risk-mitigating measures. Though there is the hope that the vaccine performs some loss mitigation, there’s still a solid likelihood that banks will see an increase in NPLs, declines in asset quality, and a rising threat of zero/negative interest rates. With these negative effects comes the need to ensure your institution is prepared to reduce and rebound from their impact–that is, the need to be resilient to the consequences.
Much of the strategy involved with risk resilience comes from a similar vein to the approaches taken in other private sectors. This larger set of strategies has taken on its own name, “Operational resilience,” which in one Accenture article is described as “the ability of firms… and the sector as a whole to prevent, respond to, recover and learn from operational disruptions” (emphasis my own). The background basis of the last few major disruptions (the 2008 crisis and the coronavirus pandemic) provides a certain level of information that is extremely valuable in this context. With that historical experience in your tool kit to help you model potential and emerging risk, you can better understand and prepare for future crises.
Operational resilience needs to be involved in every step, from governance and ownership to post-mortem disaster recovery. The biggest aspects to pull from include monitoring the current risk status of your organization, considering how new institution-level programs and methodologies interact with current financial resiliency initiatives, and defining concrete plans to remediate the aftermath of potential risk events. All of this, of course, requires careful assessment of the current financial risk status quo and a deep understanding of what is an acceptable amount of impact for your institution during a crisis event. In other words, what failure, just getting by and success mean to you. These assessments can take the form of such things as risk modeling, avoiding noise, and managing risk attention, on top of many other institution-specific approaches.
This is not to say that regulatory bodies are attempting to inject some level of systemic resilience, but because those changes are likely something you’re already familiar with, we won’t go into them here.
Roadblocks to Resiliency
Resiliency, as with anything regarding risk, has its own set of roadblocks that prevent it from being a one-and-done investment. On top of the general complexity of modeling and the increasing number of worldly uncertainties is the fact that the investment into resilience doesn’t have a concrete or consistent ROI. That isn’t to say developing resilience isn’t worth it (the opposite is true), it’s more that identifying the amount of effort you should spend to establish it can be a tricky process. Even after identification, there’s reassessment of newly discovered vulnerabilities, examining emergent risks, and more, all of which require a significant portion of time, effort, and monetary investment to ensure you can handle the newly discovered potential repercussions. Resilience requires a cultural assimilation of its ideals at the greater organizational level, not just in one aspect of your institution but across all your teams.
Another, more market-level risk that negatively impacts resiliency is the fact that many organizations share common portfolio holdings, something Alexandr Kopytov discusses in his paper “Booms, Busts, and Common Risk Exposures.” Diversifying loan portfolios can help mitigate not only individual risks, but also avoid a source of shared risk in the case of a market-level recession”. Over time, financial institutions tend to not rebalance their loan portfolios but drift towards concentrations where the greatest returns…and the greatest risks, lie. This is but one example where decreasing the potential negative results of market-level recessions or other catastrophic financial events helps reduce the shock a crisis event would create for an institution.
Viva la Resilience!!
The last year or so has been entirely filled with new events testing our ability to bounce back from negative events, and across the sector, there has been some level of success (at least when you consider how bad things could’ve been). Jeff Bezos made a great point when he said “we must remain vigilant and maintain a sense of urgency.” Resilience up to this point has paid off in mitigating some of the negative consequences of the pandemic. It has also provided us with a rallying cry. Continuing a shift toward a level of cultural resilience in the greater scheme of the financial sector can help us ensure that even when the next crisis event comes along, we will be ready.