The different depictions of risks

The origin of risk was the uncertainty of coming back alive. There is a great article on rituals as controls that I used many years ago in a workshop. (My old office let me run free like a wild child. They are fabulously good sports all the HODs.)

Malinowski found that magic was not used in lagoon fishing, where men could rely solely on their knowledge and skill. But when fishing on the open sea, Trobrianders used a great deal of magical ritual to ensure safety and increase their catch.

In the world where there is physical dangers, risk continues to be conflated with safety. In that article, it was sea fishing. Other industries that think of risk similiarly are mining, construction, armed escorting, heavily bombed or areas where they are frequent gunfires. I also notice that manufacturing plant where the materials or processing is dangerous would think of risk the same way. In these areas, risk is monitored like blood pressure readings.

The mathematics of risk was born out of gambling. It was beneficial to being able to apply knowledge to skew the chances of winning. This would apply to fields where knowledge can skew chances: baseball, football, horses and poker. It would not apply to 4D and and other lottery. The space race is another area where skills and learning skew chances of winning the race. (Astounding book on this by Deborah Cadbury is highly reccomended.) This is also the area where traders operate. A rather well known example is Nissam Taleb applying his knowledge to bet on black swans events. In these areas, risk is described as uncertainty of winning and risk is given a factor.

Where money is promised to be exchanged at the onset of an event, the stranger who shook hands on the deal could be unwilling or unable to pay. For exchanges such as a loan or the benefits of an insurance payment, the unwillingness (ie moral hazard) was eliminated with legalease. In insurance, it meant preventing payments. In loans, that meant exercising the rights to get the collateral/security. If there was no security, it was based almost entirely on the pain of being black marked or harrassed. (AAA rating dropping straight into into D, for example.) The problem of being unable to pay can be hard to figure out. More or less, the risk of default became tied to cashflow or observations of payment patterns for a person, a company, an industry or a country. For instance, your industry sunsetting, there is risk of cuts, you have lost your job, or you missed one more payments. In insurance, missing the premiums cease insurance protection. In loans, missing loan payments brings the debt collector to your door in polite legal letters.

In these traditional areas of risk, the problem that we have been dealing with can broadly be described as uncertainty and its management (ie safety, ability to win or cashflow). With the flourish of risk management, the strenous marketing of basel, GARP FRM and PRM and risk events, there is an infestation of risk workers.

Risk has invaded into every department and its name spread like a contagion.

Compliance risk, legal risk, fraud risk, technology risk, operations risk, business risk, finance risk, people risk, marketing (they were sly and named it reputational risk), tax risk, AML risk, Sanction risk. Risk when inserted in a department’s name, perfumes the original department with an aura of knowingness. Admitting ignorance and uncertainty has become the equivalent of being a sophisticated man about the world. However, these worlds are by and large, the equivalent of the lagoon fishing. If you behave as an ordinary fisherman would you would get fish. Now and then there will be holes in the net that requires mending. One mends the net and continue fishing. One does not need to be frightened and measure the width of the holes, how often the holes are made, etc. For purposes of efficiency, one would prefers noticing the small holes and getting them fixed quickly so to continue fishing activities. There will be most certainly holes as one uses the nets. As an insider working in the company, there is no uncertainty – I have (relatively) full knowledge of policies, procedures and systems. That means I have more certainty than others. An onlooker or investor would consider this a risk because there is no view. So Warren Buffet tries to mitigate the risk of holding equity by visiting the company or talking to the people in there. A minor investor has no such access or perhaps no need for such long term view. He would base his investment decisions on by comparing which company appears more desirable in terms of returns. A beautifully maintained net doesn’t mean the fishermen know how to fish. Eventually, even Basel gave up on letting a thousand flowers bloom in the measurement of operational risk.

With this infestation of risk persons, with banks appointing CROs and declaring their risk management in annual reports, uncertainty didn’t get any clearer.

This is an interesting take on controls for risk management folks by Will Smith