This is a follow up to an earlier series of articles on risk culture in banks the last of which can be accessed here.
The best institutions and organisations are those which define themselves in terms of how they have they can best serve their customers (and the wider community) and not how they intend to manage risks.
This is a lesson that bankers, regulators and governments all need to learn—the future success of the banking industry depends not on more rules and regulations but how well banks transform their customer culture. As we shall see, that has very little to do with how they measure risk.
The Difference Between Risk And Organisational Culture
The term “risk culture” and what it means or implies simply has to be one of the hottest topics in banking today. Many still believe that risk culture can operate successfully independent of an organisational culture while others are of the opinion that it is merely a subset of organisational culture.
Both views are incorrect.
As has been illustrated in a number of previous articles on this blog, a bad organisational culture will always subvert a good risk culture and it would appear that a consensus is just beginning to form around this particular view. However, this consensus is often inspired or accompanied by the second view—that management must consider risk culture within the framework of the organisational culture in order to ensure good risk management.
The question we must ask ourselves is this: do great and highly innovative organisations start with a consideration of risk and how to manage it when they are developing their strategy? Or, do great organisations develop a vision that inspires them to be the best at offering a unique and valuable proposition to their customers?
Surely, it must be the latter.
What Is It That Makes Other Industries Successful?
In order to answer this question we only have to think of the truly pioneering and successful companies of the modern era; Microsoft, Google, Apple, Amazon, Samsung or even those more traditional companies such as GE, Coca Cola and Toyota. None of these organisations are defined by how well they manage their risks but by the power and value of their brand.
What is a brand and what does it represent?
“Brand equity” is defined by the American Marketing Association as “the value of a brand” (although not in the financial sense of “value”), while, according to P. Kotler and K. Keller in their book Marketing Management, it is “the added value endowed to products and services.” Keller, in Strategic Brand Management, writes that a brand “has positive customer-based brand equity when consumers react more favorably to a product and the way it is marketed when the brand is identified than when it is not.” David Aaker (Managing Brand Equity) calls it “the set of assets and liabilities linked to a brand’s name and symbol that adds to or subtracts from the value provided by a product or service to a firm and/or that firm’s customers.”
Crucially, none of these definitions mention the term risk and almost all are focused on the relationship between organisations and their customers—it is a lesson that those who seek to shape the future of the banking industry should not ignore.
The fact is that too many banks have been engaged in a game which focuses on their competitors offerings in terms of products and customer market segments—when they and all the rest of us would have been much better off if they had focused on what was best for their own customers.
Developing A Winning Strategy
Ultimately, a winning strategy has to be based on doing what is best for your customers. That is in stark contrast to what has actually transpired in the banking industry.
In the past several years banks have competed against each other to make very bad mortgages and then further competed against each other to sell securitised versions of those very bad mortgages to investors. Afterwards, the very same banks turned around and foreclosed on the very bad mortgages which they themselves had originated.
The financial crisis would not have happened if banks had less risk management but a whole lot more focus on the wellbeing of their customers—homeowners and investors alike.
Since the financial crisis the evidence suggests that the banking industry’s inability to properly focus on their customers is not limited to making bad mortgage decisions. Later scandals such as Libor and energy market manipulation have hurt both customers and the wider community.
Thus the question that banks need to answer is not how good is their risk culture or their risk appetite? The real question is how good is their customer culture and the organisational culture that enables them to deliver on it?
As the example of Kodak in the section below demonstrates, good organisational culture has nothing to do with minimising risks.
A Kodak Lesson For Bankers
The story of the rise and fall of Kodak provides us with a prime example of why customer focus and the culture that it engenders are far more important than risk culture. Kodak is an example of a company that fell into bankruptcy because it refused to take the risk of acknowledging that its customers were changing.
Eastman Kodak was founded in the late 19th century and for over 100 years was a if not the dominant firm in photography and photographic products.
As the age of digital photography emerged Kodak became increasingly reluctant to invest in digital technology for fear of cannibalising its traditional products. In other words the company did not want to do anything to place its then franchise at risk.
Unfortunately for Kodak the rest of the market had no such compulsion and the likes of Sony and Nikon forged ahead and made successful transitions to the digital age while Apple and Samsung began to dominate via their mobile devices.
By the time Kodak decided that it had to change its strategy the market had already moved ahead and the company that did not want to take any risks filed for bankruptcy in 2012.
What Is Your Organisation’s Customer Culture?
How can a winning customer culture implemented in practical terms?
In answering this question I turn once more to my favourite example; Toyota and the principles of Lean Production. I was trying to explain the difference between organisational and risk culture to someone when quite fortunately I came across this story from a fellow blogger at Lean Builds. I have reproduced the relevant extract below and invite you to read it carefully and pay very special attention to the final sentence:
Stop the Line manufacturing is a technique introduced by Taiichi Ohno (of Toyota Production System fame) in which every employee on the assembly line has a responsibility to push a big red button that stops everything whenever they notice a defect on the assembly line. When this was first introduced people couldn’t wrap their heads around it; it was part of manufacturing dogma that the best thing you could do as a plant manager was to keep your assembly lines running full steam as many hours of the day as possible so that you’re maximizing throughput. His idea, however, was that by fixing inefficiencies and problems as they occur what you’re doing instead of maximizing your existing process is actually proactively building a better one.
When he put this system into practice he found that some of his managers took his advice and some didn’t The managers who implemented Stop the Line had their productivity drop by a shocking amount; they were spending much of their time fixing defects on the line rather than actually producing any goods. The managers who hadn’t listened thought this was a great victory for them, and I can just imagine them feeling sorry for poor Taiichi Ohno who would be ruined for having come up with such a horrible and wasteful idea.
Before long, however, something strange started to happen. Slowly but surely the managers that had spent so much time fixing defects instead of producing goods started producing their goods faster, cheaper, and more reliably than their counterparts to the point where the caught up with and then exceeded the lines who hadn’t made improvements. The initial investment in improved process and tools had paid off and Toyota went on to be quite successful using this method. Even today their engineers and managers share a cultural belief that their job is not actually to manufacture cars but instead to learn to manufacture cars better than anyone else.
The best way for a bank or any organisation to improve its risk culture is to define an organisational culture that is first committed to acting in the best interests of its customers and the wider community.
Jonathan Ledwidge is the author of the book Clearing The Bull, The Financial Crisis And Why Banks Need A Human Transformation (iUniverse).