Risk Management - The Indian Way

In the aftermath of the global financial crisis triggered mainly by the US housing market crash and collapse of the structured products market linked to it, the one term that has assumed importance of gigantic proportion is “Risk Management”. It has become the focal point in most of the board meetings and business luncheons.

Financial Risk Management (FiRM) in India is still in its infancy. Blame it on the underdeveloped financial markets or the policy bandwagon that focuses more on the financial services industry (and greatly ignoring non-financial corporates that are equally vulnerable to the peril of a financial crisis)* or the management philosophy that risk management is just another tool to increase their bottom-line (rather than protecting it). We would like to focus on the last aspect as the other two are beyond the control of an organization.

The philosophy of profiting from risk management function can be attributed to the typical Indian mentality of making the most out of everything. There is nothing wrong with the concept of making profits out of risk management except that – a) profit is most of the time measured in terms of absolute income generated rather than restriction of probable losses (the classical paradox of hedging vs. speculating) and b) undermining of risk associated with various methodologies of risk management (absolutely absurd expectation of risk vs. return).

Analyze the cases of forex losses incurred by many Indian companies in the past couple of years and these are the two main factors that would pop up as culprits. Yes, the financial institution are to be blamed for so called miss-selling of products to certain extent; but majority of blame should lie with companies that entered in to such transactions in the first place. Most of them entered in to such contracts because they were: greedy of so called risk less profits (look around you and you will find many such examples in stock market) and the financial institutions heavily downplaying the riskiness of such instruments (I wonder if RBI would ever come out with any rigorous stress testing requirements for such complex products).

India Inc has a long way to go before maturing enough to understand the true perspective of risk management (and we bet they will never exhibit this unless it is forced upon them by way of some strict regulation and supervision). Today, the board of directors is given the responsibility to review the risk management of a company and we doubt whether they are capable enough to do so (the doubt lies more in their capability to understand the discipline of risk management rather than questioning their credentials). The concept of CRO (Chief Risk Officer) is still alien, the reporting structure of the risk manager is such that most important information gets filtered before it even reaches the board of directors (most of the time either CFO or the owner has some vested interest in not exposing themselves to fiery question from the board on undue risk taking, remember the Satyam saga) and foremost it appears that people just do not want to accept the new norms of risk management, after all Gordon Gekko said in the movie Wall Street that ‘Greed is Good’.

The need of the hour is educating people right from the board of directors to the chairman, MD, CFO, treasury managers and the entire gamut of people involved in managing either forex or interest rate or operations or credit or counterparty or commodities risk, about the true identity of risk management and hopefully avoid any Enron, WorldCom or Lehman ‘Made in India’.