This morning I delivered a talk to the Credit Union Compliance Center Annual Conference. Part of the talk was on the results of short survey which they had issued to the risk and compliance officers of their 160 members.
So , what a momentous week this was. Ireland through to the second round of the Euro championships, revisiting the heady days of the 1988 one, which heralded a new era of self belief and might even have helped with the national psyche for the real tiger times. Oh, and Brexit. Followed by the certainty of a second Scottish referendum.
This is a version of my column published in the Irish Examiner 29 March 2014. One thing we know from even a cursory study of economics and finance is that there are cycles. This time is rarely different. Sometimes the cycles are short, sometimes longer. But they are there. Regulators and officials contracted to mitigate the effects of cycles need to first be aware of them and then to understand them in a holistic fashion. Understanding them requires more than just advanced quantitative techniques.
This week I hosted a one day symposium on people risk in finance. We had a good audience composed of academics, bankers, Central Bankers (but not, as far as I am aware, from the Department of Finance) and researchers. The general consensus at the conclusion was that we have, in modern finance regulation and oversight, lost sight of the centrality of people. And that is a problem
Consider for example the data from the Operational Riskdata eXchange Association , a non profit body which looks at financial services risk and losses. Losses are very skewed – the vast majority of losses rise from a small number of issues. These issues tend to be concentrated in areas where the ultimate control is a person. The greatest part of these losses are not down to fraud; they are down to issues such as poor business practices and poor execution of these practices. A particular challenge for finance is that many of the problems that it faces are systemic. While in a healthcare or automotive context individuals can and do take responsibility for ameliorating risk (not leaving surgical tools in body cavities, not forgetting to reconnect brake cables) this is not the case in finance. There we find a significant disconnect. Take LIBOR – if an individual were to have not cooperated in the rigging scandal they would in all probability been sanctioned, and the system would have continued. Rogue traders are almost never driven by personal greed and a fraudulent aim. Therefore exemplary punishment and condign treatment of one will have no great effect on others – they fall prey to and then become trapped in system failure, and it is at the level of systems that regulation needs to work as well.
A key weakness of the modern financial regulatory system architecture is that it is not systemic. Nobody is looking at large parts (FX in particular) of the system; other regulators are nationally, industry or product bounded. As a consequence, the coupling of parts of the system to other parts can become looser or tighter without anyone being able to intervene or even perhaps notice.
A further key weakness is that it is focused on quantitative approaches. Quantification of risk is funny thing. It relies on failure – to know how often we will have a large market drawdown or a rogue trader or a systemic crisis we require a baseline of a number of these events. In the Irish context we have financial regulator and central bank that has been very strongly hiring quantitatively skilled persons. These are ideal at looking at the probability of a mortgage default given lender demographics, or at the role of SME finance etc However, they are limited to the data which they have. This data is typically partial- nobody is looking at the system as a whole, domestically or internationally. What is more, an over reliance on quantitative techniques alone misses the crucial human element. Systems fail either because they are poorly designed or because people find a way around them. The best designed system will not survive contact with someone inept or determined enough to circumvent it. Chernobyl comes to mind… This raises the question – where are the holistic risk managers?
The vast majority of risk management approaches in finance, as seen in the professional risk manager programs and certification, are rigorously quantitative. But they are almost bereft of even behavioural economics or finance. They contain little if any around economic or financial history. They are not people cantered. This is a major weakness. Our regulatory bodies need to take on board a much more holistic approach . On one level this means that we need to see a push for greater scope of regulation on areas such as the Repo or FX or commodity markets where existing regulations are weaker. At another more fundamental level it requires hiring psychologists, behavioural finance and economic specialists, anthropologists, sociologists and historians. Cross disciplinary teams need to be more than accountants and economists. For so long as we do not regulate finance in a human cantered systemic manner we give an implicit nod that these issues are not important. They are and we should begin to signal that clearly and unambiguously.
We need more regulation and better (more holistic) regulation. We need finance to learn from other areas such as surgery or engineering, where safety and risk mitigation are inherent. We need to change culture – this can happen as we have seen in airlines- where individuals are not only empowered but required to halt the system when it is in their opinion going awry. And we need to recenter and deglamorize finance – it needs to be seen as a boring utility.
The people risk symposium held yesterday was well attended, with about 75 delegates from a variety of financial and regulatory bodies. A general consensus was evident that financial services needs to be much more concerned about systems and their interlinkages, and to take on board more insights from anthropology, sociology, psychology etc.
The proceedings were recorded and will be made available later. Meanwhile below see slides where available.
1030-1115 Framing effects in reasoning about the moral acceptability of risky choices (Ruth Byrne, TCD School of Psychology) No slides available
1115-1200 – From Hubris to Nemesis ; Irish Banks, behavioral biases and the crisis (Michael Dowling, DCU Business School) Dowling- Lucey Slides
1200-1245 – The meaning of leadership integrity (Mary Keating, TCD Business School) Keating Slides
1330-1415 – Board Directors – What can we expect from them? (Blanaid Clarke, TCD Law School) Clark Slides
1415-1515 – KEYNOTE – Systemic People Risk : The Final Frontier? (Dr Pat McConnell, Macquarie School of Management) McConnell Slides
The ESRC seminar series on people risk (being organized by this motley crew) rolls into Dublin next Wednesday. The final running order is as below.
For more details and to register see here: REGISTER
The seminar is free, and coffee/tea and a light lunch will be provided. Venue is Institute of Bankers, IFSC.
1015-1030 Welcome and Introduction : Brian Lucey
1030-1115 Framing effects in reasoning about the moral acceptability of risky choices (Ruth Byrne, TCD School of Psychology)
1115-1200 – From Hubris to Nemesis ; Irish Banks, behavioral biases and the crisis (Michael Dowling, DCU Business School)
1200-1245 – The meaning of leadership integrity (Mary Keating, TCD Business School)
1245-1330 – Light lunch
1330-1415 – Board Directors – What can we expect from them? (Blanaid Clarke, TCD Law School)
1415-1515 – KEYNOTE – Systemic People Risk : The Final Frontier? (Dr Pat McConnell, Macquarie School of Management)
1515-1600 – Roundtable discussion on future research and policy directions (Moderator, Brian Lucey)
Despite the harsh realities of the 2008 financial crisis, lessons are still being learnt and fines for misbehaviour in the sector continue to abound.
As recently as February 2014 the Financial Conduct Authority issued its ‘largest ever’ fine of £30 million for product mis-selling to the insurance company HomeServe. Tracey McDermott, the FCA’s director of enforcement and financial crime stated ‘the firm’s culture, controls and remuneration structures meant that staff were focussed on quantity not quality.’ In Ireland we have seen the commencement of legal action against senior individuals of banks. In other countries such proceedings have concluded.
Following our successful inaugural seminar in December 2013, this seminar will focus upon behavioural issues and the paradox of employees being both the most important asset to a financial institution but also its major source of risk.
In co-ordination with Trinity College, Dublin the seminar brings together inspiring people from the disciplines of human resource management, law, finance and business to share their perspectives and learn from each other.
Dr Pat McConnell, Honorary Fellow at the Macquarie University Applied Finance Centre. Dr McConnell is an expert in People Risk, Systemic Operational Risk and the Strategic Risks faced by Systemically Important Financial Institutions. He will be discussing his paper: ‘Systemic People Risk – the Final Frontier?’
Dr McConnell will be joined by:
Professor Ruth Byrne, Professor of Cognitive Science at Trinity College Dublin who will discuss: ‘Framing Effects in Reasoning about the Moral Acceptability of Risky Choices’
Professor Blanaid Clarke, who holds the McCann FitzGerald Chair in Corporate Law at Trinity College Dublin. Professor Clarke will present her paper: ‘Board Directors: What can we Expect of Them?’
Dr Michael Dowling, Lecturer in ﬁnance in Dublin City University, Ireland will present his work on Irish banks: ‘From Hubris to Nemesis: Irish Banks, Behavioural Biases, and the Crisis’
Dr Mary Keating, Associate Professor at the School of Business at Trinity College Dublin, will present her research regarding ethical leadership: ‘The Meaning of Leader Integrity’
Wednesday 26 March 2014
09:30 to 16:00
Institute of Bankers in Ireland
1 North Wall Quay
Attendance is FREE but the seminar is strictly limited so please book early.
We have a limited number of small travel bursaries available for attendees and a few bursaries to cover travel expenses for PhD students. Please indicate if you want to be considered for a bursary when you register by emailing Dr Cormac Bryce: firstname.lastname@example.org
With grateful thanks from the Economic and Social Research Council
after the congratulations of the Forbes report on us being the best little country in the world in which to do business, here are two charts that might make us take pause…
Both are from a new ESRI study. They are on relative poverty risk in the EU. It looks at what is called the “at Risk of Poverty Rate” AROP. This is defined as
The at-risk-of-poverty rate before social transfers is the share of persons with an equivalised disposable income, before social transfers, below the risk-of-poverty threshold, which is set at 60% of the national median equivalised disposable income (after social transfers).
Think of it as just at risk of poverty.
First, across the EU.
Yes.. we are number one. Without state transfers fully 1/2 of the population would be at risk of poverty. But it gets more stark…look over time. We have seen the largest increase in AROP since 2005.
This, this is success?
Short answer :they are tolerant, but it depends on a number of demographic and other factors. In particular, gender, age and the level of education matter. We also find little evidence of urban/rural divides in risk tolerance. This is to our knowledge the first benchmark survey of risk tolerance to be published for irish adults, 650 of whom are surveyed here.
This post is an extended version of an opinion piece published on 17 March in the Irish Examiner:http://www.irishexaminer.com/business/women-are-the-stabilising-hand-in-finance-187420.html
Last week we saw international women’s day, a day that in theory is devoted to the celebration of female achievement. It is celebrated as a public holiday in some countries, mainly those part of the ex soviet bloc, where the holiday originated. Originally an overtly political event that trumpeted the (real, if with mixed outcomes) achievements of the soviet state in enshrining women’s rights, it has more generally evolved to be a celebration of women and female achievements. This weekend sees Mothers Day, a very mobile feast, which of course celebrates mothers and motherhood.
Perhaps the time then is right to consider what finance has to say about women, and in particular to look at some recent research. I dont refer here to personal financial management, although this is an area where women also show distinct differences, but to ‘professional’ financial activities.
The news, gentlemen, is not good: women, qua women, exhibit traits which whether due to the subtleties of the female brain or due to culture, might well make them better financial operatives. This is not to celebrate naive housewife economics, whether the Swabian or Lincolnshire variety so beloved of Dr. Merkel and Mrs. Thatcher. There is a large and emergng body of literature on what we might call the neurophysiology of risk, and among that is the discussion on gender differences. Gillian Tett of the Financial Times has an interesting opinion piece on this.
First, we all know that boys will be boys. In finance this manifests itself as excessive overconfidence by males. Males trade more, take more risk and as a consequence tend to find that on average monies managed by males show greater volatility. Women in general take less risk and adopt a more ‘steady’ hand, avoiding excessive trading costs. This extends from trading to corporate activities, where recent evidence suggests that companies run by females engage in less risky activities, with lower merger and acquisition activities and less debt issue.
Second there have recently emerged a number of papers on women on boards. My research indicates that the appointment of women to boards is market-negative. This makes sense when you consider the earlier findings; boards more female dominated will take less risk, and recent DCU research notes that this will result in lower (short run) returns. Changing board structures to mandate more female members, something that I would wholeheartedly support, will thus have shortterm costs. In the longer term however there is recent evidence that female chief finance officers obtain loan financing that is significantly lower than the average, demonstrating that while the equity market may penalize the loan market values this tradeoff of longer-term slower sustainability for short-term returns. The market, we should recall, is both a valuation and a voting machine. Thus, negative reactions to female activities is a function of both and if there are conscious or unconscious biases (and some research suggests there are) in either by the dominant group (males) these need to be considered.
Thus we find that women in financial situations exhibit a greater aversion to taking risk than do men. This finding is not just evident from these ‘top down’ studies, but is also evident when we survey individuals. Again my own research on Irish adults is in line with international findings. Women show a greater reluctance to take financial risks and this maps to funds managed by women whether on their own behalf or for others. While this might be something valued by some kinds of funds the costs, in terms of lower volatility, to get higher return you have to accept higher volatility. Finance has now moved to the acceptance that not only does risk matter but the perception of risk by the risk taker matters. Risk and feelings about risk go together, and women tend to be more affected by (prospective or actual) risk taking than do men. Females worry more about financial activities than men
Third, research indicates that women are more selfless and less selfish than men in economic and financial transactions. Thus financial settings where ‘winner takes all’ are more likely to be attractive to and dominated by men. The testosterone driven ‘you eat what you kill’ attitude of investment banking and trading rooms is thus the natural environment of men, but of course this as we know comes at the cost of overconfidence and excessive risk taking. Boys will be boys. In more social financial situations, such as startups and venture capital situations where success is inherently to be shared, we find as we do that more balanced gender in the investing groups has a major effect. A caveat however is that this depends very significantly on social capital. While women and men may have similar levels of social capital, important in areas such as financial analysts and venture capital, women gain less from this than men. There is some evidence, quell surprise, that there is discrimination against women in the financial industry. Female fund managers, despite having almost more consistent performance than males attract lower inflows; this prejudice also follows through to ‘foreign sounding’ names it should be noted. IPOs with more female involvement tend to be looked on less favorably than those without. Women can indulge in a touch of Schadenfreude however as startups with higher degrees of gender discrimination show markedly lower survival rates., while the higher the percentage of females in first hires the greater the likelihood of success. This is of course entirely in line with the risktaking and selfish approach of men versus the more inclusive approach of women in economic activity, as startups require both drive and collaboration to get over the first few months.
The bottom line then is that if you seek shortterm gains, more males would be optimal, while for longterm consistent but per period lower returns, more female. The hare and the tortoise analogy comes to mind. The implications are clear for organizations with different time horizons such as pension funds versus trading houses, and for companies with different time horizons in terms of corporate strategy. A system which is set up and dominated by men is unlikely to be conducive to women success, unless they share the same risk attributes as do men. We need to consider that financial markets are social constructs, and that gender differences (whether innate or cultural) are likely to both impact on that and to require us to consider them when analysing or teaching around them.