And we must delve more deeply as well, penetrating the cultural substrata of organizational behavior and management decision-making. Humans are a cultural species. This is reflected in all our thoughts and deeds, and it accounts for the “historical, institutional, psychological and other highly relevant factors” that Professor Hodgson urges us to consider, and that orthodox risk models most often fail to contemplate.
Mark Pagel is a Fellow of the Royal Society and Professor of Evolutionary Biology at University of Reading. In one of the articles from The Academy featured herein, Pagel explains that “our species has occupied the World by adapting at the cultural level — by acquiring the knowledge, skills and technologies suited to the particular environments we inhabit.” [See also the Academy Article We May Underestimate the Power of Social Media] This ability is unique to humans, and we have evolved to “embrace the arbitrary and unknown culture into which we happen to be born.” And to embrace the cultural norms of the workplaces in which we happen to be employed. “Copying and social comparison,” Pagel notes, allow us to “navigate a complex and nuanced social world where we cannot possibly always know how to behave.” We take our behavioral cues from the social context in which we’re embedded. This penchant for social mimicry has served us well: “Having a shared culture means being able to pool the knowledge, skills and good luck of large numbers of actors to solve problems and create innovations,” Pagel maintains.
But because orthodox risk management science most often fails to incorporate consideration of organizational culture, we operate without the benefit of that “species of judgment” which Professor Hodgson highlights. This robs us of tools by which to improve our performance in pursuit of opportunity, or to better our odds amidst adversity. Viewing the market from the banks of the Charles, an economist in Cambridge might ignore the ‘background noise’ of humanity without peril. Not so a trader on the Hudson or the Thames.
Nor policymakers on the Potomac. A former Senior Policy Advisor to the Under Secretary for Domestic Finance at the US Department of the Treasury, Kristen Jaconi spent the decade after the financial crisis with a premier consultancy, helping firms to establish best-in-class enterprise risk management programs. Today, she leads the Peter Arkley Institute for Risk Management at the University of Southern California Marshall School of Business. In an interview from The Academy, Jaconi complains herein that, despite equipping clients with all the “right” elements of risk management that orthodoxy had prescribed, risk management failures continued, unabated, nevertheless. [See also the Academy Article An Interview with Professor Kristen Jaconi] “The three lines of defense we had built up at our banking institutions,” she concludes, “are mere Maginot lines without a risk-caring culture to buttress them.” Jaconi describes such a “risk-caring culture” as one in which “all employees sincerely feel they contribute to the risk management process and wish to do so.” It is unclear whether or how bank examiners test for cultures that promote such caring.
“Economics likes to see itself as a foundational discipline, like physics, not a practical one, like engineering,” the Economist newspaper observes in an April 2023 article entitled “Why economics does not understand business.”1 Most of what makes for a flourishing business — like a risk-caring culture — cannot be captured in mathematical equations. “Strong businesses are shaped by shared values and common ideas about the right way to do things — by corporate culture,” the Economist contends. “These are not natural subjects for economists.” While there are certainly economic ideas that we ignore at peril, “Economics is never enough.” Alas, the Economist concludes, “economics has little of practical use to say about what makes a successful company.” And yet orthodox economics forms the bedrock of risk management practices.
This is regrettable, in fair weather or poor. An Advisor to the Federal Reserve Bank of New York, Joshua Rosenberg previously served as its Chief Risk Officer. “Risk management is mainly a way to stop bad things from happening,” he writes in an In Focus article featured herein. [See also the In Focus Article In Defense of the Second Line of Defense] “But, risk management, in my view, should also help the right things happen by giving us tools to work more effectively.” Among those tools, for instance, is an ability to promote innovation in risk management. “An organization’s approach to risk management can determine whether it flourishes or fails,” Rosenberg emphasizes. The responsibilities of risk managers should thus be seen to imply multiple roles: that of the risk expert, the trusted adviser, and the enterprise guardian. And risk managers must work to facilitate performance improvement as much so as risk mitigation. “Risk minimization is not risk management,” Rosenberg asserts.
Regulators, supervisors, and international standard setters appear increasingly aware that the thinking, practice, and tools they bring to their task must shift. They have yet to achieve consensus as to what this entails, however.
Other Articles in the Comments, Contributions, and Conclusions Series
“What is it that distinguishes the thousands of years of history from what we think of as modern times?”
Hidden inexactitudes
“Radical Uncertainty”
"Why did no one see it coming?"
The real trouble with this world of ours
More meaningful metrics
“Too Big to Manage”
Drifting into failure
“Lying to Ourselves”
"We have literally no time even to be astonished."
“We need to develop a culture that empowers supervisors to act in the face of uncertainty.”
“Culture, more than rule books…”
“Proactive identification of threats to trust in banking.”
Blitzkrise
The illusion of control
What is Conduct Risk
“Changing banking for good”
Outcomes oriented
Achieving foresight
Trust matters
Mapping and tapping workplace networks
“An Epidemic of Loneliness”
The fourth wave
System shifts
Conduct: the new prudential risk
The costs of misconduct
Has banking changed for good?
Tribulations, and trials
Audit Quality Indicators
Shared interest and collective action
Nothing ventured…
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