Financial Executives Facing New Lethal Risks
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As a rule, financial engineering is good for the world economy, because ever more sophisticated instruments allow both households and businesses to manage financial risk more efficiently. People and companies are healthier when they have a greater choice of tailored financial products for protection, borrowing and saving.
But in the last few years, the sheer pace and scale of innovation has created a new risk environment that is virtually impossible for economists to quantify and manage. Or put in another way, innovation mixed with speed and growth has resulted in a lethal cocktail of complexity with the potential to knock out even the most competent financial executive.
Innovation may be beneficial in itself if it happens as a response to real customer need and if the potential financial consequences of using the new products are known and understood. Partnered by increased competition between banks and other financial institutions, it can ease and broaden the access to funding for businesses and households.
But if the connection between innovation and demand is lost, and the consequences of dealing in the new financial products are poorly understood, disaster can ensue, as we have seen.
More Speed, Less Haste
Whilst there is likely to be a post-credit crisis call for ‘going back to basics', it would be wrong to attempt to scale back innovation completely.
It is impossible to deny the very obvious benefits delivered by financial innovation in recent years. The broadened range of financial products has helped both companies and households improve on their risk management and become more financially efficient, and these benefits should not be lost.
We can no more turn the clock back than we can unwind progress. But it is important to remember that not all the financial market innovation that we have witnessed in the last few years can be classified as progress.
It is not progress, when the speed of innovation is so rapid, and the growth so staggering, that financial institutions, regulators and governments no longer understand the scale of the risks that are being taken in the market or the potential consequences when things go badly wrong.
For this reason, what must happen now is a slow-down of development, where "more speed, less haste" is the watchword. We need to re-establish the link between financial products and real customer demand. We also need to regain control of market complexity and make sure that essential information can be accessed equally by all market participants.
Taking Control
It is not only financial executives who must ask themselves how they can protect their assets in this new complex and interconnected world of risk. The financial supervisory authorities, too, face a considerable challenge in regaining lost understanding and control.
As we saw earlier, advances in IT have helped foster financial innovation, which in turn has helped households and business manage their risks more efficiently.
It must be clear that IT also holds part of the answer, when it comes to understanding the increased complexity that has followed in the wake of innovation.
From Data to Wisdom
If we have learnt nothing else from the credit crisis, we ought to have learnt this:
Data becomes information, when presented in a structured and transparent way. Information becomes knowledge, when it is interpreted and used. Knowledge becomes experience, when you have seen the various results and outcomes of your decisions. And experience becomes wisdom, when you learn, that no matter how much knowledge and experience you have, the past doesn't equal the future.
While financial executives may in due course be tempted to sip once more from the lethal cocktail of innovation, speed and growth, they should know by now that the hangover hurts, is expensive and lasts a very long time.
The article as a whole and its sources have been published in Affecto Customer Magazine 2/2008.
[8.12.2008 15:05]
