Strategic Risk Management: Disclosure by Systemically Important Banks

Abstract

This paper considers the Governance of Strategic Risk in eighteen of the world's largest 'Systemically Important Banks' (SIBs), using a cross-sectional study of statutory disclosures in their Annual Reports. Twelve of these banks, which all follow an 'Anglo-Saxon' model of Corporate Governance, are Globally Important (G-SIBs), the remainder Domestically Important (D-SIBs). As official inquiries into the failures of several large banks during the Global Financial Crisis shows, Strategic Risk is one of the greatest risks facing any firm. But this study finds that the SIBs studied do not appear to pay sufficient attention to this critical area, despite banking regulators identifying Strategic Risk as warranting additional and intrusive supervision. The study identifies a number of deficiencies of governance of Strategic Risk in practice concluding that, apart from a few notable exceptions, the strategies disclosed in Annual Reports are vague and bland, even banal. Though by no means unique, this vagueness is exemplified by the strategy disclosed by Citigroup in their 2010 Annual Report, Our core strategy of being the world’s global bank for consumers and institutions. What exactly does this strategy mean? While such a statement is grandiose, maybe even inspiring, without measurable objectives and a coherent plan for achieving this lofty position, the words are little more than a slogan.Few of the 'strategies' disclosed by the banks studied have explicit objectives, beyond the following financial year, against which Boards and management can be measured and held accountable. Even fewer of the banks disclose that they have robust processes for determining the risks in its Strategic Positioning (i.e. where the bank is headed) or its Strategic Execution (how the bank intends to get there). More worrying still is that there appears to be no consistent oversight of the management of Strategic Risks, especially in the situations where the roles of CEO and Chairman of the Board are invested in one person. Analysis of the Risk Factors disclosed by these systemically important banks in their shareholder disclosures are, aside from a few firms, formulaic and anodyne, and are little more that a 'tick in the box' exercise with little discussion of the relative riskiness of certain risks and an absence of information on possible mitigating actions. Far from having clear strategies for the future against which they can be measured and remunerated, most banks in the study appear to be on 'auto-pilot', merely doing today what they did yesterday which generally happens to be what the rest of the industry is also doing. The majority of these banks are acting as if they were part of a 'herd' betting on the same business model. In the light of the systemic failures that occurred during the GFC as a result of many large banks loading up on the same risks, regulators should consider whether more diversity, or at the very least a clearer understanding of exactly where important banks are headed, might be better for the overall stability of the financial system. The paper finally proposes some potential solutions to help address some these Governance problems.