Risk Management...

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Economist recommends banks focus spending on risk management

Are we heading toward a double-dip recession? Analysts and economists are speculating about the possibility. They're looking toward the uncertainty in the Middle East and at oil prices rocketing above $30 per barrel. And despite the $7 trillion that has disappeared from consumers' portfolios, sales of consumer durables shot up nearly 40 percent at the end of last year--instead of the expected decrease in consumption.

Analysts say this denial in the face of a slowdown can't go on: They think we're heading toward another downturn--in other words, a double-dip recession.

The fear is worse in business. Even if we're on the cusp of a recovery, growth seems likely to hover around 1 percent. But that's an economist's recovery, not one with growth rates of 3 to 4 percent that businesses can enjoy. This is one reason the IT sector continues to suffer.

Last month, Oracle released its quarterly results, just hitting Wall Street predictions, though accompanied by notes of caution. "Our assumption throughout the next quarter is we won't expect sharp improvement," CFO Jeff Henley said.

Oracle might suffer more than some because its products are more vulnerable than others. Services and security will fare better--post-Sept.11, they're even booming. But during a period in which cost-cutting is key, when companies need to be able to really justify any IT spending, one question that CIOs, IT directors, and managers face is what they should spend money on.

For an answer, I turned to Lester Thurow, a professor of management and economics at the MIT Sloan School of Management. Thurow was pretty clear about where money is currently well spent: risk management.

Banking is about loans, he reasoned, so no one gets a promotion if they say a customer can't borrow money. But this puts banks on the edge, always at risk. Even more so because, even if the risk seems big, it's human nature not to say no--after all, with great risk often comes great reward.

However, banks that managed to avoid the bad loans of yesterday, be they to South American governments or North American corporations, are in better shape than most. Everyone had a stake in Argentina, and no one could resist the bubble that was Enron.

But if those banks had assessed the nature of the risk more fully, they might have hedged better, risked less, or even--though the thought is almost unthinkable--said no. So learn the lesson and spend on risk-assessment systems, Thurow said.

He argued that, contrary to current wisdom, other areas of IT spending are not so important. For example, while there's a lot of current buzz around security, he believes banks are relatively secure businesses already, and they certainly protect themselves well enough for now.

Alternatively, the need to integrate systems is also much discussed, and rightly so. However, again comparing banks to other businesses, banks already have a high percentage of automated operations. More work on this front can wait without detriment, Thurow said.

But risk increases in a downturn: Pies get smaller, companies go under, and markets wobble. The bank that can navigate these turbulent waters will pull ahead of its competitors. Hence, IT will make a better business case, which will chime with the concerns of the board, if it proposes spending on risk management.

Will banks take Thurow's advice? Perhaps: Meridien Research recently reported that there's some anticipatory spending going on in the area of risk management amid the world's top 500 financial institutions. But all are cautious about capital investment right now. Perhaps they should be encouraged to take a risk--with risk management.