Working smartly with the human condition

Why did the risk management systems in general use not prevent the recent Western banking collapse? Has the industry been able to adequately address the issues raised?

It's a very valid question. But you have to realise that the near-implementation of a risk management system doesn't prevent anything from happening. There is something in the middle. It is how you use a risk management system. So technology and risk management systems are meant to help the decision-making process, but they don't make the decision themselves.

Having a proper risk management system can give enough information for the decision-maker in real time to make the adequate decisions. [But] he might ignore these signs. He might not look at these signs initially. Obviously if you don't have a risk management system you are definitely exposed. If you do have one, then you have the right tools and right means, but you should have the right strategy and the right internal processes to mitigate these risks.

Whether the industry has been able to address the issues raised —it is evolving like everything else. The financial markets are evolving. The instruments that we trade today are different from the ones we traded three or ten years back. So, as the financial market gets more complex, the risk management tools have to get more complex. The issues I would say are not 100 per cent resolved... because it's an evolving thing.

To what extent can risk management systems offset or compensate for human error?

First of all, the collapse of the banking sector was not a result of human error. It was a hole in the financial system, it was a black spot that the light did not shine on so that we could have seen it early enough to solve it. So it was not one person's mistake.

But if you look at it from how risk management can moderate the scope for human error — as one individual error — this is a valid question. When you talk about risk management, to simplify, three factors have to be taken into account: there is market risk, there is credit risk and operation risk.

Operations risk touches a bit on the human aspect. For example, one of the criteria that we help banks monitor is some of the human errors and how frequent these happen. A teller coming ten minutes late to his desk — how much would that cost the bank? Or the teller missing to put an instruction in a certain transaction — we count these, we monitor them, we see their effect and they are built into the value of the risk management of the bank.

How can risk management be preventive? I would say using technology in general — be it in manufacturing product lines or in banking — you try as much as possible to eliminate the dependency on humans. Once you have advanced technological platforms, where for example you have one point of entry from the beginning right to the end and there is minimum intervention unless required, then you are eliminating human error.

From a global perspective, how far is technology embedded in the risk management process? To what extent is progress being driven by regulators, or by banks themselves? Is there a danger that over-reliance on risk management systems leaves users and markets vulnerable to system errors?

First, as we have already touched upon, technology touches every aspect of financial markets and non-financial markets, and risk management is not an exception but right at the top.

Regardless of getting into financial details, if you have straight-through-processing (STP), if you have visibility over the entire operations of the bank — like you know your balance sheet details, you know the transactions, as simple as knowing your exposure to interest rates over three months and on a real-time basis — these are all the information you can achieve if you have an advanced technology platform.

The second thing is STP where [there is] human error, and this is again mitigating risk management. Technology and risk management are quite tightly close together.

Probably before the crisis, it was more regulators than banks [as drivers]. Now, it is everywhere. From our experience with banks, every bank looks at reports differently, every bank asks for reports differently. We have seen that after this recession there is more demand for transparency and that demand comes from the regulator, from the shareholders, from managers.

As to over-relying on risk management — risk management by nature should not be preventive of making more business. The entire objective of risk management [accepts]: if you don't take risk, you don't make profit. Risk is as available as profit. The question is how to take calculated risk. To take that sort of risk, you must know what it is.

Know your risk, decide on what risk you are going to take, take it, and make a profit or loss. That is the simple formula.

If you don't know your risk there are two things [in play]: either you take an action and then you cross your fingers; or, nowadays, any board will not take any action.

For me, having risk management will actually help you to make more money. Having said that, I am also not hiding the fact that having a risk management system will constrain a little bit of the aggressiveness, or the front office willingness to enter new markets.

Previously, if the head of treasury would like to trade a new instrument or go into a new market, it would probably take him couple of days of study, and that's it. Now he has to go through risk approvals, and it might delay couple of days or weeks — but at least he is doing it the right way.

What have been the most significant technological advances in recent years within the financial sector, and how have they improved banking operations? What technology advances are in the pipeline?

This is an interesting question. Obviously there are no straight answers that we have done ‘this' or ‘that'. We have a theme within Sungard and we had it in 2010 and it is going to continue in 2011. It is called TEN (Transparency, Efficiency and Networks). And we believe that three pillars are important for the success and growth of any financial institution.

Significant advances in recent years: it's being able to be transparent, so banks are able clearly to report their financial results, their positions, their risk takings; it's also being more efficient.

Efficiency comes with cost-effectiveness, so this could be by having STP, online banking, by having mobile banking, by having a call centre. All these require technology to become more efficient by lowering cost and increasing profit.

Next comes networks. You cannot succeed in the new financial market if you don't have your own cloud networks that you can interact with.

How is that related to the Middle East — very much so. This theme is international but probably to the Middle East it is even more important.

Transparency is key — it is to be able to report to the regulator (based on the new regulations) your financial results. Transparency means you cannot have your brokerage licence if you don't comply with X, Y, Z. Transparency means that for you as a financial institution to be able to trade in derivatives, for example, these are the prerequisite requirements in terms of capital adequacy, in terms of degrees. You have to have the right technology to be able to communicate to the regulator — and today not only to the investor but to the public — what you are doing. Lack of transparency equals risk, equals: nobody wants to work with you.

More transparency means confidence, following regulations, and therefore ‘let's do business'.

The same is [true] for efficiency. It is becoming extremely competitive. You have seen how many brokerage companies have shut down in the past two years. Margins are lower and trading volumes are lower. If you are not really efficient you are out of business. And networks is where we need the most help in this region. I am talking about social networks. This is the way forward. We are catching up on that. One of the challenges as an international vendor is to bring that experience to the region. And this is where we are pushing.

To what extent is technology even driving business rather than just responding to business needs?

If I am forced to do a comparison, in the West the technology is driven by business needs. Here it is not so as much, because technology is created outside, in the West.

Having said that, in emerging markets some have been more involved in technology than others because we don't have the legacy systems. We have the privilege of being ‘new technology': we can pick and choose and we can implement it.

In the context of Gulf and UAE markets, it could be that [both aspects prevail], but it's more the other way here [technology as initiator].

Lots of banks are very innovative here, and they even challenge the technology provider. But, if I were to generalise, I will say that we localise or regionalise international experience to provide here locally.

But there is another flow that comes out of the Middle East, which is not even done internationally. It is something that every local market has. For example, we don't have lots of financial institutions that are highly specialised in certain areas. They are general financial institutions. They do brokerage, they do asset management, they do private banking, wealth management, so you need a solution that can cover [the combination].

In the West, there will be one company doing private banking and a separate company doing wealth management solutions. Here it's the same company doing them. In that case it drives technology towards more integration, towards one system that covers all aspects.

I believe that the financial sector in the Gulf is willingly or unwillingly very much endorsing technology and investing in technology.