Essay/Brave New World of RAF, Revisited in the face of Covid-19 challenges
Promontory Financial Japan
Uncertainties surrounding the management of financial institutions are growing dramatically as the impact of Covid-19 on the macroeconomy, people’s lifestyles, and even people’s way of thinking is becoming permanent. In addition, the intensification of climate change due to global warming, the social divide in industrialized democracies due to the widening gap between rich and poor, and the start of a new Cold War due to the intensification of U.S.-China confrontation, are all examples of situations that have seriously undermined the premise of our lives.
In this situation, business leaders could not be allowed to dismiss those uncertainties as “it’s no use thinking about those impossibilities under the normal situation” but is expected to struggle with understanding these uncertainties, and also measuring the uncertainty using one’s own yardstick (as measuring the life in “Rent”). They are also expected to share the outcome of this exercise with stakeholders so that one’s yardstick does not become self-righteous, and finally start actions to address uncertainties based on the consent of stakeholders.
The visualization of the way of addressing uncertainty and its sharing with key stakeholders is exactly the concept of the risk appetite framework (RAF). In an era in which the world of tomorrow is in most cases just the extension of today, or uncertainty is quite limited, we do not need to clarify our own measure of risk and share it with stakeholders. What we need is to read the surrounding atmosphere carefully and try to see the direction of businesses by simply responding to the expectations of that atmosphere. We didn’t have to bring in difficult concepts such as RAF as stakeholders rarely disagree with the outcome of management’s reading of their expectations.
Unfortunately, those days are over. A variety of serious (unsolved) confrontations have clearly emerged in the values of the world. Recent examples include; stimulus measures through monetary easing and tax cuts that ignores the widening gap between rich and poor vs. a reduction in the gap that sacrifices economic expansion to some extent, expanding nuclear power plants to reduce CO2 emissions vs. accepting loose CO2 emissions target to abolish nuclear power plants, the U.S. leading populism-biased democracies vs. China leading new communism (or state capitalism?), etc. In a world of uncertainty in which the final winner cannot be seen, it is necessary for business leaders to choose the camp that they will follow. This should be the true risk appetite statement (RAS) that states clearly the leaders’ decision on which side to take in the battle of values.
There might be the following counterarguments to the above statement. That is, “Isn’t it business leaders to think of the ways to overcome conflicts?”. Of course, it would be better if we could satisfy the expectations of all stakeholders who have seemingly conflicting expectations. However, the reality is that it is usually quite hard. Choosing such a path is one way of balancing different expectations of stakeholders, but to do so, at least in RAS, the business leaders have to explain how to achieve it. The worst case is to declare in RAS that we will satisfy the different expectations of all stakeholders without showing any solutions. As long as there is no solution, such a declaration will likely disappoint all stakeholders.
From now on, I will periodically show my thoughts on RAF in this site. I would highly appreciate your views and comments, which you can sent me though the following contact form.