Credit where it’s due

The economic crisis has damaged the reputation of risk management. Yet, if done properly, it can help organisations move ahead during an economic downturn.

Banks once were willing to lend to practically anyone. Now counterparty risk is a serious concern. It has taken some spectacular failures, but most senior financial executives would acknowledge that managing credit risk strategically is essential.

There are clear benefits. Some organisations will find credit hard to come by as financial institutions tighten their lending terms, but those with identifiably good risk management might be able to jump ahead in the queue for cash. And when the banks do start lending again, the firms with the tightest grip on their risks are likely to be at the front of the line.

As the trading environment deteriorates and financial markets continue to look unstable, businesses want more reassurance that their financial instruments are sustainable. These concerns are demonstrated clearly in the commercial insurance market. Corporates wary of the losses insurers sustained after an active hurricane season, the financial crisis and poor investment returns are considering how much risk they should put into an unsteady market.

This mistrust has been exacerbated by the failure of credit rating agencies to issue timely warnings about companies and their losses.

Insurers wanting to win good business need to be more transparent about their financial position so insurance buyers can do their due diligence and reassure their boards – even though this demand for more detailed and up-to-the-minute information means increased paperwork and legwork for intermediaries.

All businesses are taking a closer look at the value of their assets. The same goes for commercial insurers, which will become more selective about the risks they take on. That may increase the amount of risk retention in the corporate sector, as insurance becomes more expensive in a hardening market.

But it will also focus more attention on companies and their risk management credentials. Like the banks, insurers will look more closely at the quality of the businesses they trade with. Buyers will be expected to present detailed and wide-ranging information about the risks they want to transfer.

Another consideration for big commercial buyers is the number of insurers on large schemes. It makes sense to spread the risk among many carriers and reduce the impact if one of them goes under. The commercial insurance market also remains fairly well capitalised – the few casualties of the financial crisis are notable exceptions.

The main lesson from the financial crisis is that risk management is only truly effective if it is done strategically. That means getting an overall picture of the risk and matching it up with a company’s goals.

It also suggests that organisations should breed a culture that values the role risk management plays. To achieve this, risk managers need to step up to the challenge and present the right insights but, equally, senior managers need to take on board that advice. Times are tough. Risk managers must now prove how they add value – or they could be on the chopping board.

nathan.skinner@strategicrisk.eu