Risk: Strategic key that’s often missing

As summer fades to fall, banks will start up an annual ritual that consumes endless hours and satisfies no one—the dreaded strategic planning process.

Everyone “knows” that a bank must have a plan. To say otherwise suggests that a bank is rudderless and incoherent. Regulators, employees, and investors crave reassurance that management has a satisfying vision and a workable plan to achieve that vision.

Unfortunately, most planning exercises are ultimately unsatisfying because reality rarely follows the intended script.

There are many reasons for this. Among the most important is that the planners rarely consider strategic risks in the same sentence as strategic rewards. Ambitious plans come to naught and attractive opportunities are overlooked because management does not make a serious attempt to gauge and manage the risks of the plan.

Where plans go wrong

The worst sort of plan is nothing more than an annual budget based on vague hopes: “Last year plus 10%.”

But most banks are more thoughtful about their plans. Each business submits annual forecasts of revenue and expense by category, management scrutinizes and challenges the results, and the consolidated plan is tallied. These steps are repeated until top managers reach numbers that they and the board can accept.

These annual earnings-based plans serve various purposes such as establishing earnings goals for businesses;  offering reassurance to constituents that  management is awake and steering the ship; and providing an excuse for management and staff to engage in intensive discussions about what is going on in each of the businesses and the bank as a whole.

That is why banks keep the ritual alive even in the face of perpetual distaste for  the process.

But where in all this is a serious discussion of strategic risks? 

The trading desk says it plans to earn $100 million this year. But what strategy will it follow to earn that $100 million? How much could it lose using that strategy? Under what circumstances? Over what time period? Is there a better strategy? Is it worth the risk to have a trading desk all?

That last question would not come up in many bank planning sessions. That’s because most banks are really doing tactical plans, not strategic plans. Tactical plans rarely disturb the bank’s existing business mix and ways of doing business. Fine tuning is the order of the day.

What goes into real strategic plans

Genuine strategic plans tackle the big questions:

• What changes in the business environment must we confront?

• What businesses should we be in? 

• What are our competitive strengths and weaknesses?

• What investments in people and systems to we need to make?

• What kinds of talent do we need to be successful?

• How do we need to change the culture to both grow and protect the franchise?

• And last, but not least, how much risk are we willing to take as a company to achieve our strategic goals?

What goes into a real strategic process

You cannot have an effective strategic planning process without:

• Looking well beyond a one-year horizon. Sometimes you can see things coming from a long way off. Sometimes you can’t, but it’s worth a try.

• Evaluating a variety of possible scenarios for the future. The future is unpredictable but it is not unimaginable. Chance favors the prepared mind.

• Making the plan contingent on events. “If this happens what will we do?”

• Having a sound methodology for identifying and gauging risks in all the businesses. Relying solely on anecdotes and seat-of-the-pants guesswork will not do. Judgment without analysis is unnecessary and foolish. Analysis without judgment is dangerous.

• Taking a portfolio view. Looking for linkages across businesses that can be used to decrease avoidable risks or increase attractive opportunities.

• Having a disciplined intelligence-gathering capability. This serves as a radar screen for emerging risks and opportunities.

• Avoiding perverse incentives. Paying only for short-term earnings is a proven recipe for disaster.

• Paying attention to unconventional competitors. Other banks are not your only worry.

• Making sure that you have sufficient capital and resources. The bank has to be able to back the strategy.

Thinking strategically is not easy. But it is much more rewarding than grinding through earnings spreadsheets that are not anchored in business realities that will be unfolding in the future.