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The Final Word -NAB March 2004 - Banking : a risk adverse or risk attacking industry

By Michael Vincent

26 December, 2006

Over the last several weeks we have read about the trouble at the National Australia Bank culminating with the resignation of its CEO.  Some of us have probably enjoyed the embarrassment caused to the largest financial institution in Australia.  Others have watched in disbelief as the cyclical nature of speculation and systemic bank error repeats itself with another victim.  When will we learn? 

 

I have watched the events unfold with disappointment but have not been surprised because history continually repeats itself.  Banking is currently a generational industry where knowledge walks out the door with retirement or resignation and may not be replaced at the timing needed for safety. History is a mentor for risk managers.  Quite simply once an organisation believes it is bigger than the market then it is headed for disaster.

 

This feeling of superiority is not a conscience act but rather a subliminal shift that goes with being dominant and successful.  Correct and directed risk management will ensure the external image is managed internally with strong controls and fusion across the myriad of management systems that interact to create the culture of an organisation.

 

How can these events happen in today's world with all its sophistication, technology and systems?  The answer may be quite simple, it could be systemic within the NAB, it could be confusing compliance with risk management or indeed it could be just plain sloppy management at multi layers within the organisation. 

 

In this article individuals will not be discussed or blame apportioned, rather it will be a critical look through the eyes of an outsider who will hypothesise on what may have gone wrong and will be based on no inside knowledge what-so-ever.  It is a chance to use an event that has had severe consequences for the NAB as a learning curve for all of us. When we confuse core business activities with speculation and do not recognise that we are in fact gambling with shareholder wealth then the scene is set for disaster.  I am reminded of an old saying "there but for the grace of God go I", let us learn so we as risk managers can ensure similar events cannot happen within our organisation.

 

Again it is the foreign exchange operation of a bank that has caused a large loss, at least the NAB has the depth to recover and build again unlike some previous victims of speculation.  Money market dealing and speculation is a young person's game, they bring energy, risk taking, the belief that they are indestructible and can do no wrong.  They rely on their theoretical education for guidance and if successful are accepted by the organisation as a font of cashflow that will last forever. 

 

Therefore if they are successful in their early days they will increasingly be highly regarded by the organisation and allowed to speculate more and more to meet profit targets as set by the ever present tension between credit control and return on investment.  

 

They will not be custodians of corporate memory or organisational learning; they may in fact decry that information as irrelevant.  Their energy and ambition must be used and harnessed within bounds, exemption to limits must be exactly that - exemptions.  If a young dealer exceeds limits and is allowed to continue then it becomes a habit, one a habit downside is inevitable.  Senior management are the custodians of the wealth of the organisation, it is their job to judge how much shareholder wealth is gambled for speculative gain.  You can off-lay responsibility but you cannot off-lay accountability.  Senior management are responsible for managing the dealer in the speculative arena and their prime function is to monitor the level of exposure and know when to crystalise losses.  A dealer will always look for a win and will if allowed use the old punters trick of doubling up to recoup losses.  Management knows when to take timely losses and when to enter or exit markets in a general sense.

 

When managing a dealing operation layered controls are fundamental to long term success, you can make your own judgement whether they were functional within the NAB at the time of the event.

 

1. Organisational Controls - This control is the direct expression of the culture of the organisation, it sets the scene for the dynamics of the dealing operation and management. The fundamental method of organisation control is the recognition of the need for segregation of duties. This could be described as a strong back office and front office structure and operation.

If we look at the functions that are needed to complete a foreign exchange transaction we actually give ourselves the potential to develop strong organisation controls.  To be effective the functions must not be concentrated upon one individual but rather spread across many.

 

            Duties that cannot be shared for good corporate governance

a. Dealing - the start of the transactionb. Determination of dealing tacticsc. Operational duties - recording of transactions, exchange of deal confirmations and arrangement of settlement.d. Teller functions.e. Accounting for transactions and final reconciliation of relevance of transactions.

 

2. Operational Controls - these are the functional controls that ensure the transaction is genuine and completed according to the requirements established at the start of the deal.f. Transactions must be fully recorded in the books of the organisation and give assurance that no fraudulent entries are present.g. The records evidence correct settlement of transaction.h. Unauthorised deals are identified in a timely manner and reported to the correct management layer. 3. Limit Controls - are an individual matter between the dealer and the organisation through the defined management structure. Limits should be set bearing in mind the experience of the individual dealer and the approved risk position of the organisation. The following are some of the factors that must be considered.

i.         Limits are set for defined periods and are withdrawn for periods of leave or absence.  They are for day and overnight dealings if allowed.

j.          Limits can be by way of number of transactions or by currency or by amount.

         k.         Limits on mismatching the timing of exposures

 

Did the NAB have these sorts of controls, very likely, if so then it is an error of omission and poor management?  If not, why not again poor management.

 

More importantly if our organisation has foreign currency dealing of a sizable nature do we have the above controls?  From other peoples' discomfort comes organisational and system learning.

About the Authors

Director

Australasian Risk Management Unit

Faculty of Business and Economics

Monash University