Management Strategies

10:25 AM
Mick Simonelli
Mick Simonelli
Commentary
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Risk Aversion: The Biggest Innovation Obstacle

Fear of risk is the biggest factor holding financial services organizations back from innovating.

There are numerous obstacles that banks face when trying to innovate. There are things such as funding, people resources, the right ideas, customer needs, and the list goes on … All of these are important, but there is one underlying obstacle that must be overcome while taking on the other issues, and that obstacle is risk aversion.

Risk, by its nature, is something that large companies avoid. Risk is especially critical in banking. Most of my clients have some sort of major initiative launched around risk mitigation. Yet, contrarily, they also usually have some sort of innovation program that introduces risk. Risk and innovation go hand in hand, so banks need to be aware of how they manage and react to innovation risk.

[For more on innovation strategy from Mick Simonelli, check out: To Patent or Not to Patent.]

Generally speaking, risk is even harder to overcome if certain factors are present. I’ve found that there are five major determinants of risk aversion that I can use before I even work with a company in order to know how strongly the company will resist risk (and hence resist change and innovation). Those factors are:

  1. Size of the company
  2. Age of the company
  3. Organizational structure
  4. Customers
  5. Market

The size and age of the company are usually good indicators of risk aversion. The larger and older the organization, the more risk averse it usually is. Large and old companies develop formal ways to identify and avoid risk so that risk aversion actually becomes embedded in the culture. 

The organizational structure of a company also influences its ability to assume risk. The more hierarchical and formal the organizational structure is, the more likely it is to reduce risk at each level of the hierarchy. There were numerous innovations that I led for a major bank that started off as potential game-changers. However, these innovations became filtered and watered down by various levels of bureaucratic risk reduction into very mediocre, incremental innovations.

Comparatively speaking, I sometimes work with smaller organizations with flatter organizational structures that are more agile and less risk averse due to their structure. Hierarchy and formality in an organizational structure tends to increase risk aversion.

The customers and the market are the last two significant indicators of a company’s risk aversion. Customers are having a growing impact on the types of changes and the pace of change that companies are finding themselves adhering to. And the specific market of banking tends to reflect the aggregated desires of the customer base.

If the customer base and market is characterized by risk avoidance and distrust (i.e. the banking industry), then risk aversion will be strong. With Dodd Frank and the increased regulatory constraints on banking, risk aversion has become stronger. In many banks, risk reduction is even a strategic initiative. If the leadership hasn’t built a protected environment for new ideas, they will quickly get killed or reduced by the risk reduction initiatives.

The five traits of size, age, structure, customers, and market provide a solid basis from which to determine if your company is risk averse. Suffice it to say, if you’re in a large, established bank, you’re probably in a fairly risk averse environment.

Mick is an independent consultant and thought leader on innovation in financial services. Previously, Mick served as the senior innovation executive for USAA, where he built and led the innovation program to world class status. During his tenure, USAA received numerous awards ... View Full Bio

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Jonathan_Camhi
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Jonathan_Camhi,
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11/30/2014 | 10:10:26 PM
Re: Risk and Size
I hear a lot from smaller banks about trying to differentiate themselves in online and moble banking. I think they're starting to realize that it isn't enough for them to just copy what other banks of different sizes are already doing. They need to do someting different, and are probably more willing to take risks to do that.
Becca L
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Becca L,
User Rank: Author
11/29/2014 | 4:31:24 PM
Re: Risk and Size
Few industries are as risk adverse as banks! I am glad to learn you're noticing the smaller players taking some risk - I suppose their successes are valuable case studies for the bigger players, who can use them to slowly deploy tests in their regions.
KBurger
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KBurger,
User Rank: Author
11/18/2014 | 10:33:11 AM
Re: Risk and Size
This is a great analysis, Rick. But don't you think a lot of the risk aversion related to innovation is also because in the past we have seen terrible consequences because of bad risks taken in the name of innovation? For example, Enron was touted as a true innovator in energy pricing/trading, but what they called innovation was basically greed, scam and inappropriate procedures. Similarly, a lot of the activity around subprime, CDOs, etc. that led to the financial crisis was touted as innovative ways to drive growth. I'm not saying that innovation is bad because it's risky, I'm saying that the conflation of innovation with risk is sometimes understandable & not so much because of company culture but because of an inevitable backlash to disastrous endeavors. So then the challenge becomes, not so much "change your culture" but rather, understand better what innovation is and is not?
MickSimonelli
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MickSimonelli,
User Rank: Author
11/17/2014 | 7:31:25 PM
Re: Risk and Size
I think you're right that the banking industry in general is risk averse. But I do see some credit unions and smaller banks realizing their tenuous positions and being a little more willing to accept risks. Most have a loooong way to go though.
Jonathan_Camhi
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Jonathan_Camhi,
User Rank: Author
11/17/2014 | 4:35:13 PM
Risk and Size
I think it's interesting that you find larger companies are usually more risk averse, Mick. I often find that in banking, the smaller institutions are very risk averse as well. And they have trouble with the resources and talent needed to create the kind of "protected environment" that you mention as a key for innovation to flourish. Do you find that smaller banks are more willing to try new things and think outside the box?
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