Strategic Risk Management – The Beanstalk Syndrome

Abstract

Growth can be good – but can also be dangerous! When firms grow with superior products and services, then directors, executives, staff, shareholders, customers, suppliers and the general economy benefit. But delivering on a 'growth strategy' is notoriously difficult, as such a strategy often involves committing all of the firm's resources to achieve growth targets. If such a strategy succeeds, riches can follow but, if not, the outcome can be catastrophic.

This paper looks at several examples of large financial institutions that adopted some form of aggressive growth strategy only to have it blow up when the Global Financial Crisis (GFC) hit. All of the banks considered in this paper had adopted strategies that were built on significantly growing their balance sheets but they failed to manage the risks inherent in these strategies, in particular the need to manage their leverage and their liquidity. Their Boards and management were, this paper argues, bedazzled by a type of 'Beanstalk Syndrome', where they believed they could, like the mythical Jack, plant some 'magic beans' that would somehow grow into a constant supply of profits. Prudence was abandoned as each firm discovered a 'golden goose' that could seemingly produce profits forever. Unlike Jack, however, the beanstalk came crashing down, killing not the giant but the bank itself.

This paper argues that these cases illustrate a lack of proper Strategic Risk Management (SRM), or the proactive management of the risks to corporate strategies. It further argues that regulators have a responsibility to ensure that Boards of Systemically Important Banks (SIBs) that adopt risky strategies, put in place the necessary risk management policies to ensure that taxpayers do not have to bail the companies out if/when the strategies fail.

Keywords: Strategic Risk, Corporate Governance, Behavioural Finance, Growth Strategy, Bank of Scotland, Anglo Irish Bank, Lehman, Northern Rock, Royal Bank of Scotland, Washington Mutual

JEL Classification: G18, G28