Risk Appetite & Risk Culture: No Scope at all for Process of Knowledge without Intangible

 

Rating System for Banking and Financial Services Industry:

Not since 1966 when Cost Audit emerged that another idea could have impacted corporate management as SEBI’s Mandatory Grading. Volumes could be written on the contribution of Cost Audit to management efficiency whereas mandatory grading can be best described as for want of a good rating system opportunity,  for sustainability of – efficiency, value system and profits – is frittered away.

Letter to The Chairman, SEBI – Securities and Exchange Board of India for ‘an objective risk rating system’, enjoining to create a rating system of one’s own and eliminate reliance on external ratings.


Letter to SEBI

August 2, 2012

Shri U K Sinha, Chairman
Securities & Exchange Board of India (SEBI)
Plot No.C4-A,’G’ Block,
Bandra Kurla Complex,
Bandra (East),
Mumbai 400051

Dear Sir,

Sub: An Objective Risk Rating System ~ Mandatory Grading

Not since 1966 when Cost Audit emerged that another idea could have impacted corporate management as mandatory grading. Volumes could be written on the contribution of Cost Audit to management efficiency whereas mandatory grading can be best described as for want of a good rating system opportunity for sustainability of – efficiency, value system and profits – is frittered away.

Not since treating zero when found as a number on its own right that intangible is found as a standard to Measure what is measurable, and make measurable what is not so. Mandatory grading consists of 5 criteria – EPS, financial risks, accounting quality, corporate governance and management quality – of Qualitative and Quantitative elements. What is crucial is to bring the abstractions into reality, acknowledge value where value is due, and deconstruct what is valueless. Without intangible there is no scope at all for the process of knowledge of the criteria set for the mandatory grading. Intangible is bound to play the most significant rating system for Corporate Management in future.

IBCM© Research is pleased to submit ‘an objective risk rating system’.

Executive Review

Value system: Critically important to the survival of Corporate World is the value system. However it is the cost system that takes precedence over the value system. Rightly so, considering the longevity of the organisation within the economic system, crucial for the society to survive where profits are the means. Efficiency, value system and profits in that order ensure the survival of the corporates to a sustainable future indefinitely. Profits are the results of efficiency whereas sustainability of profits is dependant on the value system.

Value system is the fulcrum of sustainability of efficiency and sustainability of profits. Profits are maximised when risks are taken, the essence of economics. Society is at risk when the process of profits maximisation is insatiable without boundaries set on risk appetite. Efficiency and Profits are inter-related but emanate from within the corporate walls. Value system emerges from outside the corporate walls overseen by the regulatory bodies on behalf of the society. Regulatory authorities therefore are the links between the society and the corporates.

Cost Audit: Regulatory authorities play a major role interpreting the cost system of the companies and the consequential profits. Corporates resist the thought of being checked on their cost system as pricing is considered the domain of the free enterprise. Yet regulatory bodies over the years have managed to get into the corporate books and had dictated what ought to be the pricing charged to the public. It was in year 1966 government of India enforced successfully cost audit system for essential commodities such as vegetable oils and later extended to many such products. During 1966 cost audit of vegetable oils were quite exhaustive that companies had to submit every fortnight costs for increased pricing of their products. In both the ends corporate as well as government the cost calculations were quite brilliant, one adding cost drivers for many a cost apportionment and government in many cases agreeing for. Commodity exchange market was in vogue that some of the cost drivers for stock loss and stock profits were of great value for the corporates as well as the government. Government was well protected when the first Management Accountant of both the Institutes – Chartered and Cost – was brought in as an under-secretary. It was a pioneering effort and collaboration between corporates and the government at a difficult time for India.

Liberalisation: On 15th August 1947 many farmers wanting to reach Delhi for the celebrations were surprised they were to pay for the bus tickets in an Independent India! Possibly many an entrepreneur thought as much when license-raj was said to have been abandoned while ushering in liberalisation in the year 1991. In 1995 UN World Economic Surveyi rightly predicted for many of the world’s citizens,an era of hardship – and worse suffering seems to lie ahead. 1995 saw a Dutch firm ING, buying up Baring plc for a nominal amount of $1.60, after one single individual Nick Leeson aged 28 brought down the bank with reckless gambling, speculating on the Tokyo Stock Exchange losing $1.3 billion, making the 220 year old bank insolvent. 1998 saw the emergence of accounting standards for Intangible Assets IAS 38 deregulating Balance Sheet opening doors to reckless investment in intangibles that became unmanageable and unaccounted. Nakamura estimated the value of U.S. gross investments in intangibles in 2000 to be at least $1 trillion annually. More recently, Corrado and Hulten (2010) estimate that in 2007, by omitting investments in intangibles, $4.1 trillion was excluded from published national accounts data in the United Statesii. Excluding $4.1 trillion during the economic crisis of 2008 is a telling state of tracking investments in intangibles when CDOs and sub-prime lending of as a lesser amount were highlighted.

The bubble: The impression was created that 2004-2007 were boom years. The Emerging Markets, led by the giants of Brazil, Russia, India, and China (the BRIC countries) had been posting 7 per cent – 10 per cent growth rates for years. By 2006, about 40 percent of all profits of S&P 500 firms was coming from financial institutions. In 2006 Goldman Sachs sold at least 3.1 billion dollars’ worth of toxic CDOs in the first half of the year. So when SEBI the market regulator made grading mandatory for all IPOs in March 2007 and credit rating agencies such as Crisil, ICRA, CARE and Fitch were then supposed to grade issues on a 5-point scale, doubts were raised that it would be a non-starter. Besides, this is a practice, which has perhaps no precedence in the world, and so agencies, which have so far had experience in rating only the debt instruments, would face difficulty rating equities, it was surmised iii.

Mandatory Grading ~ Intangible: The five criteria set for the mandatory grading were:   earnings per share, financial risks, accounting quality, corporate governance and management quality. In a letter to the rating agencies and industry bodies, Sebi chairman M Damodaran:The measure…is being decried in the hope that it would be discontinued. It is Sebi’s intention to press ahead with the introduction of the mandatory grading exerciseiv. In a letter dated 29th April 2007 addressed to the then Chairman of SEBI Mr. Damodaran, yours truly states: four of the five criteria set need the evaluation and measurement of intangibles and offered to assist SEBI and the rating agencies in implementing this process of grading effectively with a Cc: Mr. Ravimohan, MD, CRISIL .

Rating agencies: By late 2006, Goldman had taken things a step further. It didn’t just sell toxic CDOs; it started actively betting against them at the same time it was telling customers that they were high-quality investments. By purchasing credit default swaps from AIG, Goldman could bet against CDOs it didn’t own, and get paid when the CDOs failedv. Rating agencies: two-thirds of the loans were rated AAA, which meant they were rated as safe as government securities. The three rating agencies — Moody’s, S&P, and Fitch — made billions of dollars giving high ratings to risky securities. Moody’s, the largest rating agency, quadrupled its profits between 2000 and 2007vi.

However by the time the next letter was written by this author on 29th September 2010 to the then Chairman of SEBI Shri CB Bhave, the global economy had gone topsy turvy, to the brink of depression and SEBI’s mandatory grading lost its sheen and SEBI a golden opportunity.

Mandatory grading is the crux of the value system. The effort and energy put behind Cost Audit System of 1966 was clearly lacking since mandatory grading was introduced in 2007. In the logical expansion of mandatory grading from IPOs to companies in general SEBI missed a great opportunity having pioneered the idea. SEBI did conceptualise the idea, communicated its intention, formed a team to oversee the grading, formulated the steps to be taken but failed to bring in Quality to the policy document. Quality of mandatory grading system is in the measurement of Qualitative elements. Rating agencies had failed to grasp the subject-object division intrinsic Qualitative and Quantitative elements that mandatory grading system demands.

Way forward:

  1. Create a rating system of one’s own and eliminate reliance on external ratings. IIF Report Findingsvii, under Risk Management Methodologies and Procedures, suggest to reduce reliance on external ratings. SEBI mandatory grading shall be a rating system applicable to all corporates, akin to preparation of a Balance Sheet, within the company.
  2. Rating system shall derive a single rating of 0 to 5, covering the three main areas: efficiency, value system and profitability, by constructing bottom-up building-blocks with identifiable granular data.
  3. The rating shall by public reporting be made available on real-time.

Pleased to give below ‘an objective risk rating system’ that shall satisfy the three criteria set for Corporate Critical Density (CCD), an IBCM© Research study, for Banking and Financial Services Industry. Corporate Critical Density is the rating of sustainability of – efficiency, values and profitability.

India did well with the introduction of Cost Audit in the year 1966. SEBI’s initiative on mandatory grading is no less important that needs to be applied vigorously.

Here is the proposal for ‘an objective risk rating system’ or Banking and Financial Services Industry where Intangible provides the basis of measurement.

What is crucial is to create a rating system of one’s own and eliminate reliance on external ratings.

Jayaraman Rajah Iyer

camp Mumbai, 2nd August 2012

cc to Dr. K Ramakrishnan Chief Executive Indian Banks’ Association

cc to: Mr.V.S.Narayanan , CEO Association of Investment Bankers of India

For to create a rating system of one’s own and eliminate reliance on external ratings.

Objective risk rating system:

1. Synopsis of what ‘an objective risk taking system’ would entail?

  1. Development of an objective risk rating system for Banking and Financial Services Industry (the Industry).
  2. Identification of Qualitative and Quantitative elements that are subject-object division intrinsic where multiplicity of object characteristics are governed by subject, the fulcrum on which the process of knowledge of risk management rests.
  3. Creation of metrics not dependent on a hypothesis but calibrated appropriately to risk management by eliminating reference to multiple models and metrics
  4. Understanding how Nature unties knots the industry has entangled itself, designing remedial actions to address the technical limitations of risk metrics, models, and techniques, facilitating a study of cost consequence before the bubble bursts, an essential ingredient of risk management.
  5. Rating
    • A rating system of one’s own to eliminate reliance on external ratings.
    • Construct bottom-up building-blocks, rating each block to form subject-object division intrinsic – resource ~ process area matrix with a strong granular data.
    • Energy of the whole unit derived by each building-block that is comparable between one and the other within as well as with any building-block outside of the corporate matrix.
    • Rating of efficiency, values and profits derived eliminating insider trading possibilities enabling investors, stakeholders, society and market with information more of content and value, highlighting value deficiency and the resultant being less speculative.
    • Rating incremental value to each building-block as the basis for compensation.
    • Keeps track of BASEL III targets on real-time, beneficial to the industry, regulatory bodies and the investors alike.
    • An integrated Corporate Capability~ Accountability Model of Active ~ Inactive properties of Qualitative ~ Quantitative elements.

The rationale: ‘an objective risk rating system’ is executable:

  1. Risk profile template: Single risk profile template for different types of risks.
  2. Root cause analysis: Whereas object characteristics multiply, conscious subject remains the cause for any added value (or value-deficiency <nay accountability>). The single indivisible unit of energy force, common to every subject, is responsible for objects and variations in object characteristics. All man-made objects and their characteristics are measured by the single energy force – Intangible, the unit of measurement for creative as well as action process.
  3. Causality: The causality of subject-object characteristics runs through a pattern – i. identical during creative process, ending up as a tangible object of quality and ii. during Action process of task accomplishment unique to the respective Quality of the object characteristics. The relationship between cause and effect is clearly evident –by assigning a binary value of – 1 or 0 – for added value or value-deficiency, at each stage of movement during both the processes – intangible is either Active or Inactive. Therefore metrics created has no hypothesis for it is a fact that is experienced as to the presence or absence of energy.
  4. Sustainable Profits: Profits are the resultant task accomplishments, as evident from object characteristics of quantitative elements. Whereas Sustainable Profits are the resultant task accomplishment of qualitative elements – of efficiency and values. Integrating both i.e., Qualitative and Quantitative elements provide the ground for sustainability.
  5. Inference engine: The drivers that drive the inference engine for investors of the Industry need a stronger platform to bring the abstractions into reality, acknowledge value where value is due, and deconstruct what is valueless. Without the conscious subject being measured there is no scope at all for the process of knowledge – of risk appetite and risk culture – of policies and practices.

Thus CCD is the measurement of Policies and Practices with the third P on toe – People, ensuring sustainability of – efficiency, values and profits a rating system of synergy within. People are the purpose of the Industry – 3Ps therefore form the nucleus of the Industry – obtaining the Goldilocks effect for the Industry working in just right dimensions allowing things to go on indefinitely – Intangible holding the 3Pstogether.

2. Golden opportunity that SEBI proposed but rating agencies disposed?

  1. The purpose of ‘an objective risk rating system’ is to offer solution to the multifarious problems of the the Industry.
  2. The ‘an objective risk rating system’ takes note of:
  • The factual and historical data as derived by IIF Report Findingsviii highlighting the current problem the industry faces and their Principles and Recommendations.
  • Mandatory Grading: In order to protect the investors and alleviate many a problem they face, on 21 April 2007 SEBI introduced mandatory grading for all IPOs, which was reported at that time to have had no precedence in the world.
  • Mandatory grading consists of 5 criteria – EPS, financial risks, accounting quality, corporate governance and management quality
  • Four of the five parameters set by mandatory grading belong to ensuring value system companies practice that are rated during IPOs. They belong to the Qualitative elements of the organisation rated.
  • Either by design or indifference the initiative was rendered ineffective by the rating agencies entrusted with the valuation of mandatory grading. When Mr. Damodaran the then Chairman of SEBI stated – “The measure…is being decried in the hope that it would be discontinued. It is Sebi’s intention to press ahead with the introduction of the mandatory grading exercise.”
  • At the same time rating agencies were unenthusiastic, as could be discerned from the press reports – Sebi makes case for IPO gradingix: “However, the regulator has attracted a lot of flak for this. Critics allege that pricing, which is the most critical factor in determining an investor’s decision to invest in an IPO, is kept away from the current system of grading making the whole process a non-starter. Besides, this is a practice, which has perhaps no precedence in the world, and so agencies, which have so far had experience in rating only debt instruments, may face difficulty rating equities.”
  • Cost Audit: In the year 1966 Cost Audit was enforced upon manufacturing companies of essential commodities regulating the prices.
  • It was a success that persuaded the government of India to embrace more number of products under pricing control that is in vogue even today.
  • Cost Audit ~ Mandatory Grading:
  • Cost Audit of companies for pricing control was an elaborate exercise but the tussle between companies bringing analytical data of cost was dealt capably and convincingly by the government of India.
  • Whereas Cost data including the cost on account of price fluctuations due to the then existing forward commodity exchange market in 1966, drivers that dealt with apportionment of costs could be noticeable.
  • What Dr. Robert Kaplan introduced several drivers of cost in 1983 by way of Activity Based Costing was in practice full flow in the year 1966.
  • Whereas in 2007 neither SEBI nor the rating agencies had deliberated more in depth, as it was for Cost Audit in 1966, the concept of intangible that comprised 4/5th of the Mandatory Grading criteria.
  • 4/5th of the criteria belong to the Qualitative elements and are subjective.
  • Opportunity:
  • From the article – The ratings soup – Rating agencies want to diversifyx: “What should be questioned is pricing, not grading,” says Atul Joshi, Managing Director and Chief Executive of Fitch Ratings India. “Should investors pay a premium for an IPO graded as having poor fundamentals?” But data shows that IPO grading is not reliable. “Experience shows little relationship between grades and returns,” says Haldea. While an IPO’s value can only be known in the medium to long term, an IPO grade, as CARE’s Dogra points out, does not have such a long shelf life.
  • Golden opportunity exists to bring a rating system uniform to all companies and make SEBI’s initiative on mandatory grading effective and reliable as Cost Audit was in 1966. Grades shall reflect a single rating for an integrated Qualitative and Quantitative elements, i.e., establish relationship between grades and returns.
  • Grading by intangible is Intangible.

3. What to measure and How to measure?

3.1 What to measure – in the Industry?

IIF Report Findings states:

  • While judgement is always required, and while the dialogue needs both objective and subjective elements, quantification to avoid unnecessary reliance on “gut feeling” also will facilitate the risk management processxi.
  • Under the heading Transparency and Accountability IIF Report examines the need to tone at the top as a necessary element, organization needs of both formal and informal channels to communicate risk information as well as warns of stereotyped stress tests in a mechanical way that create false comfort that “all the boxes have been checked.”
  • It concludes “New Recommendation C: Firms should ensure that relevant personnel have their formal responsibilities for risk clearly elaborated in their job descriptions and are evaluated for their fulfilment of these responsibilities as part of firms’ periodic performance reviews.”

Measure Transparency and Accountability:

Measure Accountability:

A statement of Accountability is an aggregation of Responsibilities – fiscal and ethical.

  • How can there be objects not perceived by the subject? An object is perceived by an act of the subject. In subject-object distinction, an organisation is seen by the objects one had created, everyone of them being transactional.
  • Whereas the subject remains hidden of their acts that however are responsible for creating such objects and their inherent characteristics.
  • ‘Success’ has many Fathers, while ‘Failure’ is an Ophan’, means Accountability is unseen and capability is unmeasurable.
  • Without the conscious subject being measured there is no scope at all for the process of knowledge of Accountability and Capability.

Measure Transparency:

  • Insider trading is inversely proportional to the index of transparency, lower the accountability higher the risks of insider trading.
  • Transparency therefore is a rating for study of cost consequence.
  • What is crucial to measure transparency is to bring the abstractions into reality, acknowledge value where value is due, and deconstruct what is valueless.

Measure Ethical and Fiscal Responsibility

  • Ethical and Fiscal Responsibility enable study of subject-object division intrinsic Qualitative and Quantitative elements of an organisation.
  • Cost consequence of ignoring i. value system of a company and ii. failure to measure accountability for ethical responsibility to the public, is enormous.
  • Define and measure ethical and fiscal responsibility for each set of acts forming a root block of the whole.
  • Measure organisation’s fiscal responsibility to communicate risk information by Public Reporting on real-time, that defines its Accountability of ethical responsibility.
  • Ethical Responsibility is only of the people and Fiscal Responsibility of the organisations including government.

Measure Accountability ~ Capability

  • Opposite value of Accountability is Capability.
  • Capability is the energy force of an organisation. Between one corporate and the other it is the energy force that would determine the capability, basis of comparison for all purposes.
  • In the subject-object distinction, measuring the subject ascertains the capability.
  • Object reveals the capability in tangible form, result of liberated energy force of resources put to use. Object remains an energy force waiting to happen.
  • Such an object is not merely ‘fixed assets’ or ‘liquid assets’ or ‘toxic assets’ but be seen in Policies and Practices as object and object characteristics respectively.
  • Measure Policies and Practices to determine Transparency and derive Accountability.
  • With particular reference to the Industry Risk Appetite and Risk Culture have to be seen in tangible form as Object.
  • An object is perceived by an act of the subject. Subject is the cause of the energy force applied to create the Object. Risk Appetite and Risk Culture have to be seen as an Object.
  • An Object in tangible form in the context of Risk Appetite and Risk Culture is a creative process – resulting in a policy document.
  • A policy document is the basis of Quality for Risk Appetite and Risk Culture – based on which Practices follow, in infinite succession of finite purposes. Subject – Object division and their characteristics behave in a pattern, build blocks accordingly and avoid “all the boxes have been checked.” syndrome.
  • In subject-object causality subject is the fulcrum on which the process of knowledge of risk management rests.

What to measure? – Energy

  • the Industry unlike any other involves the public and vice versa. They are closely interlinked with the policies and practices of the Industry.
  • Policies and Practices of the Industry become part of the Fiscal Responsibility whereas People its Ethical Responsibility.
  • By measuring the 3 Ps – Policies, Practices and People by subject-object distinction between Qualitative and Quantitative elements that are duly measured to create Corporate Critical Density – of the Industry – the energy force of individual organisation as well as the whole industry is arrived at.
  • Like the planetary system’s ‘Goldilocks effect’ – that everything is just right – the 3 Ps of an organisation stimulates towards sustainability of efficiency, sustainability of values and sustainability of profits – in that order – enabling the Industry to allow things to go on indefinitely.
  • Like gravity keeping the planetary system intact it is intangible the energy force that keeps organisations in shape.
  • Therefore the energy force of an organisation is the one to be measured, as the rating of the company assessed. The said energy force is the mass, derived from usage of 3Ps – Policies, Practices and People.

    Prove you have created mass in your organisation, prove it.

    • 3Ps – Policies, Practices as well as People add mass. People do not influence organisational identity but adds to its mass.
    • (E = mc²): E in the equation stands for Energy, m for mass and c² for the speed of light squared. In simplest term, what the equation says is that mass and energy have an equivalence. They are two forms of the same thing: energy is liberated matter: matter is energy waiting to happen. Since c² (speed of light by itself) is a truly enormous number, what the equation is saying is that there is a huge amount – a really huge amount – of energy bound up in every material thingxii.xii.
  • mass added is sustainable.

3.2. How to measure?An objective risk rating system for the Industry

Measuring Value System

  • Ernst & Young survey sponsored by IIF Making Strides In Financial Services Risk Management states” “If you are going to have a risk culture throughout the company, you need the heads of the lines of business to walk the walk and talk the talk”, adding 73% say they are still in the process of shifting the culture, 23% Significantly shifting, 4% no shift.

    E&Y Survey

    E&Y Survey

  • Take another survey 10 years from now, the comments could be no different.    The statement 23% significantly shifting must be supported by performance standards block by building-block of Risk Culture within the industry.
    • Performance standards for Risk Culture on values are Qualitative elements that need a comprehensive plan of action, supported by a Policy statement created.
    • In the year 2001 UNGC United Nations Global Compact had issued 10 Principles by 4 issue areas – Human Rights, Labour Rights, Environmental Rights and Anti-Corruption.
    • Risk culture must form part of UNGC and calibrated for measurement.
    • What is important is to have a common set of Article, sections, sub-sections and clauses so that measuring one and another would become a standard for comparison.
    • How to measure?The statement 23% significantly shifting must be supported by performance standards block by building-block of Risk Culture within the industry.
    • Performance standards for Risk Culture on values are Qualitative elements that need a comprehensive plan of action, supported by a Policy statement created.
    • In the year 2001 UNGC United Nations Global Compact had issued 10 Principles by 4 issue areas – Human Rights, Labour Rights, Environmental Rights and Anti-Corruption.

    Risk culture must form part of UNGC and calibrated for measurement.

    • What is important is to have a common set of Article, sections, sub-sections and clauses so that measuring one and another would become a standard for comparison.

How to measure?

  • Risk culture must be seen in the background of a policy statement.

  • In the above referred E&Y survey, 4% ‘no shift’ indicates that they are yet to conceptualize the idea of risk culture, 73% process of shifting the culture means they are in communication stage, 23% significantly shifting indicates they are in formation stage. Formulation of policies and policy document are yet to emerge for 100%.

  • By measuring the stages from 0 to 5, indicating the process or stages of development towards a policy statement,it is feasible to arrive at rating for the process area of risk culture.

  • Illustratively, E&Y survey as above can be rated and it would give an average rating of 1 in the scale of 0 to 5, indicating the current status of 1 and the distance to cover for optimal rating of 5.

  • Optimal rating in the context of risk culture is to go forward from the current stage 1 which is at the stage of conceptualization towards communication, formation, formulation and come out with a tangible substance called Risk Culture Policy.

  • Risk culture as Industry Policy needs to travel a great distance before measurement of any individual company within the industry. As of now as per the E&Y survey the industry is not ready with the Risk Culture. How to measure? – status and the distance yet to cover – Capability ~ Accountability rating.

Policy is a declaration of Quality

  • Of the 3 Ps only one, that is Risk Culture as a Policy statement is figured by reading the E&Y Survey of Risk Culture preparedness.

  • Risk Culture Policy is at a nascent stage of 1.

  • Stage 1 has no Quality attached to it. It is a state of conceptualisation.

  • Looking at LIBOR scandal with $800 trillion transactions affected by the non-existence of Risk Culture within the Industry, the magnitude of rating for example Barclays at 0 , provides an impact assessment of where Barclays stand at the moment.

  • Similarly looking at the steps initiated by Goldman Sachs despite the tsunami of overwhelming scandals the Risk Culture Policy continues to remain at 0 .

  • When E&Y survey is calibrated for Rating of Risk Culture by individual Banks and Finance Services companies, then rating could be obtained for each as well as an average for the Industry.

  • Rating is arrived for the industry as a simple average. If company A is 3 and Company B 2 the average is an integer on account of completed stage will be 2. 2 is in stage of communication i.e., an idea of Risk Culture is communicated for further action short by several steps before a policy statement is created.

Practices need Policy

  • Causality: The causality of subject-object characteristics runs through a pattern – i. identical during creative process, ending up as a tangible object of quality and ii. during Action process of task accomplishment unique to the respective Quality of the object characteristics.

  • Whereas Policy is a statement of Quality, Practices are unique action process to the respective Policy.

  • Managerial Emphasis: Risk Appetite has managerial emphasis, limited to a few, such as creating toxic assets or CDOs or taking a Policy decision actively betting against the CDOs at the same time telling customers that they were high-quality investments.

  • Whereas Risk Culture has operational force emphasis.

  • For examplexiii: On LIBOR – The FSA report details numerous messages sent between Barclays traders and the bank’s “submitters” – whose role was to send accurate information about interest rates to the British Banking Association. The submitters are not supposed to be influenced by traders.
  • External trader to a Barclays trader, asking for a lower Libor submission: “If it comes in unchanged I’m a dead man.”
  • Barclays’ trader promises to “have a chat”
  • External trader to Barclays’ trader later that day: “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger.”
  • Risk Appetite as well as Risk Culture need to be rated for Policy and Practices.

People the energy force

  • People do not influence organisational identity but adds to its mass.
  • Qualitative and Quantitative elements are subject-object division intrinsic where multiplicity of object characteristics are governed by subject, the fulcrum on which the process of knowledge of risk management rests.

  • Policies and Practices do not interact with each other in isolation.

  • Policies are packed into a nucleus of an organisational atom with People, whereas Practices spin around outside of the nucleus.

  • People is a wide spectrum of Ethical Responsibility – Regulatory authorities, stakeholders, Society, Human Rights, Labour Rights, Environmental Rights, Anti-corruption, Compliance to accounting quality, Management Quality, Corporate Governance etc.

How to measure – Of What to measure?

  • Please see per Appendix 1 (not attached, you may call for it) a proposal submitted dated 28 May 2012 to RBI for creating ‘an objective risk rating system’, that addresses ‘how to measure?” of “What to measure?” for the industry.

4. The Rationale

Four criteria:

  1. Real-time Monitoring:

  • Intangible is the energy force that is either present or absent. The status of an organisation is as of ‘now’. Risk Appetite or Risk Culture is presented as on today.

  1. Study of Cost Consequence

  • Preventive measures are fundamental to risk management. Before the bubble bursts Intangible provides the basis of study of cost consequence. Intangible being a single energy force and cause for the subject to act, study of cost consequence is enabled by systematically measuring the steps taken on policies and practices.

  1. People Participation.

    • When Transparency and Accountability are measured and are reported on real-time monitoring, investors would find valuable companies emerging that were never heard of before.
  1. Public Reporting

  • Value based statement of Accountability and Capability raise the bar on public reporting of ‘confidential’ information of a company, an assurance of decisions on Quality Risk Appetite without resorting to creation of toxic assets.

5. Recommendation

  1. SEBI’s initiative of Mandatory Grading should be pursued to its logical end as achieved by Cost Audit initiatives of 60’s. It should be made mandatory by extending to all companies to declare their grading online by public reporting not merely during IPO issues.
  2. Of the Mandatory grading that consists of 5 criteria – EPS, financial risks, accounting quality, corporate governance and management quality – EPS is derived from financial data whereas for the rest quality granular data should be made available by each company in-house, as per How to measure? criteria set herein.
  3. Rating agencies: When ISO 9000 was introduced all the rating agencies were selected from certifying agencies of Shipping construction who had a good experience. With in-house granular data recommended for mandatory grading external auditors could be the natural certifying agencies as an extension of their current responsibilities. Current rating agencies themselves need to be certified by their external auditors for mandatory grading.

6. Conclusion

Collapse of world economy has direct link to the capability of rating the Qualitative elements of corporate governance. Volumes can be written on the pitfalls and problems World Economy faced leading up to financial crisis 2008.

  • Professional standards
  • In 2007, AIG’s auditors raised warnings. One of them, Joseph St. Denis, resigned in protest after Cassano repeatedly blocked him from investigating AIGFP’s accounting. During US House Oversight Committee, Henry Waxman, Chairman pinpoints to AIG: Let me tell you one person that didn’t get a bonus while everybody else was getting bonuses: – that was St. Denis, Mr. St. Denis, who tried to alert the two of you to the fact that you were running into big problems. He quit in frustration, and he didn’t get a bonus. xiv.
  • The three rating agencies — Moody’s, S&P, and Fitch — made billions of dollars giving high ratings to risky securities. Moody’s, the largest rating agency, quadrupled its profits between 2000 and 2007xv.
    Had US implemented Cost Audit in 60’s as India did, today US could have avoided what Andrew Sheng, Chief Advisor, China Banking Regulatory Commission commented: They were having massive private gains at public loss.
  • In the nucleus of subject-object intrinsic risks management, the Industry as it stands today is object oriented.
  • Divergence of object characteristics results in, as IIF Report findings state: ‘Reference to multiple models and metrics’, too much reliance on specific metrics, unavailability of granular data, lack of tested methodologies, and a generalized scepticism regarding potentially overcomplicated metrics etc.
  • Control systems would be a far cry as a finger in the Dyke plugging the holes scenario of object characteristics oriented management, nay, impossible!
  • Whereas what is needed for the Industry is the convergence to subject oriented measurement of qualitative elements. Subject remains and will remain one and the only resource of all man-made objects – people.
  • Value system is subtler than the subtle of ethics that needs to be identified by each act of subject. Without the conscious subject being measured there is no scope at all for the process of knowledge.
  • Basic difference between India and advanced economies is the focus on subject-object distinction of governance where India excels in analysis of Qualitative elements whereas the advanced economies on Quantitative elements.
  • Intangible has never been defined anywhere except from India.
  • Measuring value system by Intangible opens up a window to look at the qualitative elements that are the cause of all acts of management.
  • Intangible based measurement system opens up many doors for corporates like treating zero when found as a number on its own right measuring what is measurable and making measurable what is not so.
  • What is crucial for corporates is to measure sustainability of profits evident by Accountability ~ Capability analysis that Intangible offers.Banking in particular and Merchant Bankers have to be pro-active on BASEL III targets, for a few years to come. With intangible there is scope for the process of knowledge on sustainability.
  • In Object oriented management Qualitative elements are being superimposed by Quantitative characteristics sans Quality. It is the other way in subject oriented management.
  • With the advent of Intangible which is a fact of experience and not a hypothesis, measure what is measurable and make measurable what is not so.
  • We can’t solve problems by using the same kind of thinking we used when we created them. ~ Albert Einstein

IBCM © Research

i E/1995/50/ ST/ESA/243: Department for Economic and Social Information and Policy Analysis: World Economic and Social Survey, 1995: United Nations, New York. Preface – Boutros Boutros-Ghali, Secretary General

iiPage 3 Emerging Measures for Strategic Management http://bit.ly/oe97Ta

iii Economic Times: Sebi makes case for IPO grading: http://articles.economictimes.indiatimes.com/2007-04 21/news/28409706_1_rating-agencies-sebi-chairman-m-damodaran-ipos

iv ibid

v Inside Job:01:50:19.27

vi ibid

vii IIFReport_ReformFinancialServicesIndustry_1209 p AIII.18: Transparency and Accountability: Reform in the financial services industry: Strengthening Practices for a More Stable System The Report of the IIF Steering Committee on Implementation (SCI) Institute of International Finance

viii IIFReport_ReformFinancialServicesIndustry_1209 p AIII.18: Transparency and Accountability: Reform in the financial services industry: Strengthening Practices for a More Stable System The Report of the IIF Steering Committee on Implementation (SCI) Institute of International Finance
ix Sebi makes case for IPO grading: http://articles.economictimes.indiatimes.com/2007-04-21/news/28409706_1_rating-agencies-sebi-chairman-m-damodaran-ipos

x Business Today: The ratings soup – Rating agencies want to diversify: Rajiv Bhuva: Edition: October 16, 2011 http://businesstoday.intoday.in/story/rating-agencies-industry-in-india/1/18964.html

xi IIFReport_ReformFinancialServicesIndustry_1209 p AIII.18: Transparency and Accountability: Reform in the financial services industry: Strengthening Practices for a More Stable System The Report of the IIF Steering Committee on Implementation (SCI) Institute of International Finance

xii A Short History of Nearly Everything – Bill Bryson Illustrated – Transworld Publishers.

xiii Barclays trader talk: ‘I’m opening a bottle of Bollinger’ http://www.guardian.co.uk/business/2012/jun/27/barclays-libor-trader-talk

xiv Inside Job – 01:39:48.05

xv Ibid – 01:55:09.04

 

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