Key lesson from a top 5 "thoroughbred" bank

ERM should always consist of three key components: (a) Strategic risk management (risk taking); (b) Risk reduction management; and (c) the analysis of key risk indicators, which help you modify (a) and (b) as necessary. Sometimes in "enterprise risk management" we forget the "risk taking" side of the equation. 

There are not enough hours in the day to share the great experiences I encountered working for a bank that has proven year after year to be one of the 5 most profitable privately held banks in the nation. One strategy that stands above all the rest is the concept of consistently requiring the taking of managed risk. From their tutelage, I would like to share with you one key concept. I call it the "thoroughbred theory".

I grew up learning to ride horses on Shetlands, then the slow horse, then the old horse, until I eased into a horse that might actually get into a gallop if you were on your way back to the barn. I would be dangerous on a big fast horse. 

My best friend at the time, whose dad trained horses, did the opposite. He went big. He put his son on horses that were wild and crazy from day one. Granted this was risky, but my friend only raised the bar from there. He eventually became a successful professional thoroughbred jockey.

The Slow Horse

Some of you are like me. Because you have grown up in an environment where 5, 10 or 15% returns on equity (i.e. a slow horse) have been the norm year after year, you can't imagine yourself in any other situation. In fact, if you were to push it (return expectations that is) you would probably be dangerous.

Train Them to Ride a Big, Fast One

It seems risky and dangerous, but you have to start setting higher expectations for your team. You need to require return expectations that might even seem unhealthy at first if you want to get to somewhere eventually that you have never been. Train the team through these expectations that you expect them someday soon to be riding a bigger and faster horse. What does this mean for you? You guessed it. It means a lot more work and supervision. It means you might have to set the example and show them a thing or two about how to handle that portfolio.

Set a Return Threshold

Make it simple. Most banks don't set return thresholds at all. I can tell you, however, this simple exercise is part of the secret sauce. Require a minimum return on every investment whether it is investing, lending or an operational investment. 

This might seem like a crazy time to start demanding returns. Personally, I think it is the perfect time. This is the kind of market that will start to soften and degrade the portfolio as banks start to fight over transactions. We see it already. Some banks have already began slashing margins and credit requirements to stay afloat. 

Increase your return expectations (without changing your conservative lending policies), and your team and the transactions you start to see will rise to the equation. 

What are some of the strategies you employ to ensure your organization takes the appropriate level of growth oriented risk?