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The power of judgment in managing risk

Ari Lehavi, global head of training and certification at Moody’s Analytics, discusses the role of ‘people’ risk within financial institutions.

There have been many explanations for what caused the financial crisis. One factor, however, should feature more prominently in our analysis and guide how we prevent future problems: ‘people’ risk.

Although people may have specific skills and knowledge, there was a broad-based failure of judgment within financial institutions that led to unduly risky behaviour. It is the challenge of risk managers to make sure that people operating in financial markets are well equipped to make the right decisions.

Time and again in surveys and conversations, risk managers rate skills, knowledge and competence as critical in the wake of the financial crisis and identify training to be the most essential structural element needed for improved management and governance of risk.

The benefits are obvious — promoting a risk aware culture, reducing losses and making better risk-return decisions, and ultimately improving competitive position.

In our work with financial and training organisations around the world, we have discovered that most training programs focus on what financial professionals need to know and how it can be delivered most efficiently.

Instead, programs should focus on what skills financial professionals need to improve their risk-sensitive decisions.

They can then hone their focus on a set of competencies that will generate greater impact on their businesses, including:

  • Understanding the context of decisions: How decisions impact their organisation and link to its strategy and mission, and how policies and regulatory obligations impact their decisions. After all, no decision is made in a vacuum.
  • Applying technical skills in real scenarios: How to go beyond theory to ask the right analytical questions, focus on what is most important, analyse and synthesise information, and produce informed recommendations.
  • Understanding the behavioural and ethical dimensions of decisions: How incentive structures influence decisions, the psychology that impacts their own decisions, responsibilities to all constituents (and especially the organisation’s customers), and the obligation to do what is right.

How to limit people risk in your organisation:

  1. Ask the right questions about skills and judgment. What competencies do you emphasise? What should you emphasise? Are the people capable of developing and applying those competencies? How will you evaluate competency levels?
  2. Ask the right questions about your learning programmes. Are they geared toward producing better judgment and more informed risk-sensitive decision making? Do your training objectives address the needs of a modern financial institution? Do they incorporate the perspectives, needs and expectations of your different constituencies?
  3. Diagnose competencies. Determine where you have gaps via both qualitative assessment (surveys, practice-based activities) and quantitative assessment (testing).
  4. Design a program to address gaps in competencies. Prioritise the areas where you observe significant gaps in skills, knowledge or judgment. Keep in mind that you do not need to fix everything.
  5. Routinely assess whether the lessons have been understood and can be realistically applied to deliver results.

This can be done through simulations and practice-based exercises, surveys and assessments.

For example, we worked with a major bank in the Asia-Pacific region to build a simulation-based programme that assessed bankers’ ability to synthesise and interpret risk information from disparate sources. Moving beyond theory and traditional credit skills, the programme focused on the cumulative perspective on risk and its impact on the organisation via a credit decision. Using the simulation as a diagnostic mechanism, the bank identified a gap.

They then developed additional programmes and staff support resources to address this gap, ultimately improving performance.

In response to the financial crisis, we have seen financial organisations around the world update their risk models, software, processes and risk management strategies and policies, and focus more consistently on risk appetite and governance. It is time they address the `people’ piece as well to ensure that people really are equipped to make the right risk decisions.

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For more information, please contact Moody’s Analytics at
[email protected]

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