LECTURE 5

Strategic & Reputational Risks

• Strategic Risk
o Description
o Select Drivers: Technology
• Reputational Risk
o Importance
o Big Data & Data Analytics
• CASE STUDY: International Business Expansion

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Strategic Risk
DEFINITION (recall from Lecture 2): Strategic risk - arises when a business
does not operate according to the business model or plan. A company's
strategy becomes less effective over time and it struggles to reach its
defined goals.
Organisations take a portfolio approach to strategic decision making by
looking across all of a firm’s businesses to determine how to create the
most value, given the broader market environment. In order to develop a
corporate strategy, firms must look at how the various business they own
fit together, how they impact each other, and how the parent company is
structured in order to optimize human capital, processes, and governance.
Strategic risk can take a broader meaning in the context of a particular
business activity of strategic importance, such as the risk of losses on
large investments or acquisitions.
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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Focus on the risk opportunity and execution of company strategy.

Be mindful that all opportunities involve some risk. A key reason is that
risk-free arbitrage does not last long in any market, as the market
participants adjust their own strategies and actions, mimicking or
counteracting any superior strategy a firm may have.

Consequently, strategic risks are not inherently undesirable.

Achieving higher returns often involves taking more strategic risk. What’s
needed is effective identification and management of this risk in order to
capture the higher returns.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Approach:
• First, define the strategy optimal for the firm
o Understand the market: customers, suppliers, competitors,
geographies, products, etc.
o Understand own competitive advantages
o Devise a comprehensive plan, including creating the right
incentives at all levels of organization – to maximize profits and
minimize various risks
• Then, execute the strategy in the right way
o Ensure the right people are in the right roles
o Ensure the people are incentivised, enabled and properly equipped
to execute the strategy
• Continuously evaluate and calibrate the strategy and its execution, and
reassess the risks involved

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Evaluation of strategic risks is iterative:
• design
• implementation
• calibration
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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Select Strategic Risk Drivers: Technology

Cloud Storage & Computing

One important driver of strategic risks, especially for banks, hedge funds
and other financial institutions, is cloud storage & computing (“CSC”).

CSC provides relatively cheap and efficient access to information storage

and applications (including high-power computing applications) for smaller
firms, for whom such access would have been cost-prohibitive in the past.

It enables smaller and younger firms to better compete with the

entrenched and/or larger firms, factoring into strategic plans and risks of
all firms.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
The importance of incorporating new technologies into financial firms is
reflected in the increasing percentage of their IT spend on such tech. For
example, consider banks in Europe and North America:

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Beyond pure $ spend, new technologies are changing how many banks
and investment funds do business!

Examples are plentiful as they are significant:

• Many bonds and stocks are increasingly traded via online platforms
(rather than through dedicated Sales people).
o Some of these platforms have been designed and implemented by
banks.
• Some banks, such as Goldman Sacks, have pioneered the
incorporation of new tech into their trading platforms for various
securities, and even for investment banking processes (financial
statement analysis, modelling, due diligence) that were traditionally
done manually.
• Artificial Intelligence (AI) is now used to review contracts.
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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
FinTech & RegTech
DEFINITION FinTech: use of technology to deliver financial solutions.
From a firm’s perspective, FinTech can be an opportunity to provide a
more tech-based financial solution and potentially attract a larger
customer base.
It could also be a strategic risk, a source of external competition that
needs to be incorporated into the firm’s strategy.

Blockchain
DEFINITION Blockchain: a list of records (“blocks”) linked using
cryptography.
Blockchain permits creating records in a verifiable way that’s resistant to
tempering/modification. It’s usually open and decentralized

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Blockchain uses include:
a. Cryptocurrencies (eg, bitcoin)
b. Smart contracts: can be fully or partially executed without human
interaction
• Growing applications include Trade Finance

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
c. Financial services: for faster, more streamlined and efficient
transaction execution and record keeping.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
d. Supply chain management

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
RegTech
DEFINITION: RegTech is use of information technology for regulatory
monitoring, reporting, and compliance

Pre-2008, focus was mostly on the use of quantitative internal risk

management systems for regulatory purposes.

Now, used more for more thorough and efficient KYC (“Know Your Client”)
checks and due diligence

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
One Way of Visualising Strategic Risk:

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
GOVERNANCE is about establishing an orderly system. It is the process of
determining goals, creating tactics, controlling variables, and monitoring
results. Good governance helps organisations to properly align
behavioural incentives and to make better decisions and lessen judgment
errors.

Governance also helps to clarify management’s expectations. These are

expressed both directly using policies and procedures and indirectly (with
less explicitly defined norms, often called “company culture”).

Most Governance risks occur due to inadequate formation of the strategic

plan. These problems occur less in firms where the goals and the rules are
clear, and everyone knows what is required and expected of them to
achieve the specified objectives.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
OPERATIONAL RISKS often result from poor technology (including
information technology), insufficient training, lack of management focus on
quality, or insufficient resources or checks & procedures in the company.
Systemic inefficiency is a key cause of operational risk.

Regular and thorough evaluations of inefficient processes can help the firm
identify areas of waste, loss, manual errors and fraud.

Solid training also helps keep employee skills current and efficient. It also
reinforces the mental focus on following the rules and industry best
practices, and on everyone’s responsibility to reduce operational risk.

COMPETITIVE RISKS focus on the market the firm is in. These risks vary
by industry and type of firm.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
For example, a manufacturer or retailer may focus on changes in
purchasing decisions, overall market changes, and customer cycle and
attrition rates. In contrast, a universal bank may focus on competitors’
deposit rates and ‘upsell’ products (such as investment products and
insurance) for its commercial banking division, and on technology and
product emphasis for its investment banking division.
A competitive plan is important to identify the current landscape, industry,
economic changes, and customer needs. It is equally crucial, however, to
view the competitive plan from a big-picture context, looking at the
potential vulnerabilities to long-range growth, regulation and macro
trends.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
FINANCIAL RISKS involve revenue generation and cost control. While the
accounting or internal finance team is responsible for managing most of
these types of risk, financial vulnerabilities can occur at every department
level.
Select focal points include:
• Evaluating the financial impact of strategic objectives, growth plans,
cost reductions, organisational structure, hiring, etc.;
• Comparing corporate achievements and outcomes to competitors in
the industry;
• Examining internal processes from an efficiency and profitability
perspective;
• Continuously focusing on increasing revenues and cutting costs; and
• Ensuring that compensation and other incentives are properly tied to
financial outcomes for the firm and its shareholders.
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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
REPUTATIONAL RISKS include public and customer perception, as well as
employee engagement.
Management’s focus on reputational risks, along with a proactive strategy
and company culture aimed at minimising them, are critical.
Properly aligned incentives, free communication (including protections for
whistle blowers), and a firm-wide focus on maintaining a great reputation
go a long way.
The firm’s online / social media strategy are becoming increasingly
important.

Reputational risks are truly critical – on all levels of the organisation down
to each individual, and thus warrant a further look.
Most business transactions are ultimately based on trust.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Enforcement through the courts or arbitration has uncertainty and risks of
its own, so trust at contract formation and signing is paramount.
Even money itself derives its value ultimately from people’s trust that
money has value.
Reputation risk is now one of the biggest risk concerns, due in part to
social media, which enables instantaneous global communications that
make it harder for companies to control how they are perceived in the
marketplace.
Consequences can be dire: loss of customers / market share, decrease in
the economic value of the firm, substantial fines, etc.
Good firm culture and impactful employee training are both very important
for reducing reputational risk.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Impact of Big Data and Data Analytics
Big Data and Data Analytics can be useful to manage both Strategic Risk
and Reputational Risk, by helping companies process the vast information
available both internally and on the internet (including social media).
Processes include monitoring news about the firm itself and its
competitors, as well as customer demands.
Challenges include: quickly and efficiently sifting through the data,
determining the most important factors and risks/risk indicators, and then
appraising the data
It’s also important to continuously update the strategic risk profile and how
big data and data analytics are used to inform it.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Challenges
There are challenges at all stages of strategic risk evaluation. Being
mindful of these challenges will help you have a more optimal strategic risk
framework that should ultimately benefit all company stakeholders.

Design stage
• Agreeing the scope of strategic risks to incorporate into the firm’s
strategic risk framework.
o There’s a tradeoff between (a) including more factor to optimize in
order to have a more comprehensive assessment framework and
(b) marginal utility of each additional factor.
• Balancing short term vs. long term interests.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
 o Some parameters, such as meeting quarterly profit targets (eg, for
a publicly listed company) might be more important in the short
term.
o Other parameters, such as expanding market share and enhancing
the firm’s brand and reputation with customers, suppliers and
employees would be more important in the long term.
• Balancing the interests of the various internal and external
stakeholders.
o Internally, there is often a conflict of interest among a number of
top managers, each of whom may be incentivised to maximise the
success of their own group rather than the entire firm.
▪ In banks, investment funds and asset managers, there’s also a
conflict of interest between Credit Risk functions (who focus on

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
 minimising losses) and Trading / Investment teams (who focus
on maximising profits).
o Corporate governance must be considered especially carefully in
such situations, in order to maximise the health and profitability of
the company, including in the medium to long run.

Implementation stage
• It’s important that the employees implementing the firm’s strategic risk
framework are qualified, properly enabled (with authority and
resources) and incentivised.
• There should also be an appropriate process (“governance”) in place
for all participants to follow.

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
Calibration stage
• Again, good governance is key.
o Management should allocate sufficient resources for evaluation
and calibration of strategic risks.
o Open and frank communication should be encouraged. This would
allow any problems to be identified and dealt with early, before they
grow into bigger problems that might be too difficult to correct.
o This process could be viewed as a feedback loop:

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)
CASE STUDY

Expansion of Existing International Business by a Major UK Bank

You’re the CEO of a major UK-based bank.

Facing squeezed profit margins, low interest rate environment, volatile
GBP, increasing regulatory costs and Brexit uncertainty, you’re
considering expanding the bank’s existing international business.

Discuss the principal strategic and reputational risks, and propose how to
address them. Include fintech applications (where appropriate).

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7SSMM814 Business Risk Analytics, Lecture 5 (Gary Vinokur, Gary.Vinokur@kcl.ac.uk, King’s College)