At the heart of many branches of ancient Chinese science and philosophy is ‘yin-yang,’ a concept that describes how seemingly opposing forces are interconnected and interdependent. It is also a primary guideline of traditional Chinese medicine, and a central principle of different forms of Chinese martial arts and exercise, ‘such as baguazhang, taijiquan, and qigong,’ informs Wikipedia. “Many natural dualities – e.g. dark and light, female and male, low and high – are viewed in Chinese thought as manifestations of yin and yang.”
Inspired by this philosophy is ‘ The yin yang of financial disruption ,’ a recent report from IBM Institute for Business Value (www.ibm.com/iibv), which lays down seven ‘maxims for forging a path to financial stability and healthy financial innovation.’
For starters, the Institute describes ‘financial stability’ as ‘the strength to withstand extreme volatility and contagion risk (the tendency for financial shocks to propagate, e.g., from country to country, or from asset class to asset class) and avoid crisis.’ And the other key phrase, ‘healthy financial innovation,’ means ‘the creation and popularisation of new products, services, business and revenue models, technologies and relationships that have a positive and sustainable impact on the real economy (consumers, firms, industries, markets and, ultimately, GDP).’
To know more about the study, Business Line spoke to Suzanne Duncan, the lead author of the report, and Financial Markets Industry Leader, IBM Institute for Business Value, Cambridge, US.
Excerpts from the interview, conducted over the phone and then through email.
Moving beyond the days of financial crisis management, what do you see as the top concern of the CEOs and governance teams currently?
The last question we asked in each of the 185 interviews we conducted was “What keeps you awake at night?” Aside from the personal responses we heard such as “my teenage child,” 80 per cent of executives stated “business model uncertainty.” Executives do not know which business models will work in the future.
Firms currently suffer from what we’re calling an identity crisis. Although this may sound like a negative phenomenon, it isn’t. When times are good the industry tends to have a ‘herding’ mentality – herding together into the same products, herding over to India and China for growth – you get the picture.
However, we are encouraged to see that instead of following one another, each individual firm is thinking through for itself – “who do we want to be when we grow up – what do we want to be really good at and go after?” So this tells us that executives are focused on business model forms of innovation – and this, we believe, is a very good thing.
Your study speaks of balance between financial stability and healthy financial innovation. What can be the indicators of imbalance that organisations should be watchful about?
The most surprising finding from our 18-month research study has to do with what the governments described as their goal – which is to balance stability with innovation. The officials we spoke with spent as much time emphasising the importance of innovation as they did stability – this was both surprising and encouraging.
One government official described this ‘yin yang’ tension of stability and innovation with an interesting example: “Picture a trader running down a long hall within a bank. This trader is running towards a light of innovation at the end of the hall.” He went on to say: “This innovation may end up being beneficial and adding to GDP growth and job creation. Our goal is not to limit innovation, but rather to line the walls with enough cushion so that the trader can bounce on and off the walls all he likes without severely damaging himself, the firm, or the entire worldwide economy.”
It is the responsibility of both governments and firms to co-create a set of indicators for risks that are knowable unknowns and be prepared for the risks that are unknown unknowns. These indicators must be based on not only firm-specific data - but importantly – aggregated system-wide data.
Can you briefly explain the seven maxims?
We created seven principles that executives and government officials can use within the context of decision making. They are as follows:
• Define a shared frame of reference and use aligned measures among market participants to form the basis of design for market stability and healthy innovation.
• Balance incentives between “returns to society” and “returns to shareholders.” After all, people, firms and governments do what they are encouraged to do.
• Collaborate to innovate. Leaders must internalise that progress in this new era is not a zero-sum game: only by collaborating to grow and innovate does the “whole” become stronger.
• Develop transparency, systemic intelligence and proactive management at multiple levels across the system, because they are all essential to improve risk management, informed decision making and agile responses.
• Use new leadership approaches, because leaders must have the mindset, the insight and the means to move beyond today’s “herd mentality,” along with a commitment to clients’ and citizens’ interests and a sense of shared stewardship to chart a different course.
• Rationalise regulation and supervision in recognition of the global nature of the financial system, to allow for cohesive, streamlined, and relevant oversight of the system.
• Employ flexible models that enable innovation and progress towards orderly and transparent processing of distressed assets, crisis resolution, consumer protection and insurance to instil confidence.
We believe that adopting these maxims is the key to balancing stability with innovation.
To what extent can the monitoring of adherence to the seven maxims be automated, or built into systems and processes?
To a large extent. However, we find that most organisations use the maxims sporadically. As one executive stated: “We employ these principles typically once a year – at our annual strategy meeting, but they must really be used on a daily basis.” Based on a series of case studies we’ve conducted, we found that the leading organisations institutionalise each of the maxims and embed the principles into the culture as well as the supporting processes and technology.
Do you find that your research debunks some of the established notions, in the world of finance?
Yes. Over the past six years we have asked the same question on an annual basis: “Which business models are those most likely to succeed?” Each year, over three quarters of executives selected the universal banking business model. However, based on comparing universal models to more specialised models, we found that it is the more specialised models that have delivered anywhere between 3-5 per cent higher in terms of average annual net operating margin and 5 per cent higher in terms of ROE.
This isn’t to say that the universal model can’t succeed – it can succeed if firms simplify the inherent complexity within the models and try not to be ‘all things to all people.’ This is particularly important given that clients ranked “one-stop-shop” on the bottom of their wish list.
Ranked as top priorities are “superior client service excellence,” “unbiased high quality advice” and “convenience”. We found that complexity is getting in the way of delivering on these attributes that are of the utmost importance to clients.
Is finance getting due attention of researchers? Your observations on the gaps .
Yes, but there seems to be a bit of ‘research crowding’ into themes such as stability and risk. The largest gap that we see is in the area of innovation. This gets back to the ‘yin yang’ tension of stability and innovation. One of the research topics we’re considering for next year would fill this research gap by focusing on themes such as innovation as it relates to the financial system and business models.
