What a doozy of a global environment we live in. A highly leveraged society is now being asked to lever up again so that we can maintain perpetual growth. Perpetual growth is something that is unobservable in the natural world/universe – just something for you to consider.
Low (and negative) interest rate environments are supposed to stimulate growth through encouraging new or additional leverage. Nothing necessarily wrong with that (unless you’re a fixed income investor) but it does introduce a new spectrum of risk. That risk is exacerbated by the fact that developed, and developing, societies are currently burdened with a surfeit of debt.
Banks have long been required to have certain risk management protocols in place because of the highly-leveraged nature of their activities. These are referred to as Basel I, II & III (we get a new one after every major crisis to try and avoid a repeat). The current set (Basel III) introduces many features that would be well adopted by non-banking businesses, especially if their leverage increases in these days of cheap money. Companies with any amount of leverage should introduce internal capital adequacy, funding & liquidity and market risk metrics to identify, measure and manage risks related to their various exposures. Obviously, this should be on top of (i.e. incorporated into) their existing ERM framework that addresses their specific risk appetite, business strategy, industry exposure and operational issues.
These are some complex risk exposures that may not seem significant to your business in terms of probability of occurring or relevant to your industry. However, the consequences make it a worthwhile proposition (see footnote). With the right tools, you can even enhance your strategic management and decision making, gaining a new awareness of your business.
Morpho Advisory can help your business implement risk identification, measurement and management processes for your capital, market, liquidity & funding risks.
Footnote: In the picture above, imagine that P = debt, F = equity, and W = your business. Everything is working well until something causes the energy behind the force of debt to reduce or stop, resulting in a swing back the other way. Result: Your business crashes to the ground destroying your equity. Quantify your exposure to these external forces and develop processes to identify, measure and manage these risks!