Risk management: In boardrooms, understanding risk and building resilience are more critical than ever. The classic ‘known known’ risks and their underlying assumptions, once validated and accepted as facts, are not static. They can change swiftly, necessitating constant attention, identification, and careful monitoring. These known knowns might morph into unexpected challenges, compelling board members and CXOs to adapt quickly. For instance, economic shifts, regulatory changes, or geopolitical events can transform the business environment, turning once-reliable facts into volatile variables.
Known unknowns and unknown unknowns present Indian boards with distinct challenges. Known unknowns can encompass factors such as regulatory changes that boards know they do not fully comprehend, such as evolving data privacy laws or complex tax codes. For example, the Indian automotive sector has faced known unknowns with frequent changes in emission standards and taxation policies, requiring boards to anticipate and adapt to shifting regulations.
READ | SMEs cry foul over delayed payments, demand stricter laws
Risk management by companies
Risks arising from climate-related changes, recognised as a known unknown risk, provide an interesting case in point. Climate risk is a fundamental factor influencing the loan appraisal process in financial entities, a consideration since the inception of the loan business. For instance, in flood or drought-prone areas, the method of loan sanction intrinsically considers climate risk while determining credit risk. This is a typical case of “selective amnesia” by boards, refusing to recognise this risk for long periods. Terming a ‘gray rhino risk as a ‘black swan’ risk may survive regulatory scrutiny but would be self-deceptive for a board pursuing self-resilience.
Unknown unknowns are the enigmatic and treacherous surprises we are unaware of not knowing. These silent threats follow Murphy’s Law, waiting to strike when least expected. These unforeseen challenges often go unnoticed until it is too late, typically shared through lessons learned for future risk consideration. Assumptions are paramount in such cases, as boards must visualise, assess, and resolve them to ensure that conclusions and policy-making do not descend into chaos when these unknowns eventually materialise.
Unknown Unknowns are unforeseen surprises, like sudden geopolitical tensions or emerging global health crises such as COVID-19. These are often entirely unexpected and can catch boards off guard. A prime example is the disruption caused to Indian textile industries during the global financial crisis of 2008, which led to plummeting demand and loss of revenue, highlighting the vulnerability of businesses to unforeseeable external shocks. Provisions are not expenditures; these are reserves kept for unforeseen contingencies.
Based on institution-specific analysis of the history of such unknown unknowns and the financial strains they inflicted on institutions, “reserves for unknown unknowns” could be an addendum that smart boards start considering. Boards must contend with both types of risks: the known unknowns through proactive anticipation and the unknown unknowns through heightened resilience and adaptive strategies.
Moreover, the enigmatic Unknown Knowns, which could have been identified as Known Knowns in the planning stages but eluded detection due to poor communication or disorganised work scheduling, often emerge as unpleasant surprises. These oversights can result in costly embarrassments, highlighting the need for meticulous planning and communication within the organisation.
Indian boards have recently grappled with an array of diverse and complex risks. A notable challenge has been the economic fallout caused by the global COVID-19 pandemic, which led to supply chain disruptions, demand fluctuations, and financial instability across various industries. For instance, Indian pharmaceutical boards had to navigate increased demand for pharmaceuticals while facing challenges in procuring essential raw materials.
Additionally, regulatory changes and geopolitical tensions have introduced uncertainty, making it challenging for boards in sectors such as information technology and e-commerce to anticipate and adapt to evolving global trade dynamics. Cybersecurity threats have also loomed large, with a surge in data breaches affecting boards across industries, underscoring the need for heightened vigilance in safeguarding sensitive information.
In response to these multifaceted risks, Indian boards can take several strategic actions. Firstly, they must fortify their risk management frameworks, ensuring a robust understanding of both Known Unknowns and Unknown Unknowns. This involves proactive scenario planning, stress testing, and enhanced communication channels. Moreover, fostering a culture of risk awareness throughout the organisation is essential, encouraging employees at all levels to report potential vulnerabilities and irregularities.
Boards must explore the benefits of investing in advanced technologies and data analytics to enhance their risk assessment capabilities, allowing them to stay ahead in an ever-changing environment. Ultimately, by embracing these measures, Indian boards can better position their organisations to not only endure but thrive amidst the challenges presented by the complex and unpredictable risk landscape. Planning for “Known Unknowns” is necessary, but detecting the “Unknown Unknowns” will be the winners’ trait.
(Dr Rabi N. Mishra is a Senior BFSI Sector Governance & Surveillance Specialist.)
Srinath Sridharan is a strategic counsel with 25 years experience with leading corporates across diverse sectors including automobiles, e-commerce, advertising and financial services. He understands and ideates on intersection of finance, digital, contextual-finance, consumer, mobility, Urban transformation, and ESG. Actively engaged across growth policy conversations and public policy issues.