What Really Drives Risk? Lessons From Financial Services*

With billions of dollars at stake in their credit portfolios and trading operations, banks have been forced to look much more closely at the risks they take every day (and every minute of the day). Yet many financial institutions ignore a much more fundamental type of risk: their choices about which markets to participate in, how to compete in those markets and the impact of those choices on the risk profile of their institutions. Call this "strategic risk," if you will.

A 2004 Marakon study of the long-term performance of 1,400 leading U.S. corporations, including all the major financial services firms,¹ found that two factors drove the risk profile of the companies: whether they competed in markets and segments with attractive economics, and whether they were competitively advantaged in those markets/segments. Companies that made poor choices on these two dimensions had six times the risk (defined as the volatility of a company’s earnings relative