The latest stress tests carried out by the Bank of England, the results of which were announced last week, have attracted a lot of attention. But the mystique around what is now an annual event is not wholly helpful for those who wish to promote better business management. The fact that the stress tests are applied only to the UK’s seven largest banks, and are administered by the Bank of England, creates the mistaken impression that they are only relevant to certain sectors, and are in some way very difficult to carry out.
In fact, the Bank of England simply ensures impartiality and, while it is certainly important to gauge the resilience of systemically important banks, it is no less vital for the leaders of any company to understand the potential impact of future shocks. Of course, for larger organisations, this is not easy, but it is not so complicated as to require the technological capabilities of a central bank.
Understanding what drives value and risk in an organisation, and how those are influenced by changes in market and economic circumstances, does require complex analysis. But, given the right technology, building an accurate mathematical model of the business is within the grasp of most finance and leadership teams. Once in place, that can form the foundation of an effective ‘stress-test’ for any large company, in any industry.
A key concern of the Bank of England is to avoid what is called ‘the stability of the graveyard’ – or the fear that an excessively risk-averse attitude can result in economically damaging stagnation and consequent decline. It’s a concern with echoes in many other industries. There is no growth without risk, and a company that abjures all risk will be outmanoeuvred by competitors. In an uncertain economy, however, it can be difficult to strike the right balance.
That is where stress testing and other forms of predictive analysis can be powerful tools for enabling business growth. A proven mathematical model, that defines the relationships between internal and external drivers of value, allows business leaders to predict the impact of actions they propose, as well as the potential effect of changes in the business environment. It is then a simple matter to apply probability calculations to the various relationships in the model, generating an objective measure of risk and opportunity. That facilitates confident, more effective decision making, as well as an enhanced understanding of how external factors might affect the future development of the business.