Building Risk Management in Russia

By Vladimir A. Gamza, John J. Hampton and Valery Vyatkin

In 1989, the typical manager of a Russian factory was a highly-educated and clever apparatchik-an administrator or bureaucrat. Extensively trained in science or engineering, he presided over an operation with hundreds or thousands of employees and equipment that produced a large volume of tangible goods mostly destined for government companies.

In fairness to individuals' needs, a portion of the output was designated for consumers. The output was never enough and a factory rarely achieved the quality standards of goods produced in the free market.

To understand risk management in Russia prior to Perestroika, one only has to look at the famous (or infamous) Russian automobile-the Lada. Perhaps the car had simply achieved perfection in the 1960s, but in any case, it did not change much for 40 years. The Soviet Union never produced sufficient Ladas to satisfy the demand. There were no commercial risks to manage. Whatever was built was sold.

The word "sold" is instructive by the 1990s, when we see the start of risk management in Russia. The story begins with the first privatization wave, in which the Russian government "sold" at a fraction of their value many businesses it previously operated. Thousands of powerfully connected individuals got rich overnight.

The privatization program was accompanied by the first risk management training. The World Bank and Academy of National Economy of the Russian Government in Moscow jointly offered an extensive program on credit risk management from 1991 until 1997.

The second project was sponsored by the U.S. Department of Commerce and Port Authority of New York and New Jersey. Offered at the St. Petersburg University of Finance and Economics from 1994 to 1999, U.S. professors conducted seminars covering a range of risk management topics. Most attendees were middle-level managers in newly privatised companies.

It is easy to be glib when we say "bring risk management to Russia." It is only when we get closer to the reality of the Communist years that we can understand the scope of the problem. Prior to 1989, no person in Russia could own any tangible resource used in business. The government owned all factories, machinery, transport vehicles and other assets.

The country had no concept of risk management. The battle would start from ground zero.

To stress this point, let us return to the highly educated and clever manager of a Russian factory. How did he spend his day? At a desk amidst hundreds of people needing his approvals while the factory work went on. A locomotive pulling boxcars would pull up. The doors would open and raw materials would be secured within the building. Workers would assemble whatever was being manufactured: tanks, washing machines, engines.

A government office in Moscow decreed a production. When the process was over, finished goods were loaded on another train. Where did they go? To a destination directed by an office in Moscow.

The risk management issue intensifies when we realize how the factory operated in a central planning system. The factory was directed by a Ministry and Government Planning Committee (Gosplan) that would authorize production levels. The initial goal of the factory and its directors was to "bargain down" the level of production. Finally, an agreement would be reached.

The State Distribution Committee (Gossnab) approved funds for materials. The state bank approved funding. The State Committee for Prices approved selling prices. A Ministry approved the plan.

Now, the factory produced goods. It spent approved monies. A problem usually arose because government agencies did not honour "guaranteed" funding for salaries, utilities, office equipment, energy and other disbursements. With shortages everywhere, the factory manager had to be innovative. Once production was finished, the factory would be paid at the prices stipulated by the State Committee for Prices. There was some idea of profitability. It was the same for almost all enterprises: 12%.

To a Russian factory manager, profit means the difference between the revenues a company collects when it sells goods and the materials, labour and other costs it incurs to produce goods. But there are no costs and no sales. The train arrives with raw materials and leaves with finished goods.

The situation is no better with risks that endanger return on investment. The factory cost nothing. Nobody has visibly invested any money. In the sense of a western project, there is no ROI because there is no investment.

The early days of risk management were bleak in Russia. Since the early 1990s, Russian businesspeople have made a perilous journey from central planning to a somewhat viable market economy. With success has come the need for modern risk management.

An important sign of the progress was the 2003 creation of RusRisk, a risk management society supported by the Risk & Insurance Management Society, Marsh & McLennan Cos. Inc., American International Group Inc., and others. Established by Russian entrepreneurs, bankers and professional associations, the society supports risk management education and knowledge.

Outside the private sector, the Russian Central Bank has joined the Basel capital adequacy process, the Ministry for Emergencies addresses technology, civil and ecology risks, and economic departments of universities and business schools offer courses on business risks. More than 30 books on risk management will be published in Russia this year.

What are the signs for the future? Foreign investors in international joint ventures are insisting on risk management in any business development plans with Russian partners. Many parties are offering training in modern risk management. Risk management terminology is emerging in public speeches and interviews with government officials and corporate executives.

The success of integrating risk management into Russian entities will be affected by a number of factors.

For one, the Russian language has no equivalents for many risk management terms. Further, work is needed with respect to the legal framework to mitigate or transfer hazard, operating and catastrophic exposures. Senior managers need to better understand the role of trained risk managers.

So what is the conclusion? Russia is a risky place. Yet, we can see a strong movement into understanding how modern businesses operate. The concepts of profits and ROI are clear to a younger generation of managers. Russians are beginning to understand the key role played by risk management. In this sense, the future of risk management in Russia holds promise even if progress is likely to be slow.

This article was published June 12, 2006 in Business Insurance Europe.