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Crisis is an expected part of business these days and cannot be detached from usual business activity. Corporate crises primarily are more likely to be impulsive by market, organisational compositions, finances, innovative technology or by natural catastrophes, and may result in widespread losses of not only resources but also human life. Corporate crises inevitably injure both the financial structure and also frequently the reputation of the organizations concerned. Strategic crisis preparation is becoming a more and more important issue as organizations seek to cope successfully with possible crises.
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After executives at Soc Gen had unravelled the mystery of Mr Kerviel’s position and published their findings, the bank’s reputation for its sophisticated risk management was essentially in tatters along with the its independence (Matlack 2008). The stakeholders who were the most affected as a result of the fraud at Societe Generale included the bank’e employees and higher management along with the shareholders of the company who had to pick up the pieces. Daniel Bouton, the bank’s chairman, initially presented the incident merely a short-lived rampage attributed to a rogue trader who had been able to hack into Societe Generale’s computer systems. The chairman later had to conduct a massive PR exercise just to save his job. The potential impact of crisis upon an organisation's reputation is clear in this case.
Crisis is essentially a socially constructed process that is experienced in different ways by different stakeholders (Kellerman 2006). For instance, the bank’s senior management could have potentially lost there jobs along with other bank employees. The stockholders were also affected but in a slightly different way. Soc Gen had to raise further capital through a rights issue diluting the value of the investment of the original stockholders of the company.
It has become amply clear in public perception that Mr Kerviel’s managers ignored more warning signs that, if properly heeded, would have permitted them to prevent the trader long before he was able to carry out so much damage. When all was said and done, the total loss associated with the scandal was close to pounds 2.5 billion (Evans & Pain 2008). The culture and the incubation of crisis come into action here. Culture played its part in incubating crisis from the views of ‘after’ and ‘before’ and therefore the stakeholders were able to identify particular drivers for crisis and their interaction with the organisational culture.
Organisational level factors, such as culture, configuration, systems and stakeholders are important elements to consider in analysing SocGen’s vulnerability to crisis. As in many cases, in the immediate aftermath of a crisis, there are a lot of reports of individual’s mistakes as well as actions which may have led directly to the crisis. It also takes the form of scapegoating. The role of the individual, Mr Kerviel’s is only part of the game and draws upon the notion of human error by Reason (1990). Reason has argued that in many occasions we are unable to understand, prevent and also mitigate the impact of an individuals’ action until we have a concise understanding of the fact that action, or mistake, is a symptom of wider organisational failures. In this case the systematic failure (where can this be identified from the case and what kind of system can this be referred to, i.e a loosely or tightly coupled system?) of internal controls SocGen played a huge role in the whole episode that eventually led to the losses (McEachern 2008). In later interviews with bank executives, board members as well as investigators along with rival bankers – and Mr Kerviel’s own testimony to the French prosecutors – that have revealed a overconfident, hard-driving culture that had become part of SocGen which allowed even a middle ranking trader to repeatedly make huge bets with the bank’s money without getting detected. The fact that Mr Kerviel had knowledge about the computer and internal controls systems at Soc Gen as a result of his last position before becoming a trader allowed him to abuse the system.
Risk managers were only part to be blamed for the Soc Gen scandal. Jerome Kerviel, was working as a trader on the junior desk at headquarters in Paris, knew very well how to dodge the risk management system in place since he had already worked in the back and also middle office between the years 2000 and 2005 before he became a trader, making it almost impossible to detect the fraud. As he knew the system well, he knew how he could avoid his transactions being detected. No risk management system is totally reliable and there are always backdoor grey areas in which transactions can be undertaken without triggering monitoring activities (Mulcahy & McGinn 2008). One of the keys to this problem is to have an outside system for monitoring activities. The risk management system was made by programmers at Soc Gen and therefore there was more information and in turn vulnerability for an abuse of the system.
As with a lot of other financial frauds over the last decade or so, the crisis was systemic failure, an due to multiple failures inside and outside the organisation. The basic principles of risk management had not been respected in the Soc Gen scandal. It was a procedural breakdown on the whole. In a report on the trading losses, French regulators have revealed that previous inspections by the banking commission operating under Bank of France had discovered weaknesses in Societe Generale’s control system back 2006 which had led to a serried of recommendations for strengthening the security of operations. Certain mechanisms of the internal controls failed to function at Societe Generale, and the ones which functioned were not properly taken up by appropriate modifications. French economy minister Christine Lagarde in her report to the Prime Minister on the fraud case said that the banks management needs to be fully implicated in risk control, most apparent by creating committees as part of governance structures which are dedicated to risk supervision as well as internal controls. As is often the case with such fraud scandals, Kerviel had built up too much control illustrating a lack of supervisory procedures as well as lax monitoring from the systems standpoint. All this points to a systematic failure at the bank and the way it ran its internal control systems.
Risk management is the process of managing uncertainty that arises in the normal course of activities, including those related to business ventures. Business risks can assume many forms. In the case of Soc Gen a failure to properly assess individual risk factors and do something about them was the key to the whole issue. Various other types of risks impacted Soc Gen as a result including strategic risk, business risk, and reputational risk, among many others like non-financial operating risks (theoretical discussion, highly unnecessary). It is believed by some that the bank’s management concentrated too much on the credit risk, or the risk that a counterparty will fail to perform as expected on a contractual obligation, leading to a loss; market risk, or the risk that movements in an underlying asset or index will create a loss; and liquidity risk, or the risk that assets cannot be liquidated or funding sources cannot be accessed without creating a loss as a result of the Sub-prime exposure in America along with the financial crisis in that time period. They failed to properly asses the operational risk which is also an important area of risk management. The same goes for the risk of loss due to flaws or failures in control processes.
All risks therefore has to be included in official trading systems, without exception; failure to do so leaves a firm subject to operational risks and possible fraud. A risk process cannot function properly without clear governance. The lack of separation between front- and back-office activities and the failure of market/credit risk controls are just two of the many by-products of an ill-defined governance process. Previous failures like that at Barings had already called for independence between front- and back-office activities, a practice that most firms have but Soc Gen failed to do this on the human resource side of the equation.
Crisis preparation has been at the hub of quite a few studies of crisis management, the most significant of which was done by Pearson and Mitroff (1993) in which five stages of crisis management were summarized: signal detection, preparation/prevention, containment/damage limitation, recovery, and learning. The first and second stages ‘Signal Detection’ and ‘Preparation/Prevention’ make up the practical types of crisis management. If carried out effectively successfully, then, these activities can prevent many potential crises from taking place in the first place. The third and fourth stages ‘Containment/Damage limitation’ and ‘Recovery’ make up the reactive activities carried out after a crisis has occurred and they are called ‘Crash Management’. The fifth stage ‘The learning phase’ concerns the interactive phase of crisis management. This phase can be brought about by as a part of a crisis management planning in the absence of an actual crisis or as an effect of the experience of the crisis. (Theoretical discussion)
The relationship between organisational learning and crisis is also clear in the Soc Gen trading scandal. According to the Audit Committee’s report, all of the futures positions held have been checked against the counterparty (clearer) and specific control procedures have been implemented subsequently so that the loop holes that became apparent by the activities of trader to avoid controls can no longer repeat themselves. Beyond this, further controls are also planned and the bank has promised that substantial human resources would be mobilized for this along with the support of outside fraud specialists.
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