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Hello everyone. Welcome to the 5 Minutes Podcast. Today I'd like to talk about a concept that is, I would say, quite popular in finance but not very popular in projects and initiatives. And it's the concept of the moral hazard, and why I want to talk about that because this weekend we saw the collapse of the Silicon Valley Bank, the second largest collapse of a bank in the US, and it raised massive questions, you know, from clients, from the society, from the financial system. So there is, I would say, a dramatic situation. Is this a systemic risk, or is it just a localized risk in a financial institution in California? And this drives me to discuss the concept of moral hazard. Everybody was asking, will the government support the deposits of these banks or not. What will happen? Will the government just let those with money in the Silicon Valley Bank lose their money above the limit? And why I'm saying this is because, of course, there are limits. I'm not sure. But I think it's something like $250,000. But many companies invested billions because most of the venture capital start-ups have their funds there to be managed. So it's $250,000 is pretty much nothing. And the question is, will the government support it or not? And what is the question around moral hazard? The question is that if the government supports will this change the behavior of the financial system to say, you know, now I have a bank, I have a bank of the government, now I can do all crazy things?
I'm not saying that this was a crazy thing. Okay? I don't have the competence to say that. But what happens just by existing the chance that someone will support you when a risk becomes a fact, change changes your behavior towards the risk. And let me use an ultra-simple example. Let's suppose you are very, very young and you are playing on the street and, for example, you are having some, I would say, some trouble as a kid with your neighbor, and your neighbor is a little bit bigger than you, and you go there and say, No, don't do this, don't do that. But you look back to your house, and you see your big brother just behind you; what happens? You become far more brave, right? You are willing to take far more risks because you know that if something happens, your big brother will protect you. And this is the same logic. And you may ask me, Ricardo, why are you talking about this? We were supposed to talk about projects and initiatives because this is exactly what happens almost every single day in our projects. Let's suppose, Should I punish and find a supplier that delayed the project, or should I dismiss or fire a project manager that did not meet the deadlines? These are not judgment questions. Okay. I'm not saying that you should or should not, but I'm talking about questions because what is the problem? If you do not punish your supplier, your supplier will say, you know that clause about fines, it doesn't exist.
It was never applied. So it basically does not exist. So it does not have any effect. Because for you, you say, you know, this clause I delivered late many times, and I never got a fine. So it should not be this time that I will have the fine for the first time on the other side if you decide, okay, let's put a massive fine and destroy the supplier, then the next day you will not have that supplier. And also, other suppliers may say, you know, I will not supply to Ricardo's project because that clause is so tough that I don't want to run the risk. I prefer not to supply to him and supply to someone else because it's too risky for me. Did you see the dilemma? And it's the same dilemma that the central bank is today managing in the US. Because if I give the money and protect. Okay, great. I'm protecting the assets of all the clients, but at the same time, I'm making potential banks more lenient to risk. They will say, you know, I don't care. I will invest in more risky things because if everything goes wrong, I know that the government will bail out. But if you don't do what happens? All the banks can collapse. It's like a domino effect. For example, if you decide to punish, for example, someone in your team that did not deliver and he or she loses his or her job, it may create an escalation that other people will not want to work for you.
And this is exactly the. The concept of the moral hazard and why I'm talking about this is because this is very different from our risk approach, where we take probability, multiply it by the impact, and we calculate the exposure, and then we analyze that exposure. It doesn't work that way. There is no mathematical answer. This is, I would say, your perception because most of the time when you are managing a risk that engages all the parties, and most of them, they are related. You have the problem of asymmetry of information. It means that one side has more information than the other. Another simple example I am an insurance company. What do I do to calculate the insurance of your car? I will take some basic information about you, like your age, how many years you have a driver's license and the type of car where you live. And then I do some calculations, and I calculate, I would say, an average risk that you are exposing to me, and these will become the premium that you will pay. However, do you agree with me that you know the risks much better because you are the one that will decide if you will leave the car unlocked on the street or locked, if you will drive above the speed limit or not, if you will drive, respecting the loss or not? But in the end, if something goes wrong, you will not be the one paying because you have insurance. And this is why we're talking about the asymmetry of information.
I'm using this just as a simple example, and what is important for us is that experience, and experienced managers know how to balance this because if you go all by the book and punish, you can create a systemic risk. Now, the government is not trying just to protect one bank. It's to protect against a crisis. Because if you imagine yourself as a client of any bank in the US or any bank in the world, you just say you know, I will take out all my money. And then imagine that, like you, your neighbor, and everybody, what will happen? You will create a collapse, an absolute financial crisis like 1929, like 2008. But to stop that at the same time, you are becoming more lenient to other banks that would make risky decisions. So it's a very complex situation. And this is why most of the time, in complex risks and complex projects, you need to have experience, and you need to understand what is the best balance between being tough and working by the book and by the strict laws or being more flexible. Each of them will bring you benefits and additional risks secondary risks. Always think about that when you are analyzing risk. It's above and beyond probability and impact. Think about that. Take a look at what is going on with the Silicon Valley Bank. And take this as an example for our projects and our initiatives. I hope you enjoy this podcast, and see you next week with another 5 Minutes Podcast.
