Customer Reviews

Financial Darwinism: Create Value or Self-Destruct in a World of Risk

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I was fascinated by the premise of Financial Darwinism and found myself agreeing with most of its conclusions and remedies. The subject matter is extremely timely right now. Investors, politicians, and financial people are struggling to understand the new financial world order. An astounding amount of leverage and risk was not at all visible before this crisis and resulting losses were surprising, to say the least.

The theory is solid and fascinating and is clearly a strong suit. This is why I couldn't wait to get to the "real life" examples presented in Chapter 5, which is the heart of the message. The case study of the current financial crisis illustrates why Tilman's theory works. This chapter makes getting through the detail in prior chapters, where the reader is trying to understand the implications of the book's ideas, worth it.

Notwithstanding somewhat excessive use of dashes (the author's amusing style quirk), the clarity of thought is impressive. As a journalist and personal investor, I was afraid that this book would only be understandable (and of use) to finance experts, executives, economists, and such. This was not at all the case - thanks to all the main points clearly laid out in the first chapter.

Despite the Darwinian message, it is likely this book will become the new "bible" for businesses and investors around the world.

Is it really necessary to understand the ongoing tectonic financial shift and evolve, asks Financial Darwinism? Lehman, Fannie, Freddie, Bear Stearns, Countrywide, Wachovia, and AIG did not think so. "survival is not mandatory" is the core theme of this book. If nothing else, this statement is the evident fact of the current crisis.


Tilman's new book is a fascinating eye-opener that exposes what has been happening with capital markets and financial institutions over the past 20 years. I agree with Rubenstein's quote: this book "explains the tectonic shifts now underway in the investment world far better than any book I have seen to date."

The evolutionary thesis called Dynamic Finance is the first part. It explains how global forces have progressively pressured financial businesses and how this, in turn, changed the riskiness of financial firms and the behavior of financial markets. The major innovation here is that risk management language is used to explore issues like corporate earnings and strategy, macroeconomics, and investments. A whole new set of concepts is also introduced: risk-based business models, risk-based economic performance, and risk-based transparency. Even though most of the discussion is focused on financial institutions, all of this cannot be more relevant for non-financial corporations - just think of recent troubles with auction-rate securities, pension plans, and fx losses.

Tilman convincingly argues that a healthy amount of paranoia also won't hurt financial firms and their executives: they need to continuously evolve and strive to create value. Resistance to change inevitably leads to loss of busines`s, larger risks, and ultimately the extinction -- the crux of Darwinism. Financial executives must develop the new way of thinking about business models. Once this has been done, what will determine successes is their requisite risk management skills. The decision-making framework covered in the second half of the book should help this a great deal.

Tilman has conveyed original and far-reaching ideas in clear and knowledgeable ways. This book will spur a lot of research and discussion in the coming years.

Brilliant! A one-of-a-kind must read.

Financial Darwinism is quite a catchy phrase. And how appropriate in our current economic environment to highlight the need for financial services companies to evolve. I just began reading Leo Tilman's book on Financial Darwinism. I'm only about halfway through, but you can fairly quickly discern some good insights into what financial companies must do to survive. The two most significant ideas I've gotten from this so far are that financial organizations must:

1. make changes to their underlying business models to survive
2. begin incorporating risk management as an integral part of their enterprise-wide business decisions, not just as an after-the-fact policing or compliance function

One of my favorite quotes comes from W. Edwards Deming in an attempt to stress the importance of having the appropriate information before making decisions. "In God we trust; all others bring data." Once again, W. Edwards Deming provides some great perspective which Tilman uses to stress the importance of change for financial companies. "It is not necessary to change. Survival is not mandatory."

The need for change though is not necessarily what is illuminating. It is the type of change that companies must start to make.

No one will deny that financial companies have been making some significant changes over the past several years to deal with factors such as increased competition, reduced net interest margins, compression of banking fees, limited global inflation, the global savings glut, and other pressures to maintain the growth rates investors and shareholders had come to expect. However, what Tilman argues is that the primary reaction of finance companies was to pursue a variety of corporate finance activities to reduce the cost of captial, increase fee-based business to supplement earnings, and pursue alternative investments and complex financial products, which inherently involved higher risks necessary to provide the higher returns.

Tilman suggests that banks and other financial services organizations must begin to make more full-scale transformations to their underlying business models. Only then will they be able to adapt to the new economic reality. And this ability to evolve from their current, static business model to more dynamic business models is the core driver of Financial Darwinism.

As organizations move to more dynamic business models, the ability to understand and take into account the associated risks of any business pursuits will become that much more critical. For example, companies need to move beyond understanding customer profitability to take into account risk-adjusted profitability. To date, risk management has primarily been driven by regulatory and compliance requirements, such as Basel II. It has provided organizations with a view into risk, but even that now appears tainted.

However, if organizations can figure out how to more effectively incorporate risk management directly into their core business processes, there could be signficant benefits. I've already seen a harbinger of this at a large Korean bank. As part of a Basel II project, they chose to perform the analysis of risk data at the beginning of their credit review process. As a result, they were able to reduce credit application processing errors by 30% and dramatically improve the overall quality of their loan portfolio...in addition to becoming compliant with the Basel II regulations.

Of course, these suggestions will not ensure the survival of financial companies in today's environment. But they should at least improve the chances for success and help banks start thinking about how to create the competitive advantage they need.

Just as global climate change has increasingly brought us more frequent "once in a century" weather events, increased competition and economic globalization have resulted in lower margins, increased commodification, and increased risk - leading to a similar pattern of economic volatility centered around our financial institutions.

Leo M. Tilman's Financial Darwinism: Create Value or Self-Destruct in a World of Risk paints a rather bleak picture. He sees systemic financial crises as a "permanent feature of the dynamic new world." This isn't a book for those looking for ideas aimed at governments attempting to reregulate the financial industry, although they would certainly benefit from the reading. Instead, the book offers very practical advice to bankers, institutional investors, and other businesses on how to build risk analysis into strategic decision-making.

In the old paradigm, the risk manager was brought in after major strategic decisions had already been made. In the new paradigm, "risk management becomes the very language of enterprise-wide strategic decisions going forward and that the chief risk officer becomes an executive who gets an equal seat at the table where corporate strategy is decided."

Tillman identifies at least ten forces contributing to this shift, including:

- Globalization
- Inflation targeting and control by central banks
- Disintermediation
- Greater availability of information
- Greater financial market efficiency
- Alternative investment vehicles
- Financial deregulation
- Convergence of traditional financial businesses
- Increasingly complex instruments, such as derivatives and structured products
- Advances in technology, financial theory, analytics and risk management

In the simplest formulaic terms we have gone From: Economic performance = return on assets - cost of liabilities + fees - expenses - cost of capital

To: Economic performance = balance sheet arbitrage + principal investments + systematic risks + fees - expenses - cost of capital

Of course, that's just the beginning of the complexity. Tilman does an excellent job of explaining this paradigm shift, how we got here, what factors need to be examined going forward, and how they can be understood in relatively simple formulaic terms.

Financial Darwinism recognizes that our growing toolbox includes leverage, product design debt management, capital structure, M&A, insurance, securitization, hedging, asset strategies, etc. Each tool must be considered in developing and implementing strategy.

As the world places increasing emphasis on fair valuation, risk-based financial disclosure and risk-focused regulation, Tilman's guide becomes more important for CEOs, directors and fiduciaries who must build risk evaluation into all fundamental decisions.

"Investors and banks took risks they did not understand."
Treasury Secretary Timothy Geithner, February 10, 2009

Leo Tilman's book was published just as the current financial crisis reached it's apex. The book would have provided an excellent framework for analyzing the risks inherent in the business models of financial institutions even if the crisis had not occurred. But the book also explains both the origins and the catalysts for the crisis--including the aspect that Geithner referred to in his remark above. More importantly, the book also provides a blueprint for understanding the business models of financial institutions as they adapt to the aftermath of the current financial crisis. Although the choices of risks that financial institutions take in this new era will change, the opportunity set of risks that they face will remain basically the same. The book provides a framework both for understanding what led to the current crisis as well as how to look at the risks taken by financial institutions in the future.

Tilman's book is a "must read" for anyone who wants a better understanding of the terrain that financial institutions of all types and sizes must navigate in order to emerge from the current crisis.

Mr. Tilman's message in "Financial Darwinism" is a timely and important one, especially in the dynamic new financial world: Firms (particularly ones where revenue is tied to financial transactions) will need to be more proactive in adapting its business models as well as adopt Risk Management as an integral part of their decision-making process in order to become or maintain their status as the market leader.

This book is very thorough in defining formulaically the earnings equation of financial firms and emphasizes how the new financial environment will impact/impair each component of the earnings models and how firms can adapt their business to overcome such an attack. Although at times I found the re-emphasis of the earnings equation a little overdone, perhaps this is necessary to hone in for non-finance professionals.

One particular area where I thought Mr. Tilman could have spent more emphasis is on how the principles of Risk Management can have influence senior-level management decisions. While this point was obviously stated, little detail or examples are provided to depict its usage and effectiveness. For example, "Risk transparency" was touted as a way to improve risk management, but no specific examples of "what kinds of risk transparency" or how management should use risk transparency to better understand risk was explained. While I think the author never meant to dedicate a chapter to risk transparency, a more detailed explanation would have made the argument for utilizing the principles of risk management in boardrooms more convincing.

In all, the author wanted to show that the world of finance is undergoing a tectonic shift and that old business models are being threatened. In order for firms to survive in this new financial regime, they would need to rethink their earnings model, be creative in how they protect their income streams, and utilize Risk Management as an ex-ante and not a ex-post concept. In that end, Mr. Tilman has done a good job.

The number one questions these days are "What next? How did we get where
we are? Where are we going? What to do about it? Leo Tilman offers a
well organized and researched answer to these questions. An essential
part of his answer is that we are seeing the result of powerful
secular trends, rathen than another cyclical financial crisis. His
new book offers an analyrical framework and approach to cope with the
Darwinian process now underway in financial services. This industry
is receiving enormous government spending, and has become the core
of our economic future.