Modern economics and finance have, for centuries, normalised risk shifting rather than risk sharing as an acceptable practice. Debt becomes a necessity, be it public or private debt.
The unfortunate consequence and cost to society is widening income inequality at the expense of social and economic justice. Excessive debts mean vulnerability and systemic risk that leads to unexpected catastrophic events, or black swans, such as financial crises.
The term ‘black swan’, introduced by Nassim Nicholas Taleb (a former option trader and retired professor at New York University), refers to an event which is highly improbable but bears huge consequences that lead to catastrophic outcomes.
According to Taleb, black swan events can be mitigated by having one’s skin in the game, which refers to the alignment between risk and responsibility, with individuals or institutions bearing the consequences of their decisions.
In other words, people should have a personal stake in any venture in which they become involved to incentivise desirable behaviour through prudent management of risk.
Putting skin in the game would address the issue of moral hazard, which prevents people from taking risky decisions because they do not have to bear the full consequences of the risks.
Black swan events can be weathered through risk sharing practices rather than risk shifting, which currently dominates the financial industry. Having skin in the game is based on the ‘no risk, no reward’ principle.
Interestingly, this principle is not new. It is a part of humanity’s heuristics, or rules-of-thumb, taught by various cultures and religious beliefs for centuries. The principle is an important legal maxim in Islam.
In behavioural economics, heuristics provide mental shortcuts, offering humans quick ways to make decisions. The ‘no risk, no reward’ principle is thus a very useful and essential heuristic for risk management in economics and finance as human cognitive limitations and conventional approaches to forecasting are unable to predict black swan events.
The paradigm of taking the ‘no risk, no reward’, skin in the game approach in facing black swan events offers essential lessons for Malaysia – particularly the government, regulators, and the financial industry – as the country navigates the current tight fiscal space (contributed primarily through public debt) and manages systemic risk.
While the economy is currently in a relatively stable state, it is imperative that stakeholders take the necessary steps to implement much-needed reforms in the financial sector by shifting from debt-dominated practices to risk sharing models that can withstand black swan events and promote economic prosperity as well as financial resilience through a just financial system.
Being a global leader in Islamic finance, where risk sharing is the defining characteristic, Malaysia is indeed well-positioned to employ such strategies.
Mohammad Abdul Hamid
Head of Economic Prosperity Cluster, Pertubuhan IKRAM Malaysia
Public Policy Consultant
