Risk Management


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Risk management is a practice that deals with processes, methods, and tools for managing risks in a project/venture. It is the identification, assessment, and prioritization of risks followed by coordinated and cost-effective application of resources to lessen, supervise, and control the probability and/or impact of things going out of control.

Risk may be expected to come from uncertainty in financial markets, project failures, legal liabilities, credit risk, accidents, natural causes/disasters and deliberate attacks from a competitor. Managing risks provides a disciplined environment for proactive decision-making to continuously assess what may go awry within an organization and with its products/brand. Effective risk management can pinpoint which risks are important to settle at once and which ones can be dealt with at a later time. The implementation of efficient strategies can also mitigate risks.

For the most part, these strategies consist of the following elements, performed, more or less, in the following order.

  1. Identify, characterize, and gauge threats
  2. Review the vulnerability of critical assets to specific threats
  3. Determine the risk (i.e. the expected consequences of specific types of attacks on specific assets)
  4. Discover ways to reduce those risks
  5. Implement risk-reduction measures based on a strategy

The strategies to manage risk include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk.

The principles of risk management are a set of practices utilized by business to manage its exposure to risk, reach its objectives and goals, and to guide its conduct to meet expectations and concerns of the public interest, labor relations, human safety, the environment, and the laws governing business practices.

The Principles of Risk Management are:

Risk assessment – identifying, quantifying and prioritizing exposure to risk. When exposure to risk has been identified, quantified and prioritized, treatments for the organization’s exposure to risk can be devised.

Risk control – manages exposure to risk on a continuous basis. Part of risk control is an ongoing evaluation of risk exposure that assures the business that its plans are correct for the most current risk climate. It also involves risk mitigation, contingency planning and careful managerial supervision of the combined risk management efforts. This way, adjustments can be made to continually improve the efficiency of the business over time and guard against untreated exposure.

Introduction to Risk Management


Risk management (RM) is one of the pillars of management. It is the most important aspect of planning businesses. Business people have to implement compliance with certain measures in order to mitigate risk. These business practices are decisions, protocols, controls and other activities that impact the success of businesses.

Definition

It is defined as a process involving business practices that identify, evaluate and prioritize the various forms of risk.

Once managers identify risks, they can plan strategies to eliminate negative impact of risk on the business. Strategies vary according to the form of risk, which further differ depending on the type of business. In addition to this, managers have to keep standards for risk management in perspective. These standards are best practices developed by:

  • The Institute of Project Management
  • The National Institute of Science and Technology
  • Other regulatory organizations

Forms of Risk

Risks include occurrence of unexpected and expected events and lapses in best practices. They can be physical in nature, such as fires, natural disasters and other forms of accident. Risks can also be legal issues involving sexual harassment, theft, fraud and racial discrimination. They can also be related to unpredictable financial markets, credit risks, failures in projects and problems with data management.

Objectives of RM

The objective of compliance with risk management is to guard the business. Businesses are always vulnerable. In order to ensure continuity of the business and to reduce financial risks, managers need to protect the business continuously. In addition to this goal, RM is meant to assist managers to protect their employees. Managers also have to make sure that customers and the general public are not compromised. This also provides best practices to preserve records, data and other physical assets of the company.

Identifying and Managing Risk

Risk can be identified and manages in five simple steps.

  1. Define and identify risks
  2. Assess the information related to the threat imposed towards assets
  3. Predict consequences of the threat
  4. Establish the measures to be takes to reduce the risk
  5. Prioritize the management procedure to be followed stepwise to mitigate the risk

Strategies for Managing Risk

There are four categories of strategies for risk management:

  • Accept the consequences and budget for the loss
  • Transfer the risk to another aspect of the business
  • Close down the high risk regions of the business
  • Install back-up plans for foreseen risk scenarios

Every business must have plans to ensure risk management through compliance. This helps protect financial and physical assets.

Risk Assessment


Risk assessment is a process that evaluates the negative impact of associated risk. There is risk involved in every form of business, whether it is health related or financial business. Therefore, managers must implement certain best practices to assist them in controlling negative consequences of risks.

Definition of Risk Assessment

It is defined as an important process in business management, aimed at protecting the business and people related to it. Risk assessment is an important aspect of risk management.

Business managers and investors use risk assessment to measure the profit that will result from a particular investment. This helps in controlling financial losses to the business. In order to succeed with this, managers have to ensure compliance best practices with laws governing the business.

Importance of Risk Assessment

Risk assessment helps with implementing controls to ensure risk management. Once managers assess risk, they can foresee the negative impact of risk on assets and people related to the business. This allows them to implement necessary strategies (best practices) to mitigate and control risk.

Examples of Risk Assessment

When a lender receives a request from a creditor, there are certain protocols (best practices) that must be followed. The lender must make sure that the money lent returns on time. This means that the credit history of the person in question has to be assessed. This will tell the lender whether the applicant will return the money or not. Based on the assessment, the lender will then decide on how much interest to charge to ensure risk management. If the lender doesn’t think the creditor will pay off on time, he/she might as well decide not to give the loan at all.

Another example is risk assessment in a health care facility. Medical practitioners have to assess the risk associated with diseases. There are some diseases that are contagious and transmittable via aerosols. This means that people around the sufferer are at risk. To control this risk doctors must have a setup where people are safe and the spread of disease is controlled. This means medical practitioners have implement measures (best practices) to protect their employees and customers. This is compliance with risk management.

In simple terms, risk assessment means evaluating the extent of damage or threat imposed by failure to impose controls. Hazards must be identified to be able to decide on what measures will be appropriate.

How to Assess Risk?

Regardless of what form of business institution it is, there are five standard strategies that managers must use. These are:

  1. Identify hazards/risks
  2. Conclude where the impact of the hazard will be (e.g. employees, customers, assets)
  3. Evaluate the impact of the risk and precautions or backups needed
  4. Document the conclusion and implement control measures
  5. Review the assessment based on the outcome and document updates if necessary

There are best practices to think about when risk assessment is being conducted. First of all, define the threat or hazard. This can be ANYTHING that harms the business, employees and customers. Secondly, understand that risk can never be eliminated, but mitigated and controlled.

Risk Management Standards (RMS)


Risk management standards (RMS) are values that are fixed in order to support risk assessment. The main objective of risk management (RM) is to control negative impact of risks associated with business. There are numerous forms of risk that vary with the form of business. This is why in every business institute there are standard best practices that must be complied with.

There are two main categories of RM standards. These are international RM standards and standards set by the management of the company. Standards are set based on compliance with laws and regulations of the country or state. Moreover, there are RM standards governing every profession that exists today. The International Organization for Standards has issued more than 19, 000 standards for risk management. These are implemented as best practices worldwide.

Importance of Risk Management Standards

Fixing standards for RM is very important because they compel businesses to provide the best quality. Compliance with RM standards protects the business from unforeseen losses. There are cases where failure to ensure compliance with RM has led to legal action. To prevent this from happening, business owners set their own standards. Other business owners implement standards established by the government.

No matter what profession or form of business it is, there are quality and service expectations that must be fulfilled. For instance, in banks there are specific business protocols that have to be met. These protocols or best practices are synchronized with those of other banks worldwide. As a result of this international banking has become feasible and convenient. When standards are not fulfilled, banks fail to satisfy the financial needs of their customers.

Similarly, in healthcare intuitions, there are healthcare standards that must be met. For example, if health care insurance is involved there are requirements (best practices) that must be fulfilled. These protect both the patient and the healthcare practitioners. If a patient is wrongly treated, it proves failure of compliance with RMS. The consequence is that health care facilities get sued and shut down.

Advantage of Risk Management Standards

The main advantage of developing or implementing RM Standards is that, managers and CEOs can plan their business strategies. These standards provide the option to limit the extent of risk to be taken in the first place.

There are risks attached with every form of business and investment. RM Standards help by avoiding occurrence of circumstances that can lead to unforeseen losses. They also outline the approach business owners have to take to mitigate the risk. This is why compliance is the basic tool required for the success of every business.

Monitoring Credit Risks


Having systematic data policies for measurement of risk exposure in banking systems and individual banks is an essential best practice. There is a need to ensure compliance with data collection strategies, financial instruments and adapt to their characteristics.

According to IMF data, over the years the figures for outstanding global credit derivatives have increased drastically. Therefore, it has become a challenge for financial institutes like banks to monitor financial stability.

Banks are the forerunners in the market. They transfer substantial credit risk to individual participants in the market. The instruments they implement in order to achieve credit transfer are complex. Sometimes, understanding risk-returns becomes impossible without restructuring the system. A reference portfolio is also required in most cases.

To achieve compliance with requirements for monitoring credit risks, three best practices are recommended. These are:

Individual Transaction Risk

A systematic financial approach ensures security and a better financial-return. You have to think about what kinds of risks are associated with any individual transaction. You also have to evaluate who will face the consequences of the associated risk. The data required for this practice is very demanding and challenging. For best practices and proper data assessment, the following information about individual security is required:

  • Type of Asset
  • Worth of Each Asset
  • The Credit Associated with Individual Assets
  • Expected Rate of Financial Recovery

If these requirements are not fulfilled, managers can use a reference portfolio for reference. This is an effective best practice that helps issue timely financial reports. Besides this, one can also include compliance with new security protocols. This will help establish a reliable portfolio and standards that investors can follow. Moreover, this will guarantee quality, rating coverage, diversity, obligator concentration, standard security rate and standard recovery rate.

Individual Bank Risk

After individual transaction risks are identified with best practices, it is important to monitor the impact of certain transactions on the risk position. This has a direct impact on financial institutions like banks.

There are two effects of individual transactions on individual banks that must be considered:

  1. Does the bank take risks associated with financial transfers?
  2. Does a transaction alter the bank’s leverage on default probability?

Note: The second scenario may occur if securitization proceeds are utilized for debt holders or to pay equity. It is also likely to occur when payments are in portions other than what was previously agreed.

Systemic risk

After risk assessment is successfully completed through compliance, systemic risk evaluation follows. There are mutual interactions between investors and financial institutions that must be observed. It is important to determine who takes the systemic risk. Besides, you have to assess whether the risk is transferred outside to other financial sectors.

These best practices involved in monitoring credit risk provide a clear understanding about credit risk transfer and financial stability.

Scrutinizing Country Credit Risk


Industries that get engaged in international lending or that acquire cross-border exposure, undertake country risk. That’s because the transaction involves two countries taking a risk. Therefore, there is greater need for skilled risk management strategies in international companies.

The country of the industry involved is the key factor that differentiates the concept of domestic and international lending. Country risk encompasses every form of risk and uncertainty arising from political, economic and social conditions of the country. These factors can lead to constraints for the industry, preventing it from fulfilling its obligations to international clients. As a result, the pressure on people implementing best practices increases.

In addition to the above risks, it is also likely that country risk may result due to expropriation or nationalization. Moreover, exchange control, devaluation of currency and government repudiation also contribute to country credit risk. As a result, constraints on decision-makers of the company increase. To ensure best practices for risk management, they are forced to refrain from delivering the goods across border. Instead, they resolve to trade within the country to mitigate losses.

However, the plus point here is that country risk is one that industries can influence directly. International companies, therefore, must ensure that they utilize adequate technology and systems to manage cross-border exposure. In order to ensure risk management, CEO’s should concentrate on best practices to avoiding risk in the first place.

The success and sophistication of risk management systems implemented depend on the complexity of cross-border exposure.

Forms of Country Risks

International companies are liable to exposure to six main forms of country risks. These include:

  • Sovereign risk: This denotes the willingness and capacity of foreign governments to repay direct or indirect financial obligations. These are usually in foreign currency.
  • Transfer risk: This form of risk denotes the inability of a borrower to obtain foreign exchange to be able to fulfill external obligations. This often happens because of social, economic and political problems. The consequence of which is drained foreign currency reserves of the country. As a result, borrowers cannot convert local currency funds to foreign currency.
  • Contagion risk: This risk results when adverse conditions of one country cause negative impact on the credit of other countries in its region. This can happen regardless of whether neighboring countries are credit worthy or not.
  • Currency Risk: This is a risk associated with the probability of cash flow and domestic currency reserves becoming inadequate, due to devaluation.
  • Indirect Risk: This is when the ability to pay cross-border is endangered due to economic, social and political reasons.
  • Macroeconomic Risk: When interests go high due to failing economy, the borrower’s risk increases. This leads to constraints in best practices for international businesses that cause increase in country risk.

Therefore, it is country risk management that is important, as far as country credit risk is concerned. Banks plan an important part in this and must implement the best risk management strategies.

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