This week Tony and John give us a timely reminder of the benefits of risk management. They discuss how the risk management function using operational risk software, should be integral in management and decision-making, giving support and advice. Rather than being a cost centre, it is an engine for improving efficiencies and seeing opportunities – in other words, doing business better.
This exert is taken from their book Mastering Risk Management…
Understanding the context within which risk decisions are made is a fundamental element of informed decision-making. Good decision-making creates opportunities and benefits to the business. A visible leadership also helps to achieve an integrated risk management which works across functions, so that there is a common understanding of risk culture. Risk management must be integral to management. Clear risk governance is the base for developing an effective and consistent risk management framework.
Good governance will:
- clarify the risk policy of the firm and ensure that the board-approved risk appetite is aligned with its business policy and objectives
- give increased comfort to the board and senior management that risks which impact on the business objectives are being managed effectively and entity-wide risks are being identified
- clarify risk and control ownership and accountability, thus reducing oversights and duplication of effort
- provide greater assurance on the effectiveness of internal controls and reduce those that are ineffective
- provide a structured, consistent and continuous risk process.
But it is not just about leadership, governance and risk management. To make all that work well and enjoy the benefits, it involves buy-in from all employees. Getting buy-in comes from communicating up and down. Not just internal communications, but making sure that everybody’s eyes and ears are open to the external environment,
If the risk management function is at the table, management will gain a better understanding of how the consideration of risk may impact the choice of strategy and examine alternative strategies and potential impact on the risk profile.
Benefits from risk management
If we have good risk management, other benefits offer:
- reducing performance variability and enhancing performance and growth
- ensuring good information so that finite resources are used to the full, as well as improving resources
- increasing positive outcomes and reducing negative surprises
- enhancing resilience, so that if there is a surprise, especially if competitors have the same problem, you will be back in the market first
- streamlining procedures effectively and utilising risk capital efficiently.
Benefits of getting reporting right
Good risk reporting allows the firm to develop a common risk language, which in turn allows risk-related activity to be conducted on a like-for-like basis. Detailed risk management activity can be prioritised, based on consistent scoring across the firm. Good risk reporting will also generate management involvement and consensus, which will drive the ongoing identification, assessment and control of risk.
Senior management monitoring of risk performance will challenge the results of risk management activity and further embed the firm’s approach to risk management. Risk ownership and control ownership can be clarified through good reporting and assist in identifying priorities for enhancing controls and the firm’s risk profile.
Benefits of getting modelling right
Allocating risk capital on a risk-adjusted basis is a powerful incentive for senior management to manage its risks well. Implementing this leading practice in non-financial risk management also allows the firm to monitor more accurately its exposure against the expressed risk appetite of the board, as both exposure and appetite can be expressed in monetary terms.
Modelling allows the possibility of reducing a regulatory risk capital charge where this is applicable. The use of an integrated approach to modelling (combining losses with qualitative data) can assist the business in forecasting future losses objectively. A qualitative data approach allows the firm to target its resources and controls based on cost–benefit analysis.
Once a risk model has been established, risk costs can be incorporated into a pricing model. This is often either ignored or forgotten, leading to a lack of understanding of the true costs of a transaction to a firm and pricing which can ultimately be ruinous. Many firms in the financial services industry learned this to their disadvantage during the 2007/8 sub-prime crisis. Although this was seen as a credit risk event, it was fundamentally fuelled by the risk of failing to understand the relatively complex securitisation products which were used.
Risk Management as a marketing tool
An additional benefit of risk management is as a marketing tool. A good example of this is Volvo, which has turned safety into a marketing and sales opportunity. Safety is an attribute which is expected by the motoring public to be built into its cars, as it is an excellent mitigant of a number of motoring risks. However, Volvo has very successfully managed to use an inevitable risk control as a marketing and sales differentiator.
Similarly, in the financial services sector, many firms go beyond the regulatory requirements for the reporting of risk within their reports and accounts. One of the three pillars of Basel II of the banking international regulations was the disclosure of information about the bank’s risk management. However, the regulatory disclosure requirements for non-financial risk were minimal compared with those for credit risk. It is clear that firms perceive a competitive advantage in making it clear to any reader that they identify, measure, monitor and manage their risks thoroughly and so many go into some detail explaining what they do. Where would you rather deposit your money? A firm which is making a concerted effort in its risk management, or a firm which is unable or unwilling to articulate what it does?
International and national accounting rules, and business review rules in the UK, have also joined the trend by requiring increasing disclosure of risk in the annual report and accounts. All of these are designed to bring risk management out into the open. But, again, many firms go beyond the minimum standards and a ‘boilerplate’ approach and see marketing gain from what was initially viewed as a tedious and oppressive necessity.
Mastering Risk Management by Tony Blunden and John Thirlwell is published by FT International.
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