What is Risk Management?

Introduction

Businesses today operate in a complex, interconnected, and highly dynamic risk environment. They constantly face regulatory pressures, operational disruptions, competitive shifts, geopolitical shocks, technological advancements, cyber attacks, and more. Managing this rapidly evolving risk landscape and ensuring the organization can achieve its business goals and objectives is one of the biggest challenges that a risk practitioner faces.

In this article, we will discuss risk management in detail, including its types, the risk management process, challenges, benefits, and more.

Key Takeaways

• Risk management is the systematic process of identifying, assessing, mitigating and monitoring all types of risk in the business. It is no longer considered the sole responsibility of the risk teams; but of the entire organization.
• Risk management can be broadly classified into financial risk management and non-financial risk management. Operational risk management, enterprise risk management, and strategic risk management are the main types of non-financial risk management.
• Organizations require effective risk management to understand their business environment and the risks they face. This helps them prepare strategies to mitigate them proactively and explore opportunities.
• ISO 31000, COSO ERM Framework, British Standard (BS) 31100, and the Risk and Insurance Management Society's Risk Maturity Model (RMM) are some of the widely used risk management frameworks.

What is Risk Management?

Risk management is the identification, assessment, prioritization, mitigation, and monitoring of risks. The practice involves evaluation, relative prioritization, and recognition of similar risks and mitigation practices to best identify and accurately assess the effects of and efforts needed to manage multiple risks in an enterprise.

Effective risk management allows organizations a methodological approach toward recognizing ways to identify, avoid, control, transfer, or accept risks while reducing exposure and potentially creating risk and resiliency advantages.

What are the Different Types of Risk Management?

There are two main types of risk management – Financial Risk Management and Non-Financial Risk Management.

Financial Risk Management:

Financial risk management typically involves the assessment and monitoring of risks with the focus of protecting the economic interests of an organization. It includes managing credit risk, market risk, liquidity risk, and investment risk, among others.

Non-Financial Risk Management:

Non-financial risk management involves the study of risk typically associated with strategies that do not affect the financial interests of an organization directly. This includes:  

• Operational Risk Management: Operational risk management (ORM) is the practice of managing an organization’s risks that can disrupt business operations. These are the risks associated with business performance and internal processes, people, and systems. Banks and financial institutions follow guidance from the Basel Committee on Banking Supervision (BCBS) for managing operational risk.
• Enterprise Risk Management: Enterprise risk management (ERM) is the practice of proactively understanding and reducing the risk exposure of an enterprise, typically analyzed with a top-down approach, i.e., to primarily assess and mitigate risks at the top level of an enterprise.
• Strategic risk management: Strategic risk management is the process of identifying, assessing, and mitigating risks that can obstruct an organization in achieving its strategic goals. When done effectively, it can help an organization take calculated risk that help it gain competitive edge and drive business growth and value.

What are the Key Steps in Risk Management?

1. Risk Identification

Risk identification is the process of discovering risks associated with different aspects of an organization and their potential impact. This requires collaborating with different departments and functions to understand the risks they face. Once identified, these risks are then properly documented in a risk register.

2. Risk Assessment

Risk assessment is the practice of evaluating the likelihood and impact of the identified risks. Organizations can employ qualitative and quantitative risk assessment methods or a combination of both to understand the risk exposure of the organization.

3. Risk Mitigation (Controls, Issue, and Action Management)

Risk mitigation is a set of strategies deployed by organizations to reduce the exposure and impact of a particular risk. Once risks are assessed, organizations prioritize them for determining mitigation efforts and protecting the organization from potential damage. The strategies to be adopted for risk mitigation are as follows:

• Risk Avoidance: Involves changing the course of an action to eliminate an associated risk for the enterprise.
• Risk Control: Involves the development and deployment of measures to reduce exposure and the impact of associated risk.
• Risk Transfer: Involves the reassignment of associated risk to a different department or stakeholder(s) within an organization that can manage it better.
• Risk Acceptance: Involves the assumption of risk with no roadmaps for reduction or control, typically when the risk has a higher risk-to-reward ratio and it falls within the risk tolerance policy of an enterprise. 

4. Risk Reporting

Risk reporting is the practice of documenting and informing an enterprise of its biggest risks at a particular point in time. Risk reporting is important because it helps organizations prioritize their risks and deploy timely measures to protect their interests.

5. Continuous Monitoring 

While it may seem enough to have identified, assessed, placed controls, and created risk reports, at the core of any risk management strategy is the act of continuous monitoring. CM or continuous monitoring is one of the most important steps to manage risk in an evolving risk landscape and dynamic market environment. 

Therefore, every risk management plan must include a continuous monitoring strategy. A continuous monitoring strategy must include the following:

• The risk tolerance of the organization to continuously adapt to changing market environments and change its priorities based on ongoing events.
• Monitoring of metrics that define a risk and its indicators to help understand the severity at all times.
  Control of measures deployed to mitigate risks and monitor their effectiveness.
• Awareness of all assets owned and controlled by the organization to understand and monitor exposure and deploy measures if and when unprecedented events occur.

Why is Risk Management Important?

Risk management is too often looked at as a hindrance to business growth. However, organizations must look at risk as a strategic enabler, that allows businesses to navigate difficult situations, and to open up fruitful opportunities and rewards. There is no reward without any risk.

Here is why risk management is important for organizations:

1. Security

One of the core benefits of risk management is overall organizational security. Everything from job security for employees, and data security for systems and clients, to financial security for the organization, is a result of effective risk management.

Risk management helps organizations prepare measures to deal with threats in several aspects of an industry, therefore, when a risk materializes, the effects of the events are not detrimental to the organization.

2. Certainty

Risk management helps organizations avoid uncertainty. As risk management allows organizations to understand the possibilities of certain events occurring, when such events do occur, teams are not startled, but rather prepared to deal with them.

Such certainty brings confidence to the organization and helps teams plan with a degree of predictability. Without risk management, organizations would remain in the dark and fail to plan for future growth.

3. Efficiency

Risk management improves efficiency in an organization by preparing teams in advance for certain events that may occur. When a risk materializes, the organization is only required to deploy the measures that have already been prepared. Since a strategy is already in place, reaction time is significantly less.

Risk management prevents organizations from disrupting their operations when events occur, since measures are already in place and organizations only need to deploy them in the usual course of business. 

4. Strategy

Risk management helps organizations curate overall business strategies. When an organization understands the potential and effects of risks, it can incorporate such uncertainty into its core business strategy.

Since risk management brings certainty to an organization, decision-making at the top level can significantly be improved and plans can be prepared with consideration for possible risks and opportunities in the future.

5. Goodwill

Risk management helps organizations protect their goodwill by preserving their assets and structure. Since risk management strategies are used to prepare organizations against uncertain events that have the potential to damage several of their aspects, they can sustain and counteract their ill effects.

Risk management builds confidence amongst people for the organization as they understand the importance of addressing and preparing for risk in the market.  

What are the Limitations or Challenges to Risk Management?

Here are some of the common challenges to effective risk management:

1. Poor Governance

One of the biggest challenges to risk management is ineffective governance within an organization. The lack of due attention and validation to risks by top-level management and the board prevents organizations from mitigating risks effectively.

Poor governance prevents risk managers from getting due budgets and powers to avoid or eliminate risks through strategies. Further, the lack of proper governance prevents risk management from being incorporated into the core business strategy.

2. Lack of Transparency and Visibility

The lack of transparency and visibility within the organization prevents risk management from being effective. For a risk to be managed, mitigated, and eliminated, the organization must remain transparent to risk managers, offering access to the entire repository for teams to identify possible points of risk sunrise. Further, the lack of visibility prevents organizations from accurately identifying where, when, and how risk will originate.

3. Emphasis on Efficiency vs. Resiliency

A risk management strategy must develop to keep the organization protected for a prolonged period, through evolving risk landscape and threats. However, organizations often tend to prioritize efficiency over resiliency when developing strategies.

An efficient-only strategy may yield fruitful results in the short term and bring more immediate financial benefits, however, is likely to fail in the long run. An organization requires resilient risk management strategies to be prepared for all outcomes and evolving threats in the future. This helps organizations yield benefits in the long term and for prolonged periods, creating sustainable and continuous business.

4. Lack of Risk Analysis Techniques

The lack of modern risk analysis techniques prevents organizations from understanding the gravity of risk and its impending effects on the organization. Risk analysis is critical to an effective risk management strategy. However, organizations often do not incorporate effective techniques, leading to inaccurate measures and failed strategies.

5. Expertise

Most organizations do not understand the importance of expertise in risk management. This is typically due to a lack of understanding of the domain. However, without employing experts for managing risk, organizations remain in the dark when attempting to understand frameworks, prioritization, and workings of the risk landscape.

What are the Risk Management Standards and Frameworks?

Risk standards and frameworks are essentially guidelines that are used by enterprises to develop an effective risk management strategy. The standards are widely used across the globe and provide a rudimentary roadmap for enterprises to understand their business environment.

ISO 31000

ISO 31000 is a widely used risk management standard developed by the International Organization of Standards, first published in 2009. 

The ISO 31000 provides the following guidelines for effective risk management: 

• Transferring accountability gaps in enterprise risk management
• Aligning objectives of the governance frameworks with ISO 31000
• Embedding management system reporting mechanisms
• Creating uniform risk criteria and evaluation metrics

COSO ERM Framework   

COSO ERM Framework is one of the most widely used frameworks for risk management by medium and large enterprises throughout the world. The framework was developed in 2004 by the Committee of Sponsoring Organizations of the Treadway Commission and has seen several revisions since.

The COSO ERM Framework is composed of 5 components:

• Governance and Culture

  These are guidelines to help organizations understand the role of executive oversight, the operational structures of an organization, and the role of leadership.

• Strategy and Objective Setting

  These are guidelines to help organizations understand the effects of internal and external factors on strategy and how organizations must navigate them to reach effective ERM.

• Performance

  These guidelines help organizations improve and adjust their risk management strategy and increase its efficiency and effectiveness.

• Review and Revision

  These are guidelines to help organizations understand how to engage in continuous monitoring and adapt to changing risk landscapes.

• Information, Communication, and Reporting

  These are guidelines to help organizations improve the flow of information within the enterprise for better awareness and risk mitigation.

British Standard (BS) 31100  

The British Standard (BS) 31100 is a framework developed in 2021 in alignment with ISO 31000 standard.

The framework provides the following guidelines for risk management:

• General

  These include general guidelines to help organizations get started with preparing their risk management strategy.

• Mandate and commitment

  These include guidelines for the organization to understand the role of leadership in developing, deploying, and managing risk management measures.

• Design

  These include guidelines to help organizations understand internal and external to better design a risk management strategy.

• Implementation

  These include guidelines to help organizations understand how to deploy strategies and measures developed to mitigate risk.

• Monitoring and review

  These include guidelines for organizations to continuously monitor the effectiveness and status of a deployed measure for managing identified risk.

• Improvement

  These include guidelines to help organizations understand flaws or limitations in a strategy and improve it based on the results of monitoring and reviewing.

The Risk and Insurance Management Society's Risk Maturity Model (RMM) 

The Risk Maturity Model (RMM) was developed by the Risk and Insurance Management Society (RIMS), a non-profit organization involved in research and development for advanced risk management.

The RMM framework includes the following components:

• Adoption of ERM-Based Process

  These are guidelines to help organizations understand their risk culture and the degree of support offered by executives or the board.

• ERM Process Management

  These are guidelines to help organizations understand how widely ERM methodologies are adopted throughout the enterprise structure. These guidelines also help identify how important ERM methodologies are to business decisions.

• Risk Appetite Management

  These guidelines help organizations evaluate their awareness level of the risk-to-reward ratio, risk tolerance, risk appetite, and the gap between potential and actual risk.

• Root Cause Discipline

  These are guidelines to help organizations identify the source and cause of a particular risk, and their classification accordingly.

• Uncovering Risks

  These are guidelines to help organizations understand how widely a risk(s) is covered and identify possible leaks within the strategy.

• Performance Management

  These guidelines help organizations improve the efficiency and effectiveness of a developed strategy, understand its effect, and incorporate changes to adapt to evolving environments.

• Business Resiliency and Sustainability

  These are guidelines to help organizations evaluate the preparedness of a strategy in terms of business continuity and planning and sustainability.

What are Risk Management Best Practices?

Risk management best practices are a set of essential guidelines and strategies that risk practitioners at all levels should follow to effectively mitigate and manage potential risks and ensure resilience against emerging threats.

Industries across the globe are evolving at unprecedented rates, and consequently, risk is as well. Therefore, to be able to tackle the risk landscape of the future, organizations need to adopt practices that can help them better understand and mitigate modern risks and adapt their programs for future needs.

Here are some of industry best practices for modernizing risk management program:

1. Historical Analysis vs. Predictive Modeling

Organizations have long relied on historical data to understand the risks of the future and their effects on the organization. However, modern risks are more adaptive and dynamic. Therefore, organizations need to develop better more adaptive risk management strategies and measures to tackle them.

Modern risk management practices prompt organizations to develop predictive models based on data to understand risks better, even in isolation from historical data. As a result, predictive models allow organizations to get more accurate results and prepare more targeted strategies for mitigating risks.

2. Data Organization

Organizations need to organize data better to understand their risks better. The modern approach to risk management prompts organizations to manage their data to improve transparency and visibility. When data is better organized, enterprises can create better models. Data organization helps enterprises reveal hidden information buried within vast tracts of data, information which can prove critical to an effective strategy.

3. Continuous Approach

Finally, as discussed above, the crux of any risk management strategy is continuous monitoring. Since risk landscapes are changing continuously so must the approach to managing them. Therefore, the modern risk management approach is incomplete without a proper continuous monitoring strategy.

4. Leveraging Technology-Based Software Solutions

Technology is helping risk managers identify, assess, and mitigate risks faster every day. As technology improves, teams, become more capable of understanding and dealing and dealing with risks. Here are some of the ways technology is helping risk management:

• Risk Modeling: Technology is helping organizations create realistic and accurate risk models through the use of data. The data fed into a system can create predictive models for organizations to understand the probability of a risk arising from a particular source, the severity of the risk, and the possible effects of the risk.
• Simulation: Through technology, organizations can now run simulations of risk scenarios and understand how they can be affected if the risk materializes. Simulations allow organizations to understand the integrity of existing systems, their status at the sunrise of the risk, and the result of the event at the sunset of the risk. Simulations also allow organizations to deploy a sandbox approach and understand the effectiveness of risk mitigation measures. The simulation can help teams understand where the gaps in the risk management strategy exist, and how they need to be addressed.
• Early Warnings: Advanced systems, especially those based on artificial intelligence and machine learning can be trained with key risk indicators (KRIs) to identify the sunrise of risk, and warm organizations early into the onset. Early warning systems allow organizations to get enough time to understand the effects of the risks, how it is evolving, and which strategies can be most effective against them.

How MetricStream Can Help

Enterprise Risk Management (ERM) software from MetricStream enables organizations to identify, assess, quantify, monitor, and manage their enterprise risk in an integrated manner. It brings together all risk management related data - automated alerts, data feeds, risk libraries, risk analytics, key risk indicators, risk heat maps, graphical and trend charts, and dashboards provide increased enterprise-wide transparency into the risk management process and highlight issues that need to be addressed. 

To learn more about MetricStream Enterprise Risk Management (ERM), request a personalized demo today.

FAQ

• What is risk appetite?

  Risk appetite is a measure of organizational preparedness to accept a certain measure of risk often quantified in financial and strategic terms. Risk appetite helps organizations understand how much risk they can take without compromising their ability to sustain a healthy business, and when such acceptance of risk should be terminated to avoid damage to the organization.

• What is risk tolerance?

  Risk tolerance is the willingness of an organization to take a risk. Unlike risk appetite, where an organization decides the level of risk they can take, risk tolerance involves the threshold for the acceptance or rejection of risk.

• What are the five steps of risk management?

  The five steps of risk management are risk identification, risk assessment and prioritization, risk mitigation, risk reporting and risk monitoring.