Integrating risk management, Risks in risk management, Fragmented risk focus

document management services - Integrating risk management, Risks in risk management,  Fragmented risk focus ; RISK management is not a new phenomenon. It has been with us for ages but seemingly in ways less defined than it is today.

Notice the usual precautions that we consciously or unconsciously do in daily life inherent to and dictated by our survival instincts?

They are innocent manifestations of that natural urge to overcome or manage risk—by avoiding or by confronting, or repelling, or minimizing, or deflecting the risk and the damage that could occur from the happening of the unexpected—as in the simple risk of opting to cross a busy accident-prone intersection, or the decision to risk lending money to a neighbor or officemate, to venturing and investing in business and so on.

Indeed, all human activity involves risk.

The probability of the unexpected turning up and/or of suffering loss touches all spheres of life, be it personal or business.

As activities multiply and businesses expand so does risk. As traditional financial operations grow more complex, like in the banking business, so does RM.

It becomes increasingly sophisticated for both asset-quality or liability-related risks and for operational activity-based costs.

The dramatic developments in the field of technology; the globalization of business operations with its far-ranging risk implications; and the seriousness of the financial melt-down of late, has given RM its current prominence… acquiring its own language and its systematized, albeit at times expensive, architecture.

Fragmented risk focus

Unwittingly, however, RM-focus seems to narrow down to the usual risk exposures: credit, interest rates, foreign exchange, sovereignty, and hazards contingent and/or conditional to market forces. In not a few institutions, these exposures are still “viewed individually and dealt with in fragmented ways”.

And under this narrowed-isolated focus, the practice of RM runs the risk of being unable to sufficiently address the other, just as essential but subdued, category of risk: the operational cost or the so-called transactional-related risks which affect management quality.

Author W. Barent Wemple, a London-based financial services consultancy director, observed that transactional risks (which are deemed more controllable than the so-called conditional risks attendant to market and credit dynamics) are costing companies more than they realize.

The cost of wasted time, effort and resources are rarely captured through the accounting system, but they are embedded in every work process throughout the organization. Non-value-added activities, associated with ever-tighter monitoring and controls, or the correction of problems, or reconciliation of mistakes other staff members unmindfully make, are often not emphasized in the structuring of MIS systems which eventually impact negatively on the bottom line.

Enhancements, problems

Enhancements in control over risk-related cost, as Dir. Wemple elaborates for Bankers’ Magazine, are nonetheless being addressed through: 1. Risk analysis (so that returns gained are more commensurate with the level of risk); 2. Use of technology (thus increasing system functions, products, and services to customer); 3. Customer orientation (to reduce such undesirable outcome as inquiries and problem resolutions through customer-care initiatives and education leading to differentiation based on factors other than price).

However, Dir. Wemple adds, there are yet cogent issues or problem areas that need to be successfully addressed as well. And they are:

[1] Inconsistency in defining risk. This makes difficult determining where overall risk management has failed to address specific exposure.

[2] Fragmented responsibility. With each type of risk being addressed in isolation, more complex risks will escape proper management.

[3] Increased operational risk. Need to address poor output quality occasioned by growing process design complexity. “Automation easily makes situation worse because it vastly increases the speed at which errors are propagated thru interconnected systems before they are caught.”

[4] Inadequate process analysis.

Design changes are occurring more frequently even though existing processes may not yet have reached their optimal operating level in terms of performance and cost-efficiency.

Return on investments is therefore not recovered.

These weak points highlight the necessity, the rationale and the push for an integrated Enterprise-wide Risk Management (EWRM) if only to elevate the quality of the RM practice.

Integrating risk management

How is the integrated management of risk constituted? Dir. Wemple sums up the requisite components (which by their nature are interdependent and would entail sustained long term effort link to business strategy) into:

1.) Decision support. An executive MIS vehicle which institutionalizes: i} a financial risk integration system affecting refinement and aggregation design that bridges various specific risks in a qualitative manner; and ii} a poor-quality-risk definition system which expresses and quantifies operational activity-based cost. This will alert Management to wasted effort throughout the company’s business processes.

The Alco approach (Asset-Liability Committee) is one step that promotes integration, cross-functional and strategic thinking; enhances quality decision-making; and constantly update efforts to address, among others, waste reduction opportunities on a continuing basis where the potential returns are greatest.

2.) Well-organized responsibilities. Organizations should reflect issues of joint risk oversight, properly matched authority, as well as operating and financial risk management. (All of these issues, for example, would “exist in the loan origination, loan underwriting, and loan management activities for a given portfolio. The principal objective is to eliminate situations in which several areas contribute to a given risk but responsibility is improperly attributed to one manager. One other instance is when risk is not well understood prompting a strategy in which cost or returns are ill-matched”).

3.) Overall risk strategy. RM objectives must agree with corporate policy and strategy. Thus, management is led to managing previously fragmented body of issues with one understanding and one voice.

These factors bring out the logic of a complementing multidimensional RM unit to precipitate an integrated and more circumspect appreciation of products, processes and risks. For in EWRM it is essential to “promote consistency among executives about defined risk types, their behavior and the means to express them objectively in quantifiable way” that should likewise facilitate the process of risk mapping, monitoring and assessment.

Risky assumptions

Finally, it is worthwhile and more circumspective to also note, at this point, author Nassim N. Taleb, et al., (a Risk Engineering professor at the New York University Polytechnic Institute), who warns of risky assumptions executives fall prey in risk management, thus: 1. assuming that one can manage risk by predicting extreme events (because by focusing attention on a few extreme scenarios, we neglect other possibilities in the process); 2. that studying the past will help us manage risk (because there is no such thing as a “typical failure or a typical success” such that hindsight can substitute and serve as foresight; and further, lamely use the excuse that “this is unprecedented” not knowing that catastrophic events have no precedents more so that today’s world do not resemble the past); 3. assuming mathematically equivalent is also psychologically so (because two mathematical formulation can be unequal to the human mind when presented in different ways: like the case of a “glass half full or a glass half empty.” By just the manner of presentation, the appetite for risk could either go up or go down.); 4. thinking that efficiency and maximizing shareholder value don’t tolerate redundancy (because while leverage is good, optimization makes companies fragile and vulnerable to changes in the environment); and 5. Not listening to advice about what should not be done (because business is not just a case of making profit but also of avoiding losses. Acts of commission may be different from acts of omission but they may have the same economic impact—a peso not lost is a peso earned. Emphasis is not just on earning profits but also of avoiding losses. A company can also be successful by preventing losses while its rivals go bust.)

In sum, “RM should be about lessening the impact of what we don’t understand—not a futile attempt to develop techniques and models that perpetuate the illusion that one can predict and therefore increase risk exposure instead of limiting it and reducing the institution’s vulnerability!”

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