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RISK MANAGEMENT: THE CASE FOR AN ENTERPRISE WIDE APPROACH Enterprise Risk Management is a relatively new term that is quickly becoming viewed as the ultimate approach to risk management. Since the mid- 1990 s, enterprise risk management has emerged as a concept and as a management function within corporation. (Geneva) Enterprise-wide risk management looks within and across business lines and activities of the organization as a whole to consider how one area of the firm may affect the risks of other business lines and the enterprise as a whole. This approach is in marked contrast with the silo approach to risk management, which considers the risks of activities or business lines in isolation, without considering how those risks interrelate and affect other business lines. While individual business lines or activities should continue to enhance their own risk-management practices, as organizations gain in complexity it is important to provide the critical oversight that can come only from an enterprise-wide risk-management approach. According to the Casualty Actuarial Society (CAS), enterprise risk management defined as the process by which organizations in all industries assess, control, exploit, finance and monitor risks from all sources for the purpose of increasing the organizations short and long term value to its stakeholders. A truly holistic, integrated, future-focused and process oriented approach helps an organization manage all key business risks and opportunities with the intent of maximizing shareholder value for the enterprise as a whole. (KPMG, 2001) Furthermore, to understand enterprise risk management within organization, it is important to recognize the distinction between risk measurement and risk management.
Risk management entails the quantification of risk exposures and quantification can be a variety of forms value-at-risk, earning-at-risk, stress scenario analysis, duration gaps-depending on the type of risk being measured and degree of sophistication of the estimates. On the other side, Risk management refers to the overall process that a financial institution follows to define a business strategy, to identify the risks to which it is exposed, to quantify those risks, and to understand and control the nature of the risks it faces. According to FRBNY review enterprise risk management involves not only an attempt to quantify risk across a diversified firm, but also a much broader process of business decision making and of support to management in order to make informed decisions about the extent of risk taken both individual lines and by the firm as a whole. However, no enterprise operates in a risk free environment, and even enterprise risk management does not create such an environment. Rather, enterprise risk management enables management to operate more effectively in environments filled with risks.
According to KPMG 2001 report enterprise risk management provides enhanced capability to: Align risk appetite and strategy Link growth, risk and return Enhance risk response and decisions Minimize operational surprises and losses Identify and manage cross-enterprise risks Provide integrated responses to multiple risks Seize opportunities Rationalize capital So enterprise risk management helps an organization to achieve its performance and profitability targets and prevent loss of resources. And it helps an organization to ensure that it complies with law and regulations, effective reporting and avoiding damage to its reputation and other consequences. All together it help an entity get to where it wants to go and avoid pitfalls and surprises along the way. (Steinberg and Anderson) Moreover, one of the main reason why the risk management has received as much on going attention is that corporate disasters seems to occur on a regular basis to remind us of the perils of not getting it right. (Lam J, Erisk 2001) These can be related to natural catastrophes, accidents, human error or fraud and traditionally companies have been able to transfer such kind of risk to insurance companies. (Geneva) But few years ago, risk management problems led to the collapse of baring, kidder and confederation life, as well as huge losses related to derivatives trading at other companies. So as a result of these wake-up calls and internal risk reviews, leading companies now using enterprise wide risk management approach or overall risk management approach to business risks instead of traditional approach of risk management. As risk management help to improve bottom line positions by cost reduction and improving the likelihood of overall business success and other side speculative risk management failures such as Baring, Piper alpha and the sea Empress disaster grab headlines but many organizations suffer large cumulative losses from myriad of lesser incidents. According to Waring and Glendon (2002) objectives of risk management may be summarized as eliminating, reducing and controlling pure risk and gaining enhanced utility or benefit from speculative risk.
As an enterprise point of view both pure and speculative risks often interact e. g. an organizations financial investment and business risks are likely to adversely affected by uncontrolled security risks or IT risks. So it is therefore advantageous that both sets of risk management objectives should be considered in a holistic way. A common thread of enterprise risk management is that the overall risks of the organization are managed in aggregate, rather than independently. Risk is also viewed as a potential profit opportunity, rather than as something simply to be minimized or eliminated.
The level of decision-making under enterprise risk management is also shifted, from the insurance risk manger, who would generally seek to control risk, to the chief executive officer, or board of directors, who would be willing to embrace profitable risk opportunities (Kawamoto 2001) Basically, there are few components of enterprise risk management which organization needs to be consider. For example corporate governance, line management, portfolio management, data and technology resources, risk transfer and stakeholders management. Moreover a range of external and internal factors can cause the outcomes of companys activities to depart from those sets down in its corporate objectives. (Geneva) From company point of view there are some external factors those relate to in the market place in which company competes but some of the external factors are beyond the control of management, although active enterprise risk management require that there are systems in place to make a company more resilient and adaptable to major changes. And Issues of risk management and corporate governance are closely connected. Corporate governance is the responsibility of corporate management to ensure that an effective risk management programme in place. The aim of corporate governance should be to ensure that the company meets not just objectives of its shareholders, but also has regard to interests of other individuals and groups with a stake in the company.
Whereas line management and portfolio management are equally important from the point of view to managing risk, perhaps line management is the most important phase for assessing and pricing risk is at its inception. In the pursuit of new business and growth opportunities, line management must align its business strategy with corporate risk policy and to support the portfolio risk management objectives, risk transfer strategies should be executes to lower the cost of hedging undesirable risks, as well as to in crease the organisations capacity to originate desirable but concentrated risks. To reduce undesirable risks management should evaluate derivatives, insurance and hybrid products on a consistent basis and select the select the most cost effective alternative. E.
g. , Honeywell and Mead have executed alternative risk transfer (ART) products that combine traditional insurance protection with financial risk protection. As overall risks of an enterprise are an integral part of its corporate strategy, one way of managing these risks is through the choice of the corporate strategy itself. Moreover, risk analytics and, data and technology resources are also equal important components in enterprise wide risk management approach. The development of advanced risk analytics has supported the quantification and management of credit, market and operational risks on a more consistent basis where as the greatest challenges for enterprise risk management is the aggregation of the underlying portfolio and market data. Mainly portfolio data help to find out the risk positions that are captured in front and back office systems.
Market data include prices, volatilizes, and correlations. (Lam J, Erisk 2001) Furthermore, risk management is not only an internal management process, but it should be used to improve risk transparency to key stake holders. It includes the duties of Directors such as periodic reports and updates on the major risks faced by the organization. Regulators need to know that sound practices are in place and also an equity analysts and rating agencies need risk information to develop their investment and credit options. So during communicating and reporting to these key stakeholders, an important objective for management is to assure them that appropriate risk management strategies are in affect. In addition to these a number of other factors have also contributed to the development of enterprise risk management.
Recent technology advancement in computing power provide the powerful modelling tools necessary to perform sophisticated risk analysis for hazard risks, such as catastrophes, for financial risks, such interest rate rise movements and for the other risks. Insurers are also developing an expertise in, and a focus on, financial risk management. Some insurers are beginning to provide policies that coordinate financial and pure risk. (Either loss or no loss). Insurers are beginning to utilize the financial markets themselves through the securitization on insurance risk. (Darcy S, 2001) According to the risk magazine enterprise risk management is fast becoming the best standard because the traditional approach has not produces results. Over time, it has been increasingly apparent that fragmented approach or managing risk by silos, doesnt work properly because risk are highly interdependent and cannot be segmented and managed solely by independent units. Since the enterprise risk management involves a wide area of organization operation, and integrates a wide variety of different types of risks face by organization.
So in most cases, a team approach is used, because one person not always able to expertise in handle entire role. In team approach enterprise use the different expertise from different areas, including traditional risk management, financial risk management, management information systems, auditing, planning and line operations. Basically, team approach not allowed managers to focus on particular area of business e. g. , traditional risk manger cant remain concentrate only on hazard risk. In order for the team to be effective each area will have to...
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