Chapter 25 - Risk Governance Flashcards
List the 6 stages in the risk management control cycle.
ICM CFM
- Risk identification
- Risk classification
- Risk measurement
- Risk control
- Risk financing
- Risk monitoring
The risk identification stage of the process is more than just recognizing the risks to which an organization is exposed.
Outline the other aspects that should be identified or determined at this stage.
The following should be determined / identified:
1. Whether each risk is systematic or diversifiable
- Possible risk control processes that could be put in place for each risk.
- Opportunities to exploit risks to gain a competitive advantage
- The organization’s risk appetite or risk tolerance
Risk classification
classifying risks into groups aids the calculation of the cost of the risk and the value of diversification
Risk measurement
it is the estimation of the probability of a risk event occurring and its likely severity
Risk control
involves determining and implementing methods of risk mitigation
Risk control measures are identified to mitigate the risks or consequences of risk events by:
1. Reducing the probability of a risk occurring
2. Limiting the severity of the effects of a risk that does occur
3. Reducing the consequences of a risk that does occur
What is risk financing?
Risk financing is the determination of the likely cost of a risk and making sure that the organization has sufficient financial resources available to continue to meet its objectives after a loss event occurs
The likely cost of a risk includes the expected losses, the cost of risk mitigation measures such as insurance premiums, and the cost of capital that has to be held against retained risk.
What is risk monitoring?
I EAR
- IDENTIFY new risks or changes in the nature of existing risks
- determine if the EXPOSURE to risk or the organisation’s risk appetite has changed over time
- ASSESS whether the existing risk management process is effective
- REPORT on risks that have actually occurred and how they were managed
Benefits of risk management process
SAMOSAS PJET
- improve STABILITY and quality of business
- AVOID surprises
- improve their growth and returns through better MANAGEMENT and allocation of capital
- improve their growth and returns by exploiting risk OPPORTUNITIES
- identify opportunities arising from natural SYNERGIES
- identify opportunities arising from risk ARBITRAGE
- give STAKEHOLDERS the confidence that the business is well managed
- PRICE products to reflect the inherent level of risk
- improve JOB security and reduce variability in costs
- detect risks EARLIER: cheaper and easier to deal with
- determine cost-effective ways of risk TRANSFER
Requirements of risk management process
CHAOS
- consider all relevant CONSTRAINTS
- exploit HEDGES and portfolio effects among risks
- incorporate ALL risks ( both financial and non-financial)
- exploit OPERATIONAL and financial efficiencies within strategies
- evaluate all relevant STRATEGIES for managing risk
Explain the difference between “risk” and “uncertainty”
“Uncertainty” means that an outcome is unpredictable.
“Risk” is a consequence of an action that is taken which involves some element of uncertainty, but there may be some certainty about some components of the risk.
Systematic risk
Risk the affects an entire financial market or system, and not just specified participants. It is not possible to avoid systematic risk through diversification.
Diversifiable risk
Risk that arises from an individual component of a financial market or system. An investor is unlikely to be rewarded for taking on diversifiable risk since, by definition, it can be eliminated by diversification.
What does it mean to manage risk at the business unit level and what are the key disadvantages to this approach?
The parent company would determine its overall risk appetite and then divide it among the business units.
Each business unit would then manage its risk within the allocated risk appetite.
The key disadvantages of the approach are that it makes no allowance for the benefits of diversification or pooling of risk, and the group is unlikely to be making best use of its available capital.
What does it mean to manage risk at the enterprise level?
Enterprise risk management means that risks are managed at the enterprise or group level rather than by each business unit separately, with all risks being considers as a whole.
What are the benefits of risk management at the enterprise level
CUPPED
- Capital efficiency as capital can be targeted
- Understanding the risks better and so adding value by exploiting risk as an opportunity
- Pooling of risks
- Providing insight into risk in different parts of business, including identification of unacceptable concentrations
- Economies of scale in terms of the risk management process
- Diversification, including being able to identify undiversified areas of risk
