Chapter25-Risk governance

Question 1

Framework

Answer 1

1 Risk control cycle stages
2 Risk identification
3 Risk classification
4 Risk measurement
5 Risk control
6 Risk financing
7 Risk monitoring
8 Benefits of risk management (SAMOSA)
9 Objectives of the risk management process
10 Example of a portfolio effect/ hedge
11 Risk vs uncertainty
12 Systematic risk and diversifiable risk
13 Classification of a fall in equity market
14 Managing risk at the business unit level
15 Benefits of enterprise risk management (disadvantages)
16 Stakeholders in risk governance

Question 2

Risk control cycle stages

Answer 2

1. Risk identification*
2. Risk classification
3. Risk measurement
4. Risk control
5. Risk financing
6. Risk monitoring
   * Risk identification is seen as the hardest aspect because the risks to which an organisation is exposed are numerous and their identification needs to be comprehensive. The biggest risks are the unidentified ones, as they will not have been appropriately managed

Question 3

Risk identification

Answer 3

The following should be determined / identified:

 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 organisation’s risk appetite or risk tolerance.

Question 4

Risk classification

Answer 4

Classifying risks into groups aids the calculation of the cost of risk and the value of diversification.

It also enables a risk ‘owner’ to be allocated from the management team.

Question 5

Risk measurement

Answer 5

The two quantities estimated are:

1. the probability of a risk event occurring
2. the likely severity.

Knowing whether a risk is high, medium or low probability and severity helps in the prioritisation of risks and deciding what risk control measures should be adopted.

Question 6

Risk control

Answer 6

Risk control involves deciding whether to reject, fully accept or partially accept each identified risk. Risk control measures are identified to mitigate the risks or consequences of risk events by:

reducing the probability of a risk occurring (eg introducing good safety procedures to reduce the risk of a fire starting)

limiting the severity of the effects of a risk that does occur (eg having sprinkler systems and adequate fire extinguishers, so a fire that does occur can quickly be put out)

reducing the consequences of a risk that does occur (eg having adequate insurance in place).

Question 7

Risk financing

Answer 7

Risk financing is the determination of the likely cost of a risk and making sure that the organisation has sufficient financial resources available to continue its objectives after a loss event has occurred.

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.

Question 8

Risk monitoring

Answer 8

 The regular review and re-assessment of existing risks

 The identification of new or previously omitted risks

Question 9

Benefits of risk management (7)

Answer 9

Stability and quality of business improved

Avoid surprises

Management and allocation of capital improved (so better growth and returns)

Opportunities exploited for profit

Synergies identified (and related opportunities taken)

Arbitrage opportunities identified (where the provider has a different view on the ‘price’ of the risk relative to another party)

Stakeholders in the business given confidence

Question 10

Managing risk at the business unit level

Answer 10

The parent company would determine its overall risk appetite and then divide it amongst the business units.

Each business unit would then manage its risks within the allocated risk appetite.

The key disadvantages of this 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

Question 11

Benefits of enterprise risk management (disadvantages)

Answer 11

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 considered as a whole.

Benefits include:

1. diversification, including being able to identify undiversified areas of risk
2. pooling of risks
3. economies of scale in terms of the risk management process
4. capital efficiency as capital can be better targeted
5. providing insight into risk in different parts of business, including identification of unacceptable concentrations

6 understanding the risks better and so adding value by exploiting risk as an opportunity