Financial risk management
Risk management is giving an understanding regarding with the agenda of some financial institutions. This tackles some limitations and the roles and responsibilities of the venturing the risk management.
This Research paper will give some information if the Risk Management is really a good decision to have in an institutions, it ill also tackle the roles and the responsibilities of the Enterprise Risk Management what will be the benefit of outsourcing Enterprise Risk Management and will discuss also the global dimension of ERM and their strategies.
This Research will also discuss the Risk of going into global and the financial risk of the Global Dimension.
The traditional risk management approach has been described as a highly disadvantageous method of managing firm risks. Within this approach, various categories of risk are managed in divide units within the firm. Financial firms often manage market, credit, liquidity, and operational risk separately in individual risk silos. Usually, non financial firms have followed a related attempt to danger, financial, venture, and strategic risks (Risk Management and Insurance Review, 2003).
Enterprise Risk Management (ERM) typify as a primary shift in the way businesses must advance risk. An enterprise wide come up to risk management treats each of these risk classes as part of the firm’s overall risk assortment that is managed holistically (COSO-ERM, 2004).
WHAT IS ERM?
ERM can be define as Enterprise Risk Management which is a method, concerning by the an individual, organization and other staff, concerning tactic setting and across the enterprise, planned to “identify possible events that may affect the entity, and manage risk to be within its risk inclination, to provide sensible assertion regarding the attainment of entity objectives” (Rutledge, 2004). Enterprise Risk Management (ERM) captured the attention of risk management professional and academics globally. Not like the conventional “silo based” advance to corporate risk management, ERM enables firms to benefit from a primarily protective to increasingly unpleasant and strategic (Holton, 2004).
The economy becomes more help driven and globally pointed; businesses cannot provide to let new, unforeseen areas of risk remain unidentified. Currency instability, human resources in foreign countries, “dissolving distribution channels, corporate governance, and unprecedented dependence on technology are just a few of the new risks businesses must asses. A lot of organizations are choosing to put into a practice an Enterprise Risk Management process to ensure that a uniform approach to risk identification, measurement and treatment is utilized across the organization” (Holton, 2004).
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The Fundamental principle of Enterprise Risk Management is that every individual exists to offer value for its stakeholders. All individuals “face uncertainty and the challenge for management is to find out how much uncertainty to accept as it struggle to grow stakeholder value. Uncertainty presents both risk and opportunity, with the potential to erode or enhance value” (Beasley, 2004).
Here we can conclude that ERM represents a very thrilling opportunity for the financial services industry to create new markets for their products. “Whether they can successfully rise to the challenge will be a dominant question for the industry in this decade”( Salman& Saikh, 2004). Value is expanded when administration sets tactic and objectives to strike a most favorable balance between development and return goals and connected risks, and proficiently and effectively organizes resources in pursuit of the entity’s objectives. This rate centric has two key advantages 🙁 Salman& Saikh, 2004)
* Enumerates the impact of ERM on shareholder value.
* Construct a general “language” that unites otherwise disparate ERM processes.
Enterprise Risk Management Encompasses:
** Supporting risk inclination and strategy. Management considers the entity’s risk inclination in assessing strategic substitute, setting related objectives.
** Improving risk replying evaluation. Enterprise Risk Management offer accuracy to recognize and choose among different risk response, risk avoidance, decrease sharing and recognition.
** Decreasing functional surprises and losses. Every individual gain improved qualifications to identify possible events and determine responses, decreasing surprises and associated costs or losses.
** Classifying and controlling several and cross enterprise risks. This expertise intrinsically in project risk management help management accomplish the individual’s presentation and “profitability targets and prevents loss of resources. In total, enterprise risk management helps an entity get to where it wants to go and avoid pit falls and surprises along the way” ( Salman& Saikh, 2004)
A. Identification tools
“It is all too obvious that for a given organization, exposure identification requires systematic understanding of both the organization itself, for endogenous perils, and of its environment. It includes the overall economy, the social, and the legal and cultural components as well”. (Rutledge, 2004).
B. Roles and Responsibilities
Everybody in an entity has some responsibility for venture risk management. Other managers hold up the entity’s risk management philosophy, endorse conformity “with its risk appetite, and manage within their spheres of responsibility consistent with risk tolerances. Additional entity staffs are accountable for implementing enterprise risk management in accordance with established commands and protocols. The board of directors endows with important supervision to enterprise risk management, and is aware of the assent with the entity’s risk appetite” (Bradford, 2004). A total of outside parties, such as customers, dealer, business partners, external auditors, regulators, and fiscal analysts often give information useful in effecting venture risk management, but they are not liable for the effectiveness of, nor are they part of the entity’s enterprise risk management.
DRIVING FORCES BEHIND ERM
The trend towards the adoption of ERM is usually attributed the combination of external and internal factors. “The major external influences that have driven firms to approach risk management” in a more holistic manner are a broader scope of risks arising from factors such as globalization, industry merging, and deregulation; internal factors are centered on an emphasis to maximize shareholder wealth. ERM advocator argue that an included approach increases firm value by reducing inefficiencies intrinsic in the traditional approach, improving capital efficiency, stabilizing earnings, and reducing the expected costs of external capital and regulatory scrutiny (Halibozek & Kovacich, 2005).
In general, increased competition has shifted the emphasis of risk management from defensive focus to one that is more offensive and strategic. While traditional risk management is largely “concerned with protecting the firm against adverse financial effects of risk” (Holton, 2004). Profit-maximizing firms should consider implementing an ERM program if it increases expected shareholder wealth. Though particular advantages of distinctive risk management activities are clear, there are disadvantages to the traditional silo approach to risk management. Supervising each risk class in a split silo creates inefficiencies due to lack of harmonization between the various risk management departments. Firms that engage in ERM are able to better appreciate the cumulative risk inbuilt in different business activities. This provides them with a more objective basis fro resource allocation, thus improving capital efficiency and return on equity.
Thus, whereas individual risk management activities can lessen earnings instability from a specific source, an ERM strategy reduces instability by preventing of risk across different sources (Holton, 2004). An advance source from ERM programs take place due to improved information about the firm’s risk profile. ERM facilitate these financially opaque firms to better inform outsiders of their outline risk and also serves as a signal of their commitment to risk management. By enhancing risk management discovery, ERM is likely to lessen the expected costs of regulatory scrutiny and external capital. The nature of risks confronting financial firms has changed due to the recent wave of industry consolidation that as resulted in more complicated financial organizations. Financial corporations offer a wide selection of products that entail potential liabilities and risks that are increasingly inter-reliant.
GETTING TO FULLY IMPLEMENTED ERM IN FINANCIAL SERVICES A STRATEGIC FRAMEWORK
The major pace of performing the Enterprise Risk Management plan to create a structure that will define what will the ERM denote for the company and use this structure to expand a plan that will modified to the company’s needs. This company should accumulate a team that is inspired to implement a successful ERM agenda. The leader should work for the internal and external advisors. A team leader should be appointed who will supervise the developments. Communication on a timely basis is an integral part in the success of the program. (Goenka, 2003).
After implementing and prioritizing the strategies, financial corporations need to recognize the whole set of techniques available to them to administer these financial accounting practices. They must privately monitor the each of the company’s transaction when they occur (Goenka, 2003).
INTRODUCTION TO RISK
We would be now briefing about RISK as it is main element of Enterprise Risk Management as it determines how to manage risk within enterprise in respect to Finance and Business risk. According to the information Wikipedia, Risk is often planned to the possibility of some event which is seen as adverse. Typically the possibility of that event and some evaluation of its anticipated mischief must be combined into a credible situation (an outcome) which merge the set of risk, remorse the incentive probabilities into an expected value for that outcome. We know that number of “small” incidents did occur but have been fended off. This immediate reaction is to call up insurers, where it has been recognized and analyze beforehand. In order to survive, every business makes a decision to “broaden or increase its offerings; a modicum of risk does exist” (Bradford, 2004). The greater part of businesses face risks when they join together new offerings into their current ones take new employees, when they modify their marketing techniques sufficiently, or when they “enhance into new areas of business above and beyond the general core business. Every time new project, enterprise or offering is added to a business, “risk containment” should be engaged. It is by no means possible to get rid of all risks completely, but containing risks to an acceptable level will expand the experience and keep the overall losses at an acceptable level, if breakdown of the new or offering does occur” (Bradford, 2004).
Risk Management is a continuous process to guarantee that proper consideration is given to vagueness in all decisions made within the institutions and that the proper documentation is kept for internal and external controls. It is the process wherein organizations systematically “address the risk attaching to their activities with the goal of achieving prolonged benefit within each activity and across all the portfolio of all activities” (Crouhy & Robert & Galai, 2000).
It covers three measures: diagnosis of exposure, treatment of risk and audit of the risk management programmes. The meaning clearly refers to the essential part of the sound risk management that contains not only the justification by the third party but also observing and testifying , like for example understanding and tracking the risk decisions that have been made and how they relate to the objectives that have been set forth and also how are they executed and studied periodically to make sure the pertinence with evolution or the internal or the external contexts as well as organizations own objectives.
RISK MANAGEMENT OBJECTIVES
The organization has been defined as a dynamic combination of resources organized to reach a set of goals and missions. In any event, economic efficiency, will dictate the allocation of resources in the most economical way. Within this framework, the objective of the risk management process can be defined as the availability, under any set of circumstances, of the resources at a level compatible with the fundamental objective of the organization.
RISK MANAGEMENT PROCESS
Risk Assessment: “The overall process of risk analysis and evaluation
Risk Analysis: It includes”: (Salman & Saikh, 2004)
Risk Identification: It sets out to recognize an organization’s exposure to uncertainty. This needs personal information “of organization, the market in which it operates the legal, social, political and cultural environment in which it exists” (Salman & Saikh, 2004)
Risk Estimation: Risk Estimation can be capacity, semi-quantitative or Excellency in terms of the probability of occurrence and the possible consequence.
Risk Evaluation: When the risk analysis process has been completed, it is essential to evaluate the approximate risks against risk criteria which the organization has established. Risk assessment thus, is used to make result about the significance of risks to the organization and whether each exact risk must be accepted or treated. Risk Reporting and Communication;
Risk treatment is the process of choosing and executing measures to adapt the risk. Risk management includes as its major element, risk control/alleviation, but extends more, “for example, risk avoidance, risk transfer, risk financing, etc” (Salman & Saikh, 2004)
Monitoring Review of Risk Management Process:
Effective risk organizations oblige a reporting and review assembly to ensure those “risks are effectively identified and assessed and that appropriate controls and responses are in its place. Regular strategy and standards observance should be carried out and standards performance reviewed to identify opportunities for improvement” (Millage, 2005).
ANALYSIS OF ENTERPRISE RISK MANAGEMENT IN GLOBAL DIMENSION
“The process of the globalization started during the 1960’swith emergence of multinational and transnational corporation that coincide with expansion of international trade following the Second World War. During 1970’s a number of factors came together that molded globalization into what we see today and these were; The internationalizing the capital market, the expansion of the international securities investment and bank lending, The increasing sophistication of information technology used within commerce, the reduction state control and the subsequent rise in deregulation and oil crisis. Each of these factors led governments and organizations to consider how they could stay competitive in a commercial environment with fewer controls and increased competition. Other sought out the cheapest labor with which manufacture their goods, leading a massive basis of the industrialized world as the work was transferred to the cheaper economies of the Far East, Central Asia and most recently China” (Millage, 2005). Similar actions have impacted other global organization including Nike, Wall mart, Gap, and Shell. And behind of these actions are nongovernmental organizations, which have emerged to fill the void left governments as they withdrew fro setting the boundaries of corporate social responsibility. The continued rise in NGO’s means that organizations have to manage the risks from political, environmental and human rights advocate as a carefully as any other risk they face.
THE FINANCIAL RISK OF GLOBALIZATION
When business contact occurs across overseas borders they involve additional risk beyond those that are managed in a domestic setting. It is own as country risk and it arises because of the different business, economic and political environments that exist around the world. This means that, for those organizations that are transnational, the management of the country risk is an increasingly important capability.
How country is managed “depends very much on the nature of the relationship the organization has with the countries with which it trades”(Chorafas, 2007). In particular, political risk has to be carefully monitored in those parts of the world which have the history of instability. Country risk also varies with the type and nature of loans, long-term loans o governments usually have low economic risk, but high exchange, sovereign, and political risks, whilst a short-term loan to a private entity is typically low risk apart from transfer risk. There 6 categories of country risk; those are:
Economic Risk- This is the risk that the expected return on an investment held within the country is affected by changes in a country;\’s economic structure or growth.
Transfer Risk- This arises from restrictions in capital movements imposed by foreign governments (Chorafas, 2007).
Exchange Risk – “This is a risk that has a sudden change in the value of the country’s currency” (Chorafas, 2007).
Location or Neighborhood Risk- this is an essence where the problem of one country spill over to the next.
Sovereigns Risk- This is the risk associated with the failure of the government to meet loan requirement.
Political Risk – This relate to the general political consistency of the country that can change in times of regional war, military groups and civil war.
RISK OF GOING GLOBAL
Until recently, globalization has offered plenty of upside and not much downside. Cheap labor has allowed corporations to produce their goods with much lower input costs, thereby allowing them to increase margins. However, with the advent of the internet and the increased of the environment and the exploitation of developing nation’s workforces, transnational corporations are now at risk from pressure groups and boycotts that can seriously hit their bottom line and do not untold damage to their brand (Holmes 2002).
OUTSOURCING FROM THE PERSPECTIVE OF ERM
Nowadays, many companies are revolving their attention to foreign markets; the numbers of global companies are accelerating. A manufacturing company usually doesn’t want to waste its management resource to this function. Therefore, they prefer to outsource this function to logistic companies which posses all the necessary skills and technology in his service like for example, Marks and Spencer, one of the leading retailers has outsource their distributions. In addition, Marks and Spencer customers start to get high level of store (Geonka, 2003).
With rising incidence, outsourcing decisions are urged by chance to “encapsulate huge labor cost savings by shifting core business processes to highly capable overseas providers whose labor rates are dramatically lower than similar ones in the US” (Geonka, 2003).
An ERM view of the risk to involve with outsourcing tried to identify, evaluate, and respond to all significant risks associated with the outsourcing decision that is to an enterprise’s strategy and reputation.
An Enterprise Risk Management approach to outsourcing can help organization and the board of directors live up to expectations related to effective risk management for the organization.
The result of this research is that we believe that this topic could be methodological inspiration for the enterprise-wide risk management in other industries. They can be merged to build an enterprise wide risk model and identify probable correlations. Several reasons require the risk to address the quantification of its risk. At first the organization should know the financing program is well suited for the perils it has to face ( Chorafas, 2007). Financing programs feature must be linked to the distribution of potential losses that have to be covered. Second, when an organization has to negotiate with insurers or insurance brokers its has to be aware of the consequences that will have to face by the company. And third, the optimization of an existing financing programmed or the design or the design need a building quantitative models. “And in many ways we will all used the dealing with certain level of risk within our daily lives” ( Chorafas, 2007).
“Successful organizations there tend to be excellent risk managers not only because they understand the risks they face, but also of how they manage them. Unfortunately, managing risk is no longer a simple process. They are no longer isolated events but interconnected and liable to cause a chain reaction that can ripple around the world” ( Chorafas, 2007).
“Ultimately, all risk have a financial impact, and because of this managing , risk management must encapsulate managing strategic, business, operational and technical risks rather than those associated with pure finance such as credit, interest and current rate” ( Chorafas, 2007).
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