Risk Management Process with Examples

Risk is part of any business or organisation. It’s about identifying, assessing and mitigating the risks that could impact the entity’s operations, finances and reputation. A good risk management process means potential risks are managed well and minimised so the organisation is stable and successful.

The Risk Management Process

1. Risk Assessment

First of all you need to identify the risks. That means looking at all the areas of the business. Risks can come from financial uncertainty, legal liabilities, strategic mistakes, accidents and natural disasters.

Example: In a bank context, risk assessment might mean recognising credit risk, market risk, operational risk and compliance risk. The bank would do this through audits, inspections and analysis of past events.

2. Risk Quantification

Once the risks are identified, you need to measure them. That means quantifying the probability of the risk happening and the potential impact of the consequences. This step uses statistical models, historical data and expert judgement to score the risk.

Example: Back to the bank example, the bank would develop credit risk models to score credit risk. This might mean looking at credit scores, financial statements and historical default rates to score the probability and impact of borrowers defaulting on loans.

3. Risk Mitigation and Action

Once the risks are measured, you need to develop and implement strategies to mitigate them. That means creating action plans to reduce the likelihood of the risks happening or to minimise the impact if they do happen. Risk mitigation strategies can include controls, diversification, buying insurance and contingency planning.

Example: For credit risk, a bank might implement measures such as collateral for loans, diversify its loan book and credit limits for borrowers. These will reduce the impact of credit risk on the bank’s stability.

4. Ongoing

The final step in the risk management process is ongoing. That means reviewing and updating risk management regularly to see if it’s working. Ongoing will help you identify new risks, review existing controls and change risk management plans.

Example: A bank would monitor its credit risk by reviewing loan performance, economic changes and updating credit risk models.

Risk Management Process: A Banking Example

Let’s go through a detailed example of how a bank manages credit risk.

Step 1: Risk Assessment

The bank starts by identifying all sources of credit risk. This means reviewing the loan book, high risk borrowers and the economic environment. The bank identifies risks such as borrower default, economic downturns and interest rate changes.

Step 2: Risk Quantification

Next the bank measures the impact of credit risk. It builds credit risk models to calculate the probability of borrower default and the financial loss. The bank looks at historical data, credit scores and financial statements to gauge risk levels. For example the bank might determine there is a 5% chance of borrower default, $100,000 loss per default.

Step 3: Risk Mitigation and Execution

Based on the risk assessment the bank develops strategies to mitigate credit risk. This means requiring collateral for high risk loans, diversifying the loan book to spread risk and setting credit limits for borrowers. The bank also sets up contingency plans for potential defaults such as setting aside reserves to cover potential losses.

Step 4: Ongoing Monitoring

The bank monitors its credit risk exposure by reviewing loan performance, changes in the economic environment and updating credit risk models. It does regular audits and inspections to ensure risk management strategies are working and makes changes as needed.

Why is it Important to Know the Process?

Knowing the process is important for:

1. Core of Risk Management

The process is the core of all risk management. It provides a framework for identifying, assessing and mitigating risks so you can manage threats.

2. Better Decision Making

A defined process means better decision making by knowing the risks and their impact. So you can make informed decisions, allocate resources and plan for risks ahead of time.

3. Protects Organisational Assets

By identifying and mitigating risks the process protects an organisation’s assets including financial resources, reputation and operational capability. So the organisation can be sustainable in the long term.

4. Regulatory Compliance

Many industries are regulated and require risk management practices. Knowing the process helps organisations comply with regulations and avoid fines and penalties.

5. Builds Stakeholder Confidence

Good risk management builds confidence with stakeholders including investors, customers, employees and regulators. It shows the organisation is planning for risks and is stable and reliable.

Conclusion

Risk management is part of every organisation’s DNA. By following a process to identify, assess and mitigate risks you can manage the threats and be long term successful. Risk professionals need to understand the risk management process and it’s the foundation for developing effective risk management strategies. Whether in banking or any other industry, a structured risk management process is key to navigating the complexities and unknowns of today’s world.