Mistakes to Avoid in Risk Management
The field of risk management has undergone a sea of change in the past few decades. At one point in time, risk management decisions were based on individual expertise and gut feeling. However, now the decisions are based on sophisticated mathematical models.
From relying on human intuition to moving on to embrace artificial intelligence, the field has come a long way. A lot of money has been lost and lessons have been learned in this journey. Some of the most important mistakes have been jotted down in this article in order to help future generations of risk managers to avoid making the same mistakes.
Governance is the Number One Priority
In the earlier days of risk management, many organizations built governance structures only because the regulatory bodies mandated that such a structure is in place. However, over time, organizations realized that good governance is not for the benefit of the regulator. Instead, it is the backbone of a well-managed risk program. This is the reason that companies spend a lot of money and other resources to ensure that motivated, trained and competent people head the risk governance team. This is because the attitude and skills of the leader are mirrored in the rest of the organization. The board of directors is also often involved in the workings of the risk governance committee.
Communication is Key
Over the years, the field of risk management has become highly sophisticated and hence the advanced mathematical models tend to take all the limelight. In the pursuit of the next advanced model with more advanced features, companies often forget that risk management is a lot about communication.
All the information about risk is not generated in a single department. Instead, the information appears sporadically in a scattered manner across various departments in the organization. Hence, the risk management department has a very important job of collating this information in a timely manner and then providing it to the relevant stakeholders at the right time. Hence, risk management professionals must make sure that they dont get lost in a sea of numbers and must remember that communication is key in the long run.
Risk-Taking Not in Line With the Risk Policy
Just like individuals have a risk appetite, firms also have a risk appetite. This risk does not and should not change on a day-to-day basis. It should also not change depending upon the person who is managing the risks at the current moment.
The risk management policy of the company has to be consistent. The risk-taking should not be too less. This is because many times avoiding too many risks and playing it too safe means that the company has to let go of many opportunities. On the other hand, taking on too many risks can also be detrimental to the firm.
The inability to measure risks and to ensure that the risks remain within the bounds of a certain lower and upper threshold can prove to be a huge mistake for any organization.
Poorly Defined Team Structures
Risk management teams tend to be versatile in nature. This means that the same people may often need to play different roles. However, if the roles and responsibilities of the different team members are not clear, there could be an overlap or some responsibilities could even be missed out. It is therefore important to ensure that at any point in time, all the members of the risk management team are aware of their stakeholders and their responsibilities. It would be better if measurable goals are provided to the team members since this increases clarity.
Assuming that Risks are Static
Pretty much every risk management process makes it mandatory for the users to collect data about the risk. However, in most cases, this is done during the beginning of a project. Over time, the risk profile may change.
If the risk management department of the organization does not make an effort to stay current on the various risks that the system poses, they may not be able to predict and mitigate the risks. The risk management department must always assume that the risks are dynamic in nature and hence they must be monitored at regular intervals of time.
Being Past Oriented
A large part of risk management focuses on past data. However, it is important for organizations to realize that the past data is only for one part of the analysis.
With advances in technology and changes in the external environment, the risks which materialize in the future may be very different from the past. Hence, building models which rely heavily on past data is one of the common mistakes made by the risk management department.
Forgetting the Human Aspect
Risk management can be quite stressful. This is because when the risks actually materialize, the speed of losses being triggered can make anyone nervous. Hence, it is likely that managers may take emotional decisions irrespective of the sophisticated models that they use.
Companies that do not prepare their employees emotionally for the ups and downs which a career in risk management brings may be setting them up for failure.
The bottom line is that even though risk management has become very mathematical and statistical in nature, it is still somewhat of an enigma. Organizations have been trying to figure out the mistakes that can be avoided in order to increase their probability of success.
Authorship/Referencing - About the Author(s)
The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Risk Management - Introduction
- Benefits of Risk Management
- Principles of Risk Management
- Risk Management Process
- Risk Identification and Assessment
- Aspects of Risk Management
- Steps in Risk Management Process
- Approaches to Risk Management
- Risk Management Policy
- Commonly Used Measures of Risk
- Risk Management Plan
- Evaluation of Risk Management Plan
- Risk Treatment
- Role of HRD in Risk Management
- Enterprise Risk Management
- Implementing ERM
- Risk Management and Stock Market
- Outsourcing Risk Management Program
- Risk Management as a Profession
- Anticipating and Mitigating Organizational Risks in the Digital Age
- Challenges Facing the Australian Economy
- The Economic Costs of MeToo
- Automated Claims Processing
- Challenges in Global Insurance And International Claims
- Conflicts of Interest in the Insurance Business
- The Cost Structure in the Insurance Industry
- How Drones Will Impact the Insurance Industry?
- How Is Health Insurance Funded?
- How Self Driving Cars Impact Insurance?
- How Stock Market Volatility Affects Insurance Companies?
- Insurance Agents vs. Insurance Brokers
- The ABCs of Insurance Fraud in India
- Technological Advances in the Insurance Industry
- The Basics of Unemployment Insurance
- The Pros and Cons of Unemployment Assistance and Why it Matters in the Present Times
- The Role of Insurance In #MeToo Movement
- Why the Flood Insurance Market should be Privatized?
- Basics of Pet Insurance
- Cannabis Insurance
- Challenges Facing Cryptocurrency Insurance
- Evolution of Insurance Regulation
- Food Delivery Apps and Insurance
- How Does Captive Insurance Work?
- On-Demand Insurance
- Reinsurance vs. Double Insurance
- Solvency Regulations in the Insurance Industry
- Terrorism and Insurance
- The Basics of Microinsurance
- The Basics of Reinsurance
- Types of Captive Insurance Companies
- What is P2P Insurance?
- How Risks Affect Companies Providing Financial Services
- Risk Management Information System
- Disadvantages of Risk Management Information Systems
- The Known-Unknown Classification of Risk
- Operational Risk: Definition and Drivers
- How Regulations Have Affected Operational Risk?
- Identification of Operational Risks
- How to Identify Operational Risks
- Using Internal Loss Data to Mitigate Operational Risks
- External Loss Data in Operational Risk Management
- Risk Control Self Assessment (RCSA)
- Scenario Analysis in Risk Management
- Key Risk Indicators
- Basel Approaches in Operational Risk Management
- The Basel Risk Categories
- Cause Categories in Operational Risk Management
- Loss Distribution Approach
- The COSO Framework for Internal Control
- Mistakes to be Avoided While Building a Risk Management System
- Credit Rating Terminology
- Types of Exposures to Determine Credit Limit
- Types of Credit Events
- Active Credit Portfolio Risk Management
- Metrics to Measure Credit Risk
- Credit Derivatives: An Introduction
- Credit Linked Note
- How do Credit Default Swaps Work?
- Why are Credit Default Swaps Dangerous?
- Total Returns Swap
- What are Collateralized Debt Obligations and How do they Work?
- Collateralized Debt Obligations: Advantages and Disadvantages
- Mark To Market Accounting
- What are Recovery Rates? - Different Types of Recovery Rates
- Netting, Close Out, and Acceleration
- Expected Default Frequency (EDF)
- Expected Default Frequency: Advantages and Disadvantages
- Altmans Z Score Model
- Unexpected Loss and Economic Capital Buffer
- Stress Testing in Credit Risk Management
- Provisioning in Credit Risk Management
- How Corporate Governance Impacts Credit Risk
- Exit Strategies In Credit Risk Management
- What is Market Risk? - How its Measured and Sources of Market Risk
- Why is Market Risk Management Important?
- Introduction to Value At Risk (VaR)
- The Three Types of Value at Risk (VaR)
- Marginal, Incremental and Component Value at Risk (VAR)
- How Value at Risk (VaR) is Implemented?
- Backtesting Value at Risk (VaR)
- Advantages of Using Value at Risk (VaR) Model
- Disadvantages of Using the Value at Risk (VaR) Model
- How Margins Are Calculated Using Value at Risk (VaR)
- Market Risk Limits
- Tail Risk
- The Upside of Market Volatility
- Relationship between Volatility and Risk
- Importance of Data Quality in Risk Management
- Impact of Using Poor Quality Data and Metrics to Measure Data Quality
- Enterprise Risk Management (ERM) vs Traditional Risk Management
- Benefits of Enterprise Risk Management
- Corporate Risk Governance
- International Risk Governance Committee (IRGC) Framework
- Failure of Market Risk Management
- Mistakes to Avoid in Risk Management