Integrated Risk Management

A manager generally perceives that risk management is all about financial risk management. Three main reasons for this perspective are as follows:

  • Bulk of literature in risk management area is about financial risks and financial analysis.
  • Risk management is integrated to financial theory. This is because of the analytical and statistical problem surrounding risks.
  • Application of risk management techniques is seen more in banks and finance-service organizations.

 

An integrated approach to risk management is required. Such an integrated approach will cover risk management practices not in one area of the organization, but through out the entire organization. Initiating risk management practices in a business organization is a difficult task. The reason is that the applications vary from industry to industry. Finding an application suitable to a particular industry is a challenge.

"What we need is not risk management, but strategic thinking,” says Mr. Jack J. Hampton, Executive Director, Risk and Insurance Management Society, New York. He emphasizes that there is a need to look at risk management from a broader, integrated perspective. The risk manager has to link the customer, the product and risk exposures and then determine how they can be best managed.

So limited is the understanding of risk management subject that there is not even a generally accepted definition of ‘risk’. It is worth to state definitions of the three key terms. These are as follows:

Risk- Unpredictability in corporation/business outcome variables

Uncertainty- Unpredictability of environmental and organizational variables, which impact the corporation/business performance

Exposure- sensitivity of a firm’s/project’s cash flow to the change in interrelated uncertain variables

When a study of risks from a total organization/business perspective is done, what needs to be done is to integrate risk. Risk can be integrated with different parts of any organization. The integrated risk concept is shown in the diagram below:

It should be noted that the business risks are associated with risks in other parts of the organization. A risk in market environment will create risk in project strategy and in other areas of the business. Also a financial risk is associated with political risk, transportation risk and risk in other areas of business. Financial performance will be smooth if political, transportation, manufacturing and other environments are smooth.

That is an integrated risk management approach.

It is worth noting what different categories of uncertainties are.
Managers may see the following as uncertain:

  • General environment
  • Industry, and
  • Firm-specific variables

Each category covers many uncertainty components, as shown in the diagram below: 

 

The following gives each category in detail.

General Environmental Uncertainties
General environmental uncertainties are the factors that affect the business context across the industry. While analyzing the risk, the country unit is relevant, the country unit that is looking at the uncertainties. The relevance depends on the extent to which the uncertainties are not related across different countries. This, in turn, depends on the degree of international dependence of country’s political, economic and social systems. The classic example is the economic fall across countries after the September 11 attack on World Trade Center, New York.

Industry Uncertainties

While vast literature is available on general environmental uncertainties, the industry level uncertainties have not been fully explored. It may be taken that financial institutions and investors do carry out industry level analysis, but there is no literature in the public domain.

Firm Uncertainties

Firm uncertainties are firm-specific factors. The diagram above shows that a manager experiences many factors in day-to-day working. Issues on labor, R & D, production schedules, etc. come up everyday. The manager faces and resolves the issues, generally as they come to him. With formal understanding of integrated risk management techniques, the manager will be better prepared for the uncertainties and will not always be in a “fire fighting” mode.

How does an organization respond to uncertainties? 
Financial risk management and Strategic risk management are two responses. The diagram below outlines some typical responses to uncertainties:

 

An integrated approach is required. An integrated framework is a more effective practice for a business organization. But, as observed earlier, initiating of risk management practices in a business organization is a difficult task. The following points summarize the issues from a managerial perspective:

  • Understanding the concept of risks and their interrelation
  • Identifying risks. Having no abstract and unclear concept of risk
  • Developing a global view. That risk management is an assessment of exposure to losses and the applying of financial risk management practices is a limited view.
  • Developing responses for the identified uncertainties
  • Defining acceptance/tolerance level/limit of uncertainty
  • Developing the concept that not all uncertainties can be avoided or controlled, some have to be accepted.
  • Trade-off between marginal cost and marginal benefit while developing responses

When these issues are understood and resolved, the organization is ready for the integrated risk management approach. There is only one thing more. Implementing risk management practice in the organization requires managerial maturity, competency and organization maturity for commitments, training, processes, policies, support, etc.