Risk management has become critical as new challenges, such as the digital revolution, climate change, and geopolitical risks, continue to rise. “Companies will need to anticipate, assess, and observe threats based on disparate internal and external data points,” say experts at McKinsey & Company. But to begin with, what is risk management? Why is it important? Let’s find out.
What is Risk Management?
Risk management is the art of identifying, analyzing, and controlling potential risks or threats to an organization. These risks can be mitigated from various sources, such as legal liabilities, financial uncertainties, data loss, cybersecurity threats, or natural disasters. Effective risk management can help identify potential organizational threats and provide guidelines to control them.
Why is Risk Management Important?
McKinsey states, “The world is facing both uncertainty and rapid change. For companies, risk levels are rising — as are the expectations of employees, customers, shareholders, governments, and society at large.” Risk management helps an organization map out potential risks and prepare strategies to deal with them in advance or even avoid them altogether.
Risk Management is Essential to:
- Define the organization’s objectives for the future
- Plan and execute projects
- Minimize chances of failures
- Protect the company’s resources
- Save time and expenses
- Reduces the chance of workplace hazards
Now that we have established what is risk management and why it is important, let’s explore the risk management process.
What is the Risk Management Process
Risk identification is the process of identifying potential risks to an organization. This process mainly involves brainstorming and identifying all possible risks that can impact the organization. These risks include financial, operational, perimeter, and strategic risks.
Risk Analysis and Assessment
In risk analysis, new threats and their impact are determined. While in risk evaluation, the magnitude of each risk is determined and then ranked in order of priority. Risk analysis and assessment help in decision-making and operational efficiency. They save the time and resources of an organization.
Risk Mitigation and Monitoring
After determining the magnitude of risks, action plans are set in place to reduce their likelihood and diminish the severity of their aftermath. As risk management is a continuous process, it is imperative to constantly monitor potential threats and update the risk management plan accordingly.
Risk Mitigation Strategies
1. Risk Avoidance
It is an approach that attempts to minimize vulnerabilities that can lead to potential risks.
2. Risk Reduction
It deals with mitigating potential losses by reducing the occurrence or impact of the risk.
3. Risk Sharing
It is a preventative step to limit the loss by transferring part of the risk to a third party.
4. Risk Transfer
It is a strategy that involves shifting potential loss from one party to another, for instance, risk transferring by purchasing insurance.
5. Risk Acceptance or Retention:
It is the decision taken by an organization to take responsibility for potential risks when there is no acceptable or economically viable approach to risk avoidance or reduction.
Common Reasons Why Risk Management Fails
- Failure to take risks into account
- Mismeasurement of known risks
- Failure to manage risks
- Failure in monitoring risks
- Failure to use appropriate risk metrics
- Failure to communicate the risks to top management
Frequently Asked Question
What is Systematic Risk?
It is a risk that is caused by external and uncontrollable factors. It includes interest rate risk, political risk, market risk, and exchange rate risk.
What is Unsystematic Risk?
A risk arising due to factors existing in the organization. Includes business and financial risk.
What is Regulatory Risk?
The risk of changes in regulations and laws that might impact the economic value of an enterprise.
How is Risk Measured?
There are many ways to measure risks. The most common methods to measure risk include alpha, beta, the Sharpe ratio, R-squared, and standard deviation.
What are the Benefits of Risk Management?
It helps businesses identify potential risks and take actions to deal with them.
What are Examples of Risk Management in Healthcare?
It includes malpractice lawsuits, data privacy breaches, and misdiagnosis or delayed diagnosis.
What are Examples of Risk Management in Finance?
Some examples of risk management in Finance include credit loss, legal issues, fraud, asset liquidity, and market crash.
What are Examples of Risk Management in Project Management?
Some examples of risk management in project management include service outages, project disruption, budget issues, and poor product sales.
Risk management is integral to the smooth running of an organization. However, it requires considerable expertise and on-site experience. Check out the online courses on risk management offered by Emeritus designed to help you tackle present challenges in the industry and prepare you for the trends and risks in the future.
By Krati Joshi
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