Ever since the financial downturn of 2007 and 2008, greater scrutiny and tighter regulations have caused the world of finance to shift in both attention and practice. Risk management is now much more central to how financial firms and investment companies conduct business. Not only are more resources and time being allocated to managing risk but companies’ agendas are reflecting the need for more mitigation of risk. The result has been a boom in risk management technologies, practices, techniques and services.
Working within the field of finance has never been more complex. From increasingly complicated regulations and financial metrics to the impending approach of some kind of cyberattack, good and thoughtful risk management can mean the difference between staying in business and going to jail. Here is a closer look at the ways financial firms are beefing up their risk management profiles and practices.
An operational risk is any risk resulting from a business’s own internal activities, culture and behavior. In the realm of risk management, managing a firm’s operational risk is accomplished by paying attention to the people, systems and processes dictating the way a company operates. The level of operational risk at which an organization operates is directly tied to the inadequacies and failures its own employees and systems exhibit.
All organizations realize their employees and processes are imperfect and bound to incur mistakes. What operational risk management provides is a means and a measure to ensure the level of mistakes never rises above what is tolerable; it prevents situations where too much money is lost, customer relations are irreparably harmed or laws are broken.
The Board of Directors
Another major player in financial risk management is an organization’s board of directors. When the housing bubble and subprime mortgage market burst, it left the world in a major recession; it was revealed that many financial institutions were operating with extreme leniency prior to this burst. Now regulators are focusing on whether or not a company’s board is doing its due diligence in providing guidance and oversight in risk management. Gone are the days when boards can claim ignorance regarding a firm’s activities. Boards of directors are now expected to be in the thick of monitoring their firms’ appetite for risk and the ways that appetite is being carefully and safely managed.
Systemic risk refers to the risk of collapse for an entire financial system or market, as opposed to the risk being taken and leveraged by an individual firm or group. It refers broadly to the stability or instability of an entire financial system.
For those tasked with systemic risk management, it refers to all the components composing the interdependencies of a system or market where the collapse or failure of one piece could undo the rest, causing a cascading failure or overall market crash.
When a risk manager engages in capital modeling, she is helping her client or team use capital more efficiently, so they are protected from the constantly shifting and evolving complexities inherent within the world of finance. Having too much or too little capital on hand at any given time can raise the risk of insolvency or increase costs needlessly. Through capital modeling, risk managers help firms walk a finer line regarding risk, compliance and expense.
More and more, the threat of a cyberattack must be included in any financial firm’s risk management protocol. Too many companies are still far too underprepared and under-protected, even as organizations like the Risk and Insurance Management Society (RIMS) and the Securities and Exchange Commission (SEC) continue to stress the need for greater protections and attention regarding cyber risk. Many companies and boards seem content to assume their IT departments provide sufficient protection, but few regulatory filings even mention what a firm or company is doing to mitigate the threat. Risk management responsibilities apply here as much as anywhere else, and while much of the financial world seems reluctant to adequately apply themselves in this arena of managing risk, the next few years are likely to see a sizable increase in spending and effort to combat it.
Risk management has never played as large a role in the world of finance as it does today. As regulators try to ensure the world’s markets avoid another recession — or worse — skilled risk managers and risk management techniques are essential to both the solvency of financial firms and the ongoing stability of the marketplace — both in the U.S. and around the world.