ARM 101 Approaches To Risk Management

MIDLANDS STATE UNIVERSITY
FACULTY OF BUSINESS SCIENCES
DEPARTMENT OF ACCOUNTING SCIENCES
Fundamentals of Risk Management (ARM101)
Lecture Notes
Chapter 2: Approaches to Risk Management
2.1 Introduction
Risk management is not about controlling/mitigating risk out of existence. If business is to
perform, management must learn to take more risk and to accept failure. To perform better than
the rest, you must take greater risk, but it should be a calculated risk (the risk accepted is known,
as is the likelihood and impact). It is not acceptable to take risks unwittingly – the past practice
of silo-based approaches for managing pockets of risk, leads to unclear responsibilities and a
lack of visibility, thereby exposing the organization to unnecessary risk.Risk management can be
defined in different ways as stated below;
 Co-ordinated activities to direct and control an organization with regard to risk.
 Process which aims to help organizations understand, evaluate and take action on all their
risks with a view to increasing the probability of success and reducing the likelihood of
failure
 All the processes involved in identifying, assessing and judging risks, assigning
ownership, taking actions to mitigate or anticipate them, and monitoring and reviewing
progress.
 Selection of those risks a business should take and those which should be avoided or
mitigated, followed by action to avoid or reduce risk.
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Risk management is a constantly developing and evolving discipline. Even though risk
management has its origins in the insurance industry other branches of risk management have
strong connections with the credit and treasury functions. In modern day businesses many
functions within large organizations will have a significant risk management component to their
activities, such as tax, treasury, human resources, procurement and logistics. Some of the
specialist areas of risk management found in organizations include the following;
 clinical/medical risk management;
 energy risk management;
 financial risk management;
 IT risk management.
 project risk management
 Business continuity plan.
2.2 The Risk Management Process

Risk management has well-established stages that make up the risk management process. These
stages build into valuable risk management activities, each of which makes an important
contribution. The activities associated with risk management are as follows:
 Risk identifying
 Risk assessment
 Risk addressing,
 Risk reviewing and reporting risk.
Risk management processes requires that all organizations must have comprehensive risk
management processes and these processes should be commensurate with the size and
complexity of the institution. Each institution should tailor its risk management programme to its
needs and circumstances. Regardless of the risk management programme design, each
programme should cover the following:
2.2.1 Risk Identification
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 In order to properly manage risks, an institution must recognize and understand risks that
may arise from both existing and new business initiatives;
 Risk identification should be a continuing process, and should be understood at both the
transaction and portfolio levels.
 There are two major methods used for identifying risks which are:
o Commissioning a risk review - this is when an organisation assembles a group of
individuals (either internal or external) to look at its operations with the aim of
identifying possible risk sources.
o Risk Self-Assessment – this is when each department is tasked to inspect its
operations and identify risk factors.
2.2.2 Risk Measurement (quantification)

 Once risks have been identified, they must be measured to determine their impact on the
institution.
 This can be done using various techniques ranging from simple to sophisticated models.
 Accurate and timely measurement of risk is essential for effective risk management
system.
 An institution that does not have a risk measurement system has limited ability to control
or monitor risk levels.
 Institutions should periodically test their risk measurement tools to make sure they are
accurate.
2.2.3 Addressing Risk (Risk Control)

 After measuring risk, an institution should establish and communicate risk limits through
policies, standards, and procedures that define responsibility and authority.
 These limits should serve as a means to control exposure to various risks associated with
an organization
 Institutions may also apply various mitigating tools in minimizing exposure to various
risks.
 Institutions should have procedures to authorize and document exceptions or changes to
risk limits when warranted.
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 Risk can be mitigated using any of the following ways:
a) Tolerate
b) Treat
c) Transfer
d) Terminate
e) Detective controls
2.2.4 Risk Monitoring

 Institutions should put in place an effective management information system (MIS) to
monitor risk levels and facilitate timely review of risk positions and exceptions.
 Monitoring reports should be frequent, timely, accurate, and informative and should be
distributed to appropriate individuals to ensure action, when needed.
 Risk monitoring is important to identify new risks and also to gain certainty that risk
management is still effective, since risk may come and go.
 It is important to report risk in a language that is understood by everyone involved so that
action can be taken.
2.3 Enterprise Risk management

Another area where the risk management discipline has developed in recent times is the approach
that is referred to as enterprise or enterprise-wide risk management. The main feature that
distinguishes ERM from what might be considered more traditional risk management is the more
integrated or holistic approach that is taken in ERM. In many ways, it can be considered to be a
unifying philosophy that draws together management of all types of risks, rather than a new or
different approach. When an organization considers all of the risks that it faces and how these
risks could impact its strategy, projects and operations, then the organization is embarking on an
enterprise risk management approach. Enterprise Risk Management (‘ERM’) is a strategic
business discipline that supports the achievement of an organization’s objectives by addressing
the full spectrum of its risks and managing the combined impact of those risks as an interrelated
risk portfolio.
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The fundamental idea behind the ERM approach is to move away from the practice of risk
management as the separate management of individual risks. ERM is concerned with the
management of the risks that can impact the objectives, key dependencies or core processes of
the organization. Also, ERM is concerned with the management of opportunities, as well as the
management of control and hazard risks. There has also been consideration of the fact that many
risks are interrelated and that traditional risk management fails to address the relationship
between risks. With the ERM approach, the relationship between risks is identified by the fact
that two or more risks can have an impact on the same activity or objective.
2.3.1 Characteristics of Enterprise Risk Management

Enterprise risk management has become the established means of undertaking risk management
activities within most organizations. This allows the organization to gain an overview of all the
risks that it faces so that it can take coordinated actions to manage these risks. The following are
the special characteristics of ERM;
1.Encompasses all areas of organizational exposure to risk (financial, operational, reporting,

compliance, governance, strategic, reputational, etc).
2 Prioritizes and manages those exposures as an interrelated risk portfolio rather than as
individual ‘silos’ of risk.
3 Evaluates the risk portfolio in the context of all significant internal and external contexts,
systems, circumstances and stakeholders.
4 Recognizes that individual risks across the organization are interrelated and can create a
combined exposure that differs from the sum of the individual risks.
5 Provides a structured process for the management of all risks, whether those risks are primarily
quantitative or qualitative in nature.
6 Seeks to embed risk management as a component in all critical decisions throughout the
organization.
7 Provides a means for the organization to identify the risks that it is willing to take in order to
achieve strategic objectives.
5
8 Constructs a means of communicating on risk issues, so that there is a common understanding
of the risks faced by the organization, and their importance.
9 Supports the activities of internal audit by providing a structure for the provision of assurance
to the board and audit committee.
10 Views the effective management of risk as a competitive advantage that contributes to the
achievement of business and strategic objectives.
2.3.2 Benefits of ERM

By taking a comprehensive approach to enterprise risk management, a wide range of benefits can
be delivered and the benefits include the following;
1. Financial benefits - financial benefits that accumulate to organizations as a result of

ERM include, Reduced cost of funding and capital Better control of CapEx approvals,
Increased profitability for organization, Accurate financial risk reporting and Enhanced
corporate governance
2. Infrastructure benefits- these include efficiency and competitive advantage, achievement
of the state of no disruption, Improved supplier and staff morale, targeted risk and cost
reduction, reduced operating costs
3. Reputational benefits – These include the following ;regulators being satisfied ,
Improved utilization of company brand, enhanced shareholder value, good reputation and
publicity, improved perception of organization
4. Marketplace benefits -commercial opportunities maximized, better marketplace
presence, increased customer spend (and satisfaction) higher ratio of business successes
and Lower ratio of business disasters

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MIDLANDS STATE UNIVERSITY

FACULTY OF BUSINESS SCIENCES

DEPARTMENT OF ACCOUNTING SCIENCES

Fundamentals of Risk Management (ARM101)

Chapter 2: Approaches to Risk Management

2.2 The Risk Management Process

2.2.1 Risk Identification

2.2.2 Risk Measurement (quantification)

2.2.3 Addressing Risk (Risk Control)

2.2.4 Risk Monitoring

2.3 Enterprise Risk management

2.3.1 Characteristics of Enterprise Risk Management

1.Encompasses all areas of organizational exposure to risk (financial, operational, reporting,

2.3.2 Benefits of ERM

1. Financial benefits - financial benefits that accumulate to organizations as a result of

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