What is EMR? Exploring Risk Management in Business

The development process of every economic corporation (EC) is influenced by the business environment and carries various risks, such as competition risks, legal risks, management risks, operational risks, and notably financial risks. When financial risks increase, they lead to financial risks for the ECs. This article focuses on analyzing issues related to financial risks and financial risk management within each EC, as well as methods to prevent financial risk exposure, aiming to enhance quality management practices.

What is Enterprise Risk Management (ERM)?

Enterprise Risk Management (ERM) is a term used in business to describe the methods a company employs to identify and mitigate risks that could pose challenges to the business. Enterprise Risk Management is essential for both public and private companies to approach risk management confidently. An effective risk management approach, when integrated correctly, can significantly save costs for a company.

4 Types of Business Risks

In 2004, a research group from JLA analyzed 76 companies in the S&P 500 regarding their types of risks, in which they experienced a 30% or higher decrease in market value. They found that 61% of occurrences were due to strategic risks, 30% were operational risks, and 9% were financial risks.

• Hazard Risks: These are risks with a high degree of threat to life, health, or property.
• Financial Risks: These are risks directly related to money. They include financial consequences such as increased costs or reduced revenue.
• Strategic Risks: Strategic risks are risks that impact or are created by strategic business decisions.
• Operational Risks: Operational risks are risks that have a significant impact on an organization’s operations.

Risk Management Strategies for Business Risk Management

The board of directors selects one of the following five appropriate risk management strategies to address their identified risks:

Risk Avoidance

Eliminating risks or activities that could have a negative impact on the organization’s assets. For example, canceling or temporarily suspending a production line or a proposed product.

Risk Reduction

Minimizing or limiting the severity of losses. For instance, the management can plan regular visits to their key suppliers to identify potential issues early on.

Alternative Actions

Exploring feasible alternatives to mitigate risks.

Risk Sharing or Transfer

Actions that transfer risk to a third party, such as insurance agencies. For example, purchasing an insurance policy that can cover unexpected losses for the business.

Risk Acceptance

Acknowledging identified risks and being prepared to face the consequences. Typically, any losses resulting from uninsurable or unavoidable risks fall under risk acceptance.

The Core Elements of Enterprise Risk Management (ERM) Process

ERM follows a distinct and continuous process in which it proactively identifies and reassesses various strategic and key risks to ensure financial security for the business. This process includes five specific elements:

• Establishing Strategy/Objectives: Understanding the business’s related strategies and risks.
• Risk Identification: Providing a clear profile of key risks that could negatively impact the company’s overall financial health.
• Risk Assessment: Analyzing the identified risks rigorously to determine both their likelihood and potential impact.

Risk Response: Evaluating various risk response strategies and selecting appropriate courses of action to mitigate the identified risks within the risk appetite of management.

Communication and Monitoring: Relevant information and data need to be continually monitored and communicated at all organizational levels.

Example of an Enterprise Risk Management (ERM) Process

Establishing Strategy/Objectives: Let’s consider Tesla, a publicly traded company operating in two main segments – automotive manufacturing and energy. In this example, the ERM process would begin by examining what drives the company’s value in the process of setting strategies/objectives. For Tesla, this could include the company’s competitive advantages, strategic innovations, core product lines, or acquisitions.

• Risk Identification: After the key drivers are identified, the ERM process would commence the risk identification phase by assessing related risks that have the potential to hinder the success of each key driver.
• Risk Assessment: The identified risks must then be carefully analyzed from cross-functional perspectives in the risk assessment step.
• Risk Response: After deliberation and acknowledgment of potential risks is completed by top management, the executive directors would review an optimal risk response strategy.
• Communication and Monitoring: Finally, senior management would measure, monitor, and effectively communicate the performance of risk response strategies using any key risk indicators that the organization deems effective.

What is Enterprise Risk Management for Financial Institutions?

Enterprise Risk Management (ERM) for financial institutions pertains to the existing systems for identifying and managing all risks within a financial services company. This includes financial risks, operational risks, event risks, and strategic risks.

Why is Enterprise Risk Management important for financial institutions?

Financial institutions such as banks, insurance companies, and investment management firms are entrusted with managing the finances of the economy. Because financial institutions are of systemic importance to the economy, they are heavily regulated. The risks that these companies face can have broader economic implications, making it crucial for them to have well-developed enterprise risk management processes and systems.

Since the global financial crisis of 2008, which led to the collapse of major financial institutions like Bear Stearns and Lehman Brothers, the pressure both internally and externally to manage risks in the financial services industry has increased significantly.

Benefits of Enterprise Risk Management for Financial Institutions

Enterprise Risk Management (ERM) can benefit financial organizations in several ways, including:

• Maintaining Compliance: As previously mentioned, financial institutions are heavily regulated and may face severe penalties if they are found to be non-compliant. A robust enterprise risk management system can help financial organizations maintain regulatory compliance and avoid financial penalties and disruptions.
• Minimizing Losses: Financial organizations are exposed to various risks that can lead to financial losses. A strong enterprise risk management system can help identify potential losses in advance and enable organizations to proactively manage these risks.
• Supporting Growth: Financial organizations rely on consumer trust to operate effectively. Effective risk management processes and systems can help build and maintain consumer trust over time, leading to business growth.
• Improving Profitability: Financial organizations can improve profitability by optimizing their risk levels. A robust enterprise risk management system can help prevent and minimize losses, thereby enhancing the profitability of these companies.

In addition to these four benefits, the implementation of an effective ERM program often brings about a cultural shift within the organization. Effective ERM programs typically allow financial organizations to take a longer-term view of risks and respond to them more proactively.

The Enterprise Risk Management Framework

Managing enterprise risk for large and complex financial organizations is an extremely challenging endeavor that requires a significant number of specialized people and resources. Successful enterprise risk management systems are typically implemented using an ERM framework. The enterprise risk management framework consists of four key elements:

• Risk Transparency: Risks such as threats, potential crises, legal issues, and financial risks need to be identified, clearly defined, and communicated to the appropriate decision-makers. Transparency in understanding and reporting risks is crucial.
• Risk Strategy: Management teams need to establish risk tolerance levels within which the company will operate. These tolerance levels are compared to the current observed risks to develop a strategy for managing these risks across the organization.
• Risk Decision-Making: Once risks are understood, and risk tolerance levels are set, decisions regarding risk acceptance, risk prevention, risk transfer, and/or risk mitigation are made.
• Risk Organization: Financial service companies need to establish strong internal risk teams, systems, and processes to continuously monitor and manage the company’s overall risk profile. This includes appointing key individuals to oversee risks, setting targets and milestones, and monitoring risks over time.

Hopefully, after reading this article, you will have a better understanding of what Financial Enterprise Risk Management is and the benefits it brings when implemented effectively.