Risk Management Challenges

A company may overcome risk management challenges by establishing adequate operating controls.

Risk management challenges are implicit in a corporation's activities because risk events are typically uncertain. Top management often applies complex quantitative tools, such as stress testing or computer models, to measure financial risks inherent in corporate activities, but risk levels may remain high if securities markets and economic trends are unfavorable to the company's investments.

Function

An effective risk management process helps a company's top leadership establish rules to prevent operating losses due to human error, employee carelessness, technological malfunction or fraud. To illustrate, a company's management may put into place internal controls and procedures as well as periodic internal audit reviews to ensure that employees comply with rules when performing duties. A risk management policy also may cover financial risks such as credit and market risks.

Significance

Challenges that may arise in risk management processes may be significant if a corporation does not establish proper decision-making mechanisms, and internal controls are not "adequate" or "functional." A "functional" procedure provides appropriate solutions to internal problems. An "adequate" policy instructs employees on how to perform tasks and report problems. Risk management challenges may include staff noncompliance with rules and regulations, technological problems due to software or hardware updates and inaccuracies that may exist in financial market data.

Types

Challenges that exist in corporate risk management systems may relate to operational, technological or compliance risks. Assume a company wants to establish an online risk management program to ensure that employees adhere with Securities and Exchange Commission (SEC) regulations when performing duties. The company may be unable to comply with SEC rules if employees are reluctant to use the new Web tool. Risk control challenges also may relate to financial risks. Let's say the bank's employees need to download data from the New York Stock Exchange (NYSE) Web site. If the Web portal security software does not allow direct import, the bank may have a risk management challenge.

Market Risk

A financial institution, such as a bank or a hedge fund, may experience challenges in its market risk management mechanisms because of market data inaccuracies or technological problems. For example, a hedge fund that needs to calculate its daily market risk loss estimate using VaR (value at risk) may be unable to do so if it cannot download accurate historical data.

Credit Risk

A lender may face problems in credit risk management mechanisms if it cannot rely on accurate data from financial markets or borrowers. To illustrate, assume a U.S.-based manufacturing company wants to lend money to a business partner in Latin America. The company may be unable to provide the loan if the Latin American firm cannot provide accurate financial statements and credit references that the manufacturer can verify.

References

• Federal Reserve Bank of New York: Risk Management Challenges in the U.S. Financial System
• The Ten Great Challenges of Risk Management
• Symantec: Risk Management Challenges and Basel II