B.Matanda 10.10.2011RISK, RISK MANAGEMENT & UNCERTAINTYRisk, uncertainty & Risk ManagementBy Bebura Matanda<br />Risk, Uncertainty and Risk Management<br />Risk refers to the possibility that something unexpected or not planned for will happen. Risks are uncertain future events that could influence companies’ objectives. This can include strategic, operational, financial and compliance objectives. However some risks must be taken in pursuing the opportunities available but the company should be protected against avoidable losses. In the financial world risk is often measured in terms of volatility or variability or spread of returns.<br />Uncertainty refers to not knowing exactly what will happen in the future. With any financing/investment decision there is some uncertainty about its outcome.<br />These terms risk and uncertainty are sometimes used interchangeably; however there is a distinction between the two<br />Risk is how we measure/characterize how much uncertainty exist. The greater the uncertainty the greater the risk<br />Risk can also be defined as the degree of uncertainty.<br />Managing Risk<br />Risk Management on the other side is the framework within which a firm manages and controls various types of risk that it faces. It is both a set of tools and techniques a process that is required to implement a strategy of a firm.<br />In financial institution there is also a subset of risk management -treasury management has gained more attention because of the price volatility in financial markets and globalization of business. Treasury management is concerned with managing the banks/firms exposure to changes in interest rates, foreign exchange rates, price of commodities and other market fundamentals.<br />The main objective of risk management is to optimize the risk-reward trade off by accurately measuring risk in order to monitor and control them.<br />Risk management is not an end t itself but supports the firm/financial institution by;<br /><ul><li>Assists in the forecasting of a possible future outcome
Its an aid to decision making , ie an effective risk management system is developed to the level where it aids decision making i.e reporting and hedging and influencing the decision making process before decisions are made.
It’s an aid for pricing decisions. The price of a commodity should include a premium depending on risk of the client. (risk weighted premium).Knowledge of risk enables appropriate prices to be charged to customers
A mispricing attracts high risk customers whom the lower risk customers subsidies. Mispricing overcharges the lower risk clients whom competitors can attract with lower prices to the detriment of the bank.
Risk management can also assist in the development of competitive advantage .Controlling current and future costs is also a contribution to income both present and future.</li></ul>Key Elements of Risk Management<br />The key elements of RM should be comprehensive, proven in practice to be effective and likely to stand test of time, they include’<br />-An active and effective board of directors and senior management oversight.<br />-Framework for managing risk - there should be a framework for managing risk that is effective, comprehensive and consistent<br />-Integration of risk management -<br />-Business line accountability<br />-Risk evaluation/measurement –all risks should be qualitatively evaluated on recurring basis.<br />-Independent review – Risk assessments should be validated by independent review functions with authority and expertise.<br />-Contingent planning – RM policies and processes to address potential crises and unusual circumstances should be in places and tested as appropriate.<br />Life Cycle of Risk Management<br />The life cycle of the risk management process starts from identification of risk, through measurement of risk, risk planning, monitoring and up to control and communication of risk.<br />Identification- involves searching for location of risk before it becomes a problem. Risks changes overtime and tools such as internal audits in place should be able detect such risk.<br />Measurement- Risk data is transformed into decision making information. Risk measurement encompasses evaluation of impact of risk, probability of occurrence, classification of risk and prioritization of risk.<br />Planning – involves the translation of risk information into decision and mitigating actions as well as implementation of those actions.<br />Monitoring – monitoring risk indicators as well as monitoring risk actions <br />Control – correction of deviation from the risk mitigation plans .Risk control relies not just on the system of controls being in place but also on the system controls being applied properly and regularly checked by management.<br />Communication – provision of information and feedback to internal and external operators, a management and the board on the risk activities. Communications happens throughout all the functions/stages of risk management<br />