In brief
- Effective risk management prevents financial and reputational losses, helps maintain regulatory compliance, improves trust among customers and investors, and allows you to identify issues early on.
- Key strategies: Explore the core risk management techniques: risk avoidance, reduction, sharing, transfer, and retention.
- Regulatory compliance: Learn about the importance of adhering to frameworks like DORA and the consequences of failing to comply.
- Expert insights: Discover how Luxoft's expertise in banking and capital markets, insurance, IT risk, and operational resilience can tailor solutions to regional and industry-specific needs.
Would you ever go rock climbing without a proper rope, harness, self-locking device, or a buddy to secure your ascent and descent? Probably not. Even if you’re skilled enough not to fall, the risks are too dangerous to ignore.
While free solo climbing is a thing, only the most experienced climbers with a huge appetite for risk dare to venture it.
Running a company can sometimes be like rock climbing. You must be mindful of the risks you entail when climbing the market ladder. And you need proper equipment – i.e., the right risk management strategies – to mitigate them.
Why risk management matters
Implementing a solid risk management strategy lets you avoid financial and reputational losses, stay in line with regulations, and secure trust.
Ensuring regulatory compliance
In certain industries, a risk management strategy is not an option. For instance, financial institutions operating in the EU (European Union) have to abide by DORA (Digital Operational Resilience Act), which contains strict regulatory requirements on ICT (Information and Communications Technology) risk management.
Failure to comply with legal obligations has become an important risk. It’s no joke, as regulators don’t shy away from fining offenders. Equifax, for example, had to settle a $575 million fine for losing the personal and financial data of 150 million consumers due to an unaddressed database vulnerability.
Preventing reputational losses
In 2016, Delta Airlines’ operations center lost its power for five hours. That cost the company $150 million as the airline had to cancel around a thousand flights and ground another thousand.
This is one of those risk management examples that aren’t only about financial losses. Delta had promoted itself as an “always on-time” airline that “cancels cancellations.” Arguably, reputational losses cost the airline even more than canceling and grounding flights.
Securing the bottom line
When they take organizations by surprise, materialized risks can cost an arm and a leg. A data breach can lead to multimillion-dollar fines. Unexpected downtime or service disruptions mean missing out on revenue.
Take compliance risk as an example. Meta (Facebook) was fined a record 1.2 billion euros for failing to comply with the EU data protection regulations.
Catching issues before they wreak havoc
An effective risk management strategy involves more than managing risks. It also sets the framework for identifying realized risks and addressing them before they can cause substantial financial losses.
For example, it can involve putting together a robust automated anomaly detection system to identify potential security breaches early on.
Securing the trust of customers and investors alike
An effective risk management framework sends a clear signal to your investors; you have everything under control. Limiting risk exposure and properly handling unavoidable risks protect their investment from financial and reputational losses.
Customers are also more likely to trust a company that manages its risks, especially regarding personal data. Protecting customer data is the number one factor that instills trust in a company among consumers.
First things first: Bring the right people on board
Before you dive into selecting risk management methods, you need to establish an enterprise risk management team (if you haven’t yet). This group will continuously identify and track risks, manage them, and refine the strategy based on new risks.
An enterprise risk management team brings together:
- Board of directors, in the form of a representative or board-level committee, provides corporate oversight of the team
- Chief risk officer (CRO) chairs the team and supervises the strategy implementation and continuous improvement
- Chief operating officer (COO) provides a birds-eye view of all day-to-day operations and helps identify risk management gaps and mitigate risks
- Chief financial officer (CFO) weighs in on risks to revenue and profitability, as well as insurance risks if applicable
- Chief legal officer offers their perspective on the organization’s legal matters and potential liability issues
- Chief compliance officer ensures full regulatory compliance across the board, from worker safety to cybersecurity
- Chief information officer (CIO) handles IT risks and ensures business continuity if they materialize
- Chief human resources officer (CHRO) manages risks associated with the workforce
- Chief communications officer offers perspective on the potential reputational risks
- Department heads, as designated risk owners, provide a hands-on understanding of risks in their respective business functions
5 key risk management strategies to know
The most common risk management techniques are risk avoidance, reduction, sharing, transfer, and retention.
Risk avoidance
This risk management strategy means avoiding activities that carry substantial risks and may negatively impact the organization. What’s a typical sign that you need to employ it? Check if the potential benefits don’t outweigh the risks. Alternatively, potential threats may pose an existential danger to the organization.
Loss prevention/risk reduction
Certain risks are impossible to eliminate. For example, it’s impossible to fully avoid the risk of adverse weather events. The only thing you can do is prevent or minimize losses.
For instance, risk reduction can involve installing flood vents and sump pumps to minimize flooding damage. In healthcare, risk reduction typically takes the form of preventative care.
Risk sharing
Can’t avoid or reduce risk? You can reduce exposure by sharing risks, instead. Under this risk management strategy, if the risk materializes, losses are distributed among multiple parties, softening the blow for each of them.
Shareholding is a good example of risk sharing: if the company doesn’t turn a profit, losses are distributed among its investors.
Risk transfer
This strategy involves transferring risk to a third party as a contractual obligation. It is a suitable approach to managing risk that is too large for organizations to handle losses independently.
Risk transfer typically means purchasing insurance against natural disasters or legal action. You can also transfer risk to a subcontractor as part of a service contract.
Risk acceptance/retention
When all the other risk management strategies have been exhausted, risk acceptance is the final option on the table. Accepting risks means either a) the risk is impossible to eliminate, or b) the costs of applying other strategies outweigh the benefits.
To implement risk retention, you need to set aside the budget and other resources necessary to handle the impact of this residual risk. This risk can take the form of routine customer complaints or minor operational glitches, for example.
Choosing the right strategy: 4 risk assessment methods
An insurance company is exposed to different risks than, say, a tech startup. Analyzing their potential impact typically involves a combination of the following risk assessment methods.
Quantitative risk assessment
Quantitative risk assessment allows you to put a number on each risk’s potential cost and prioritize risks accordingly. Quantitative risk analysis has its appeal as it returns measurable, objective results that are easy to comprehend and compare.
However, quantitative risk assessment isn’t a one-size-fits-all solution. Some organizations may lack high-quality data to be able to estimate potential losses accurately. Certain impacts, such as reputational losses, may be hard to quantify at all.
Common quantitative risk analysis techniques include:
- Three-point estimate: Calculating the best-case, most-likely, and worst-case projections to derive the best estimate
- Decision tree analysis: Creating a diagram that demonstrates the potential impact of decision-making alternatives
- Expected monetary value: Establishing contingency reserves for budget and schedule
- Sensitivity analysis: Determining the risk that will have the largest impact on a process or project
- Monte Carlo simulation: Calculating the probability of different outcomes in a process that involves random variables
- Fault tree analysis: Creating a diagram to identify the elements that can lead to system failure
Qualitative risk assessment
This risk assessment approach allows you to pinpoint areas requiring more in-depth analysis and hands-on management. It involves discussing risk and its potential impact with people across the organization.
Qualitative methods include:
- Keep It Super Simple (KISS): Rating potential risk events on a basic scale from very high to very low
- Probability/Impact: Rating the likelihood of risk occurring and its impact on a scale from 1 to 10 or 1 to 5 on a two-dimensional chart
Qualitative risk assessment takes into account the factors that are hard to quantify. On the other hand, it relies on subjective judgments and opinions and can be tainted by bias.
Asset-based risk assessment
This approach identifies risks that may affect the organization’s assets, such as equipment, property, and intellectual property. It involves:
- Creating a register of all available assets
- Assessing the effectiveness of existing risk controls
- Enlisting the help of asset owners to list potential risks for each asset
- Prioritizing identified risks based on their likelihood and severity of the impact
While asset-based risk assessments produce easy-to-understand results, they do not consider certain risks inherent to the organization’s policies or processes.
Vulnerability-based risk assessment
This approach focuses on revealing vulnerabilities in each organization or system. Instead of starting with a list of the company’s assets, vulnerability-based assessments involve:
- Pinpointing known weaknesses and inefficiencies in the organization or system
- Identifying how those weaknesses could be exploited
- Assessing the potential impact of each exploit
While this approach provides a more well-rounded overview of risks, there’s one caveat: it’s based on known vulnerabilities. Ergo, the vulnerabilities that remain overlooked will continue to pose risks.
Which risk management strategy is right for you?
Selecting the right combination of risk management strategies requires a crystal-clear understanding of the organization’s risks and their potential impact. Therefore, it’s impossible to give one-size-fits-all risk management tips on this or that strategy.
That said, organizations tend to choose certain strategies in certain cases:
- Avoiding risk is the strategy of choice if the risk’s potential impact outweighs the benefits of the activity
- Reducing risk is a suitable choice if avoiding it isn’t an option, but you can still implement measures for controlling risk
- Sharing risk is common for projects too large or complex for a single party to manage risk alone
- Retaining risk is typical for low-impact risks that are inherent to day-to-day operations
- Transferring risk is common for high-impact, large-scale risks that would be too costly for an organization to manage
Your strategy choice, however, will depend on the risk severity, key stakeholders' risk appetite, and the resources available.
How to develop your risk management strategy in 5 steps
The risk management process consists of five stages: identifying risks, assessing them, developing a risk treatment strategy, implementing, monitoring, and refining it.
1. Risk identification
First, you need a full overview of all the potential risks your organization faces. Document all the identified risks in a document such as a risk register – a database of risks, their likelihood and potential impact, risk owners, and selected risk treatment strategy.
To identify all potential risks:
- Discuss them with both frontline workers and senior leadership using surveys, brainstorming sessions, and interviews.
- Look into past risk events and identify their causes.
- Use data analysis to derive risk insights using historical data.
Consider both internal and external risks across these seven types of risk:
- Financial risks: risks concerning the company’s financial resources (e.g., insolvency risk)
- Operational risks: risks to day-to-day operations (e.g., employee errors)
- Regulatory and compliance risks: risks posed by a shift in regulations or non-compliance with existing requirements
- Reputation risks: risks concerning the public’s perception of your brand
- Economic risks: risks posed by market changes and national or global economies
- Hazard risks: risks that affect the health and safety of your employees
- Security risks: risks to the security of intellectual property and confidential information
2. Risk analysis
Now, it’s time to assign the level of severity to each of the identified risks. For each risk, determine:
- Risk event that, if it occurs, will negatively affect the organization
- Factors that may trigger the risk event, both internal and external
- Likelihood of the risk event occurring
- Impact of the risk event
- Timeframe, or how fast the risk event can unfold
You can aggregate your findings in a risk matrix with the risk likelihood on one axis and impact severity on the other.
Once you complete the assessment, you can prioritize risks from the most to least severe.
3. Risk treatment plan
To manage risk, select your strategy first – avoidance, reduction, sharing, transfer, or retention. You can combine multiple types of risk management strategies when addressing the same risk.
Then, outline a risk management plan for each risk, including the risk management activities, policies, and administrative controls to mitigate it. Select the appropriate risk metrics to monitor, too.
4. Risk management implementation
With the plan outlined, it’s time to put it into practice. Make sure you also communicate risks to your key stakeholders to ensure they’re aware of them and properly engage in risk management processes.
In addition, implement a system to track the risk metrics you identified in the previous step. You can also work out a data analytics solution to derive insights from that information.
5. Monitoring and refinement
Effective risk management is an ongoing process, not a one-and-done project. To manage risks efficiently:
- Continuously track risk metrics, such as the liquidity ratio or equipment downtime
- Regularly review the risk register, reassess risks, and keep an eye out for emerging risks
- Continuously monitor and enforce risk mitigation measures
- Regularly review and refine your mitigation plans and controls
- Seek feedback on your risk management practices from key stakeholders
- Conduct regular internal audits
What makes a good risk manager?
The most valuable risk management skills include analytical and strategic thinking, interpersonal and leadership skills, and regulatory and financial knowledge.
Analytical thinking
Risk management requires analyzing various data. A good risk manager can make sound decisions based on the collected data while considering both quantitative and qualitative information.
Strategic thinking
Risk managers need a holistic understanding of the company’s strategy and how risk management fits into it. They can’t do well without seeing the big picture and pinpointing opportunities others may have missed.
Interpersonal and communication skills
To be effective, risk management requires extensive cross-functional cooperation. The risk manager’s job is facilitating this collaboration between key stakeholders and collecting feedback.
People management and leadership skills
At some point, risk managers must enforce risk management practices across the organization. This requires a good sense of how to motivate people to follow through on mitigation plans and inspire an honest conversation about risks.
Regulatory knowledge
Any risk management strategy is likely to be subject to certain regulations. Therefore, risk managers need to know legal risk management requirements and how to achieve compliance in practice.
Financial knowledge
Risk managers need to quantify risks almost daily. That’s impossible without vast financial knowledge of every aspect of business operations, from the cost of network outages to losses caused by equipment downtime.
In conclusion
In conclusion, just as a climber relies on ropes and harnesses for safety, a company must employ robust risk management strategies to navigate potential pitfalls. Whether avoiding, reducing, sharing, transferring, or retaining risks, each strategy plays a vital role in safeguarding against financial, operational, and reputational damages. Luxoft brings best-of-breed risk management expertise, domain knowledge, and financial analysis skills, drawing from extensive experience in capital markets and financial reporting, including complex areas like FRTB. Our work spans general transaction regulatory reporting and IT risk requirements, as well as operational resilience under the DORA framework. With a global presence and local focus, Luxoft is uniquely positioned to tailor risk management strategies to regional specificities while leveraging market and industry best practices. This comprehensive approach ensures organizations can address vulnerabilities proactively and maintain resilience, securing long-term success and stability.
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