Question

Develop a Financial Risk Management plan for a Professional Consultancy firm in your respective field of study, for instance, if you are studying Banking and Finance, your selected firm should be in the Banking and Financial services industry.                

Answer 1

Risk management
Risk management overview
Over the last few decades, risk management has become an area of development in financial
institutions. The area of financial services has been a business sector related to conditions of
uncertainty. The financial sector is the most volatile in the current financial crisis. Activities
within the financial sector are exposed to a large number of risks. For this reason, risk
management is more important in the financial sector than in any other sectors (Carey, 2001).
Carey regards financial institutions as the main point of risk-taking in an uncertain environment.
a) What is risk?
Risk is a function of the likelihood of something happening and the degree of losing which arises
from a situation or activity. Losses can be direct or indirect. For example, an earthquake can
cause the direct loss of buildings. Indirect losses include lost reputation, lost customer
confidence, and increased operational costs during recovery. The chance of something happening
will impact the achievement of objectives (Partnerships BC, 2005 and NIST, 2004).
“Risks are usually defined by the adverse impact on profitability of several distinct sources of
uncertainty. While the types and degree of risks an organization may be exposed to depend upon
a number of factors such as its size, complexity business activities, volume etc” (SBP, 2003
Risk can be classified into systematic and unsystematic risk (Al-Tamimi and Al-Mazrooei,
2007). Systematic risk refers to a risk inherent to the entire system or entire market. It is
sometimes called market risk, systemic risk or un-diversification risk that cannot be avoided
through diversification. Whereas, unsystematic risk is risk associated with individual assets and
hence can be avoided through diversification. It is also known as specific risk, residual risk or diversifiable risk.

What is the risk management?
Risk management can be defined in many ways. For example, Anderson and Terp (2006)
maintain that basically, risk management can be defined as a process that should seek to
eliminate, reduce and control risks, enhance benefits, and avoid detriments from speculative
exposures. The objective of risk management is to maximize the potential of success and
minimize the probability of future losses. Risk that becomes problematic can negatively affect
cost, time, quality and system performance.
The Committee of Sponsoring Organizations of the Treadway Commission (Committee of
Sponsoring Organizations, 2004, p.2) defines risk management as follows:
“Enterprise risk management is a process, effected by an entity’s board of directors, management
and other personnel, applied in strategy setting and across the enterprise, designed to identify
potential events that may affect the entity, and manage risk to be within its risk appetite, to
provide reasonable assurance regarding the achievement of entity objectives”
Risk management is the process to manage the potential risks by identifying, analyzing and
addressing them. The process can help to reduce the negative impact and emerging opportunities.
The outcome may help to mitigate the likelihood of risk occurring and the negative impact when
it happens (Partnerships BC, 2005).
Risk management involves identifying, measuring, monitoring and controlling risks. The process
is to ensure that the individual clearly understands risk management and fulfills the business
strategy and objectives (SBP, 2003).
Based on the definition above, the meaning of risk involves:
• The likelihood and consequence of something occurring.
• The chance of something happening impacting the achievement of objectives.
And risk management is about:
• The process to eliminate, reduce and control risks.
• It involves identifying, analyzing, measuring, monitoring and controlling risks
• Reducing the negative and emerging opportunities.
• Achievement of business strategy and objectives.
In order to facilitate a better understanding of risk management, the authors will describe the
important process of risk management. Ergo, the following review will explain the publication of risk management frameworks.

Preparing a risk management plan

Your risk management plan should detail strategies for dealing with risks specific to your business. It’s important to allocate time and resources to preparing your plan to reduce the likelihood of an incident affecting your business.

You can develop a risk management plan by following these steps:

1. Identify the risk
2. Assess the risk.
3. Manage the risk.
4. Monitor and review.

1. Identify the risk

Undertake a review of your business to identify potential risks. Some useful techniques for identifying risks are:

• Evaluate each function in your business and identify anything that could have a negative impact on your business.
• Review your records such as safety incidents or complaints to identify previous issues.
• Consider any external risks that could impact on your business.
• Brainstorm with your staff.

Ask yourself ‘what if’:

• you lost power?
• your premises were damaged or not accessible?
• your suppliers went out of business?
• there was a natural disaster in your area?
• one of your key staff members resigned or was injured at work?
• your computer system was hacked?
• your business documents were destroyed?

2. Assess the risk

You can assess each identified risk by establishing:

• the likelihood (frequency) of it occurring
• the consequence (impact) if it occurred

TIP: The level of risk is calculated using this formula:
Level of risk = likelihood x consequence

To determine the likelihood and consequence of each risk it is useful to identify how each risk is currently controlled. Controls may include:

• elimination
• substitution
• engineering controls
• administrative controls
• personal protective equipment.

A risk analysis matrix can assist you to determine the level of risk.

3. Manage the risk

Managing risks involves developing cost effective options to deal with them including:

• avoiding
• reducing
• transferring
• accepting.

Avoid the risk - change your business process, equipment or material to achieve a similar outcome but with less risk.

Reduce the risk - if a risk can’t be avoided reduce its likelihood and consequence. This could include staff training, documenting procedures and policies, complying with legislation, maintaining equipment, practicing emergency procedures, keeping records safely secured and contingency planning.

Transfer the risk - transfer some or all of the risk to another party through contracting, insurance, partnerships or joint ventures.

Accept the risk – this may be your only option.

4. Monitor and review

You should regularly monitor and review your risk management plan and ensure the control measures and insurance cover is adequate. Discuss your risk management plan with your insurer to check your coverage.

RATIONALE OF STUDY:
"Without financial risk management it's not possible to add value to any business"
Mr. Jignesh Shah,
CMD - Financial Technologies Group (MCX).
There's need for special attention to risk management in modern corporate have
heighten because of following factors
1) Large corporate with over increasing hierarchy and levels of manager; therefore
proper tools are essential to achieve the preferred results by covering the risks.
2) Increase in product and services provided by finance companies.
3) Global markets have become very intricate so the financial transactions and
instruments too.
4) Drastic increase in the number of international transactions (which carries its own
risks).
5) Dependence of New & Emerging markets
4. Findings
Person Discussion and Interview (for questionnaire check annexure) was arranged to
research about the practices prevailing in financial sector to handle the element
of risk i.e. Risk Management. For the same, we choose individuals from diversified
fields and the list includes:
' Practicing CA
. Private Portfolio Manager
r Bankers
The information collected is clubbed with the secondary data and is presented as
follows
4.1 How to manage credit risk
1) Exposure Ceilings -Prudential Limit is linked to Capital Funds - say l5oh for
individual bomower entity, 40%o for a group.

2) Review/Renewal - Multi-tier Credit Approving Authority, constitution wise
delegation of powers.
3) Risk Rating Model - by setting up holistic risk scoring system on a rating scale.
Well defined rating standards and appraisal of the ratings periodically.
4) Risk based scientific pricing - Link loan pricing to potential loss. An asset class
with high-risk category borrowed is to be priced high.
5) Portfolio Management - Specified quantitative upper limit on aggregate exposure
on specific rating categories, division of borrowers in various industry, business
group and conduct rapid portfolio reviews.
6) Loan Review Mechanism - Identify loans with credit weakness. Determine
adequacy of loan loss provisions. Ensure adherence to lending policies and
measures. Regular, accurate & prompt reporting to top management should be
ensured.
4.2 How to manage market risk
l) Diversify in transverse asset classes.
2) Diversify in transverse asset class alternatives.
3) Diversify and spread securities across within each select category of asset.
4) Diversify transversely in financial institutions and fund families.
5) Diversify transversely in industries and sectors.
6) Diversify across fund and portfolio managers.
7) Diversify across time sphere and intensity of liquidity.
4.3 How to manage Foreign Exchunge Risk
1) Diversification-
Diversification works finest when financiers purchase unassociated assets. Associated
describes the tendency for assets and prices to move in similar direction.
2) Currency derivatives -
Currency derivatives act as foreign exchange risk management tools because they
allow investors to lock in predestined exchange rates for given range ofperiods.
3) Currency swap Currency swaps inter exchange of payments in varying currencies between two
trading paftners. For proper, currency swaps feature netting. Under which the winning
side in the agreement receives one payment at the end of the swap term, will be
Netting balances the differences in currency valuations that happened during the swap
agreement.
4.4 How to munage interest-rate risk
I ) Matching Assets and Liabilities- Interest rate risk is the difference in time, credit,
mandate between an asset and the liability used to fund the asset.
2) Asset Matching Considerations - After writing loans, banks must determine a
hard estimate of ability to pay, whether there might be delays in payments and
whether credit quality might change thus changing the pricing of the loan. On this
basis, a bank will determine how much of the loan to fund.
3) Making the Interest Rate Balance Work- The important issue is that the balance of
assets and loan demand and the accurate prediction of interest rates will greatly
impact the earnings of the bank. Whereas banks must meet regulatory issues over
loan making, liquidity and loan diversification, these concerns must be weighed
against the banking profitability.
-1) Diversify maturities- The traditional way to hedge against interest rate risk is to
spread fixed income investments across the entire yield curve, starting with very short
dated maturities to very long-term bonds.
5) Buy fixed for floating swaps - tn practice, instead of actually swapping, the
difference between the two capital sources at the end of the agreement is calculated
and paid to the parly to which it's due.
6) Use real rate strategy- Part of reducing risk knows when it is most recent. In a way
to ascertain this is using real interest rates, the nominal interest rates minus the rate of
inflation.
4.5 How to manage liquidity risk
1) Short-Term Liabilities- They portrays deposits and debt instruments.
1))'lotational Liabilities- If notational or off lalance sheet items such as stand by Ic's
are activated new short-term liabilities are created that must be paid.

3) Short-Term Assets- Shorl-term assets must be readily available to cover all
obl i gations arisin g from short-term liabi lities.
4) Shock Test- The application of shock analysis scenarios to the short term needs of
the bank are used to determine liquidity risk policy.
5) Liquidity Risk Plan- Each bank must maintain a liquidity risk plan in order to detail
the actions that the bank would undergo in the event of a liquidity crisis.
5. CONCLUSION:
For any business to grow and stay in the market, management style is a key
and Risk management is basically the management style of managing the risks. Risk
is inherent in every business and every organization has to manage it according to its
size and nature of operation because without it no organization can survive in long
run. In addition to that the quantum of risk is higher in finance sector than any other
sector.