The Rise of Financial Risk Management

Article excerpt

OVER THE PAST decade, risk managers have witnessed both a greater acceptance of their discipline as well as a greater willingness on the part of companies to employ the term "risk management." In the banking and finance industry, however, these attitudinal changes have contributed to a situation where the manager of pure risk has gotten lost among the hordes of financial risk managers. What makes this situation prevalent here as opposed to other industries is the fact that the management of financial risk, alternatively known as market, balance sheet, speculative or, more generically, business risk, is the financial community's stock and trade.

Almost all traditional risk managers of operations and contractual risks, like William J. Kelly, senior vice president of risk management at Morgan Guaranty Trust Co. of New York, will get involved in financial risk management, but "only to the extent that there are insurance vehicles for these business risks such as credit insurance." Mr. Kelly will also get involved in contractual issues such as those related to lending and collateral for a new funding program. But that is about as far into the profit-generating area of the bank's activities his position takes him.

It is at this juncture that the company's other risk manager - the financial risk manager - takes over. It is this risk manager that must contend with interest rate risk (the risk that interest rates will rise and reduce the market value of an investment), credit risk (the risk that a borrower will be unable to make interest or principal payments in a timely manner), currency risk (the risk that the value of one's currency will rise or fall relative to another before payment is made), liquidity risk (the risk of having difficulty in liquidating an investment position without taking a significant discount from current market value) and market risk (the risk that it may be necessary to liquidate a position during a down period due to general market pressures). Financial risk management is perhaps the most volatile branch of the discipline, which is one reason why it tends not to be insurable.

Should the traditional risk manager be dealing with such financial issues or only those activities geared towards mitigating or eliminating what has been traditionally viewed as hazard, event or pure risk, such as physical damage, products liability or maybe even criminal activity? Or, as Dr. William R. Feldhaus, associate professor of risk management and insurance at Georgia State University puts it, "Should one manage positive, as well as negative, risk?" Dr. Feldhaus notes that at present, most universities and colleges limit the notion of risk management to the pure risk delineated in the traditional text books, allowing for professors to provide minor variation amongst their lectures.

Few, if any, would argue that the risk manager should become a specialist in all forms of the discipline, not even H. Felix Kloman, principal and vice president at Tillinghast, who advocates perhaps the broadest view of what a risk manager's job should entail. Mr. Kloman believes that the interrelationship between all four branches of risk management- operational, legal, political and financialnecessitates "an entirely new risk management function that would be on par with a chief strategy officer or a chief executive officer."

To illustrate his point, Mr. Kloman presents a scenario involving Philip Morris's reaction to the recent U,S. Supreme Court ruling opening up tobacco companies to an untold number of claims. "The risk manager there probably will look at the claims. But what the risk manager should be doing is questioning whether or not it makes sense to remain in this business at all." He adds, however, that currently "there are only a small handful of individuals who have the mandate to practice strategic risk management. But I believe this is the direction we are moving in."

Use and Abuse

DUE TO CHANGING government regulations, tax laws and heightened economic uncertainty stemming from the volatile 1970s, this past decade witnessed expanding responsibility for the financial risk manager and an extraordinary flurry of financial market innovations. …