Magazine article Risk Management

The Risk Budget: Using Your Human Resources

Magazine article Risk Management

The Risk Budget: Using Your Human Resources

Article excerpt

The ideal risk management system is easy to explain and, in theory, creating and implementing such a system is beguilingly simple. All a business has to do is attack the known risks and maintain the flexibility needed to recognize and adapt to the unknown. But reality does not work out so neatly and ideal systems are rarely achieved.

Nevertheless, it is possible to improve the efficiency and effectiveness of current risk management systems by examining the lessons of the past and utilizing different perspectives to study the present. The key is using all the resources within the company, from top management to front-line workers. This broad range of input can be summarized and processed in an innovative forum: the risk budget.

Rules of Thumb

Over the past decade, there has been a virtual explosion of theoretical proposals and practical applications in the examination of risk management. We have learned that:

The ideal risk management system is a moving target that can be easily missed-with often disastrous consequences--by aiming too far behind or too far ahead.

Risk management systems, approaches and instruments that claim to convert the risks we have into the risks we want are largely cosmetic. When the cosmetics fade or are inappropriately applied, the faults resurface in poor product selection, pricing and marketing strategy.

Covering a complex business organization with a sophisticated risk management system does not eliminate risk; it simply replaces one set of risks with another, which may be more opaque and threatening.

To combat unforeseen risks, companies need simple, well-communicated and blunt rules of behavior that are indifferent to any particular time, place or situation. These rules must work on an instinctive rather than cognitive level.

Risk management is a journey, not a destination. From these rules we can establish a foundation for a system-wide operational risk management program that touches and is affected by all levels of the organization. But how do we tie all the pieces together?

The annual risk budget addresses each of these risk management lessons, and can be easily worked into the framework of the annual financial budgeting process. The risk budget's purpose is to identify the sources of a company's major operating risks, determine which it is willing to face, openly discuss the best way to handle these risks, and assign responsibility for managing and tracking them. It promotes the systematic flow of information from the operating front lines to top management and helps ensure that risk management practices are not wide of the desired mark.

Internal Resources

By respecting the perspective of each level of management and operations, the risk manager develops a better overall picture of the company's health. Gathering information from the operating front lines is important not only for the risks it exposes-the roof seldom collapses without forewarning-but also for what it does not.

For example, take any of the recent disasters, including ValueJet, Chernobyl, Three Mile Island, Barings, PEG, UBS, Solomon Brothers, Orange County or the Challenger. People on the front lines knew what was happening long before each catastrophe. The real issue, after the fact-and what we can learn from-is why the information was not communicated, or if it was, why was it not used? The same analysis can be applied to the loss of national fortunes that resulted from the currency crises in Mexico, Thailand, Indonesia and Russia.

There are always explanations, but never legitimate excuses. In some cases, it was assumed that top management already knew and approved, or if it did not know, it did not want to know. In other cases, top management was not receptive to hearing bad news. Whistleblowers were seen as loose cannons, and not team players. And in the most unfortunate cases, top management knew, but either ignored the warnings or had other priorities. …

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