Consulting_In_Risk_Management.docx

CONSULTING IN RISK MANAGEMENTSECTOR RESEARCH

OPERATIONS IN SERVICE INDUSTRY

Operations in Service Sector Page 1

Consulting in Risk Management – Supply Chain Frontier

Executive Summary

Outsourcing, Just in Time, lean management & some other best business strategies in the world can reduce costs and help companies to focus on their core competitiveness, but at the same time they stretch the supply chains to its breaking point, which can leave the company vulnerable in today’s globalized world.

Supply chain disruptions can reduce company’s market share, revenue, inflate the cost of operations as well as threaten production/ distribution functions. It damages the credibility for investors and share holders, increasing the cost of capital.

More and more company’s (manufacturing as well as services firms) are recognizing the importance of supply chain management and supply chain risk management. As a result consulting in SC risk management is very much emerging branch in consulting.

The below study is just to give you a brief idea on need for risk management in SC, major players (firms offering risk management in sc- global & Indian), current issues & challenges, techniques & best practices for risk management in SC , current and future outlook of the industry including governmental policies.


Global Scenario

With increasing globalization, outsourcing, global sourcing, off shoring- whole world has become market for firms offering consulting services in risk management- SC domain. However the main markets emerging out for firms to offer these services are USA, Canada, Mexico, Japan, Germany, France, China, India & S-E Asian countries. In almost all the developed and emerging economies so called BIG FOUR consulting firms Viz.

Market Sectors


Aerospace and Defense Automotives, Chemicals & Performance Technologies, Financial Services, Infrastructure, Building & Construction, Media, Metals Mining, Oil and Gas, Pharmaceuticals, Power and Utilities, Retail and Consumer Goods, Technologies, Telecommunications, Transport & logistics Travel Leisure and Tourism.

Indian Scenario

With increase in outsourcing strategy followed by almost all manufacturing as well as services sector firms to India, India as country has emerges as one the leading market for risk management in SC. Indian market is dominated by mainly by two companies

Major Market Sectors Chemicals & Performance Technologies, Infrastructure,

Building & Construction, Metals Mining, Oil and Gas,


Pharmaceuticals, Power and Utilities, Retail and Consumer Goods, Technologies, Telecommunications, Transport & logistics.

Best Practices & Techniques APICS- Association of Operations management (USA), has

studied various firms offering Risk management in SC as service for varied market sectors. Study has resulted in culmination of best generic approach to be followed (is being followed) to make risk management very effective. The flow chart depicted below gives that generic but effective approach suggested by APICS.

Risk Management in Supply Chain (Generic Approach)


Risk IdentificationRisk Management starts with risk identification. Consultants

undergo brainstorming sessions with various supply chain


Risk Identification

Risk Classification

Risk definition (Dimentions & Scopre of risk)

Risk appettie mapping (Risk tolerance level)

Quantification of Risk level/intensity

Deciding risk responces

Risk Response Cost Vs. Benefits analysis

Generating Preventive & Contingecy risk management plans

Implementing the plans by considering it as project & following project management approch

partners to indentify the potential risk that can arise in supply chain.

Below mentioned are some of the risks involved in Supply chain.

Internal Risks to the Supply chain

External Risk to Supply Chain

Poor Quality Labor shortagesUnreliable suppliers Political instability

Supply shortagesTransportation delays due to bad weather

Equipment breakdown, lack of equipment

Financial risk due to currency instability

Incompatible/ inflexible technology

Natural disasters, Wars, Riots etc.

Uncertain demand or poor forecasting Legal/ Regulatory changesSystem Nervousness Taxation changesCommunication across different cultures Customs Risk

Service failureConsumer/ Customer pressure

Compliance Risk Poor labor/employee relations Poorly trained labors/staff

Risk Categorization

The above identified risks are then classified in various categories like

Personal risks ( internal fraud, human error) Physical assets (Loss of assets)


Technology ( Virus damages, system failure, obsolesces) Relationships (Law suit, loss of reputation) External/ Regulatory (External fraud, govt.

incentives/restrictions)Categorization helps organization to cluster planned risk response, perhaps finding aactions that can mitigate more than one risk.

Risk Definition

Scope and time frame of each risk must be well understood before going for decision of action plans. Scope defines boundaries of the risk mitigation plans to be implemented and time frame defines the period for which risks are valid.

Risk Appetite Mapping

This involves accessing the tolerance level of of firms with respect to particular risk. I.e. to decide whether firm in risk averse or risk tolerant and accordingly the plans for risk mitigations are chopped out.e.g. – Pharmaceutical companies can’t allow quality issues in the supplier’s products, as it may lead to devastating consequences on drug consumer. So in this case pharma companies are risk averse and according plans to mitigate these risks are made.

Quantification of Risk Level

Risk level can be quantified as Risk level = probability of occurrence * magnitude of loss


Deciding Risk Response

There are four basic risk responses that can be implemented.

Avoid- Changing the plan to eliminate the risk e.g. not doing business in politically unstable country. This would avoid the political risk, firm is exposed to

Accept – Accepting the risk and not executing any risk management plan. Risks having low probability of occurrence and low magnitude loss actually fall in this category.

Mitigate- Mitigating the risks in supply chain is most common strategy implementation for risk management e.g. - creating flexibility in potentially risky area od supply chain

Transfer – Transferring the risk to the party who is best suited to handle that particular risk is one of the innovative strategy being implemented recently.

International Organization for Standardization (ISO -31000)

ISO has established ISO 31000 risk management framework to help any size organization to effectively manage the risk. ISO 31000 was proposed in 2009 by ISO. By implementing ISO 31000-2009, organization can compare their risk management practices with internationally recognized benchmark, providing sound principles for effective management. This framework is very much helpful for risk management consultantThe below is mentioned ISO 31000-2009 framework.


Risk Response Cost Vs Benefit Analysis

Benefits after implementation of risk management plans should always outnumber the costs of implementing risk responses.

Generating Contingency & Preventive Plans


Creating risk preventive plans and contingency plans (Business case) is very important step which would determine the success of risk management. Various aspects like firms competitive advantage, future environment, plans etc must be taken into consideration while preparing the preventive and contingency plans.

Implementation of Plans

Final stage in risk management is implementing the risk response plans. Risk plan implementation should be considered as project and project management approach should be followed while implementation of plans.

Roles & Expectations of Risk Management in SC Consultant

Mapping the entire Supply Chain & Understanding & Interdependencies.

Identify potential failure points along the supply chain. Create Risk Awareness throughout the supply chain. Device methods the reduce risk before they become a costly

problem. Priorities funds allocation for risk management to address

critical risk and minimize overall system risk. Implement risk prevention and contingency plans as

projects. Collect, analyze and implement feedback to improve future

plans. Regular risk review risk meetings to keep plans current.


Supply Chain Risk Management – Issues & Challenges

Lack of awareness and buy-in for risk management in supply chain: - Unlike risk management in financial sector in particular, number of companies are yet to accept & appreciate the importance of risk management in supply chains. This is the biggest issue in risk management of supply chain is concerned.

High cost for risk mitigation: - Most of the supply chain risk management approaches for mitigation of risks are very costly to implement. e.g Developing an additional strategic supplier is quite costly affair.

Difficulty in quantification of benefits: - Benefits of risk management in SC are both quantitative and qualitative. While it is very difficult to quantify and winning buy-in for probable expected qualitative benefits. This makes the plan (while doing cost benefit analysis) to lose its luster.

Changes in government policies: - Unpredictable & frequent changes in the regulation and policies makes risk plans either obsolete or less beneficial. And as implementation of risk management plans is costly affair, unpredictable & frequent changes government policies are big issues/ hurdles for implementing risk management plans.

Growth Drivers Increase in risk due to rise in outsourcing:

Supply chain is more exposed to risk than ever before because of going trend for outsourcing. Outsourcing creates interdependencies of varied organization which results in culmination of potential risk.

Increase in costumers and customer locations due to globalization:


Varied location of customers and consumer make the supply chain more vulnerable while fulfilling the demands and needs of those customers.

Increase in products and variances offered due to intense competition:More products and their variances are hour of need if one wants to sustain in intense competitive market. But it also results in increase in risk involved.

Increase in supplier dependency:As the trend of virtual organization is picking up the pace more and more dependent relationships amongst the firms are required, causing potential risk exposure enhancement.

Challenging locations of manufacturing facilities, DC’s etc.: All of the above mentioned trends are responsible for increasing vulnerabilities of supply chains. Organizations quest to maintain uninterrupted flows of product, information, money throughout the supply chains is driving them to consider risk management in supply chain as a strategic advantage. All this has resulted in the growth of need for systematic risk management for supply chain domain, driving organization to seek help of experts offering consulting in risk management of supply chain as service.


Risk Management in Financial Sector

Executive Summary

Risk Management is a hot topic in the financial sector especially in the light of the recent losses of some multinational corporations e.g. collapses of Britain's Barings Bank, WorldCom and also due to the incident of 9/11. Rapid changes in business condition, restructuring of organizations to cope with ever increasing competition, development of new products, emerging markets and increase in cross border transactions along with complexity of transactions has exposed Financial Institutions to new risks dimensions. Thus the concept of risk has captured a growing importance in modern financial society.

By facilitating transactions and making credit and other financial products available, the financial sector is a crucial building block for private as well as public sector development. In


its broadest definition, it includes everything from banks, stock exchanges, and insurers, to credit unions, microfinance institutions and moneylenders. As an efficient service provider, the financial sector simultaneously fulfils an important function in the overall economy. Various types of Financial Institutions actively working in Financial Sectors include Banks, Micro Finance Banks, Leasing Companies, Assets Management Company, Mutual Funds, etc.

In the risk space, there are four major services that consultants offer:

Enterprise Risk Strategy- Enterprise risk strategy is focused on professional services that provide advice on risk oversight at the board and senior executive level. Services in this area include the establishment of risk governance at the board and committee levels, executive oversight for risk management, and company reporting on risk

Risk Audit Services- The role of audit, both internal and external, is in growing demand for risk services. Audit departments do not manage risk as this violates their auditor independence, but they do provide insight into the effectiveness of risk management along with an independent assessment of the company’s risk. Risk audit services provide professional services focused on the integration and support of risk as part of either an external or internal audit function


ERM Organization And Process Design- After you define your executive- and board-level requirements for risk management and oversight; it is then time to define your ERM organization and processes. ERM organization and process design services focus on the design and implementation of an enterprise risk management function across an organization and its entities. Services include the roles and responsibilities for risk management (often including a Chief Risk Officer), the risk organization structure and reporting, communication, and processes to facilitate risk management across business areas·

Risk Systems Design, Development, And Integration- Management of risk in today’s complex business environment requires the integration of risk and compliance monitoring and controls directly into enterprise applications and systems. Organizations engage consultants with specific industry expertise to help them develop and deploy risk and compliance processes into the technology supporting critical business processes (e.g., banking, manufacturing, logistics, and patient systems)

Specialities

Financial/treasury risk management- Financial and treasury risk management is one of the most mature segments of the risk consulting services market. It is in this area that consulting firms offer professional services focused on helping organizations manage the risk to capital, liquidity, credit, markets (e.g., interest or foreign exchange), financial transactions, investments, and hedging/derivative risk. This is a primary area of risk focus for financial services firms as well as large corporate treasury departments.

Operational Risk Management- Operational risk management (ORM) is a growing and challenging discipline of risk services. Banks particularly focused on it as a result of Basel II, but the


complexity of today’s business environment is pushing many organizations into defined processes for operational risk management.

Legal And Regulatory Risk Management- Legal and regulatory risk consulting services advise organizations around the risk of legal or regulatory sanctions, litigation, and financial loss as well as the impact of reputation and stakeholder value from events in these areas.

Geopolitical Risk Management- Geopolitical risk consulting services provide advice to companies on changing economic, political, environmental, civil, and legislative developments around the world with insight as to what it means to their business operations

Information And Technology Risk Management- Technology risk consulting services focus on advising companies regarding the management of risks specific to the information and technology environment — security, privacy, architecture, staffing, compliance, disaster recovery, information protection, outsourcing, business partner connectivity, etc. Thus today's operating environment demands systematic and more integrated risk management approach.

Today's operating environment demands systematic and more integrated risk management approach.

RiskRisk provides the basis for opportunity. The terms risk and

exposure have subtle differences in their meaning. Risk refers to the probability of loss, while exposure is the possibility of loss, although they are often used interchangeably. Risk arises as a result of exposure.


Exposure to financial markets affects most organizations, either directly or indirectly. When an organization has financial market exposure, there is a possibility of loss but also an opportunity for gain or profit. Financial market exposure may provide strategic or competitive benefits.

Risk is the likelihood of losses resulting from events such as changes in market prices. Events with a low probability of occurring, but that may result in a high loss, are particularly troublesome because they are often not anticipated. Put another way, risk is the probable variability of returns.

Potential size of loss Probability of lossPotential for Large Loss

High Probability of Occurrence

Potential for Small Loss

Low Probability of Occurrence

Since it is not always possible or desirable to eliminate risk, understanding it is an important step in determining how to manage it. Identifying exposures and risks forms the basis for an appropriate financial risk management strategy.

Risks are usually defined by the adverse impact on profitability of several distinct sources of uncertainty. More or less all financial institutions have to manage the following faces of risks:

1. Credit Risk

2. Market Risk

3. Liquidity Risk

4. Operational Risk


5. Country Risk

6. Legal Risks

7. Compliance Risk

8. Reputational Risk

Broadly speaking there are four risks as per Risk Management Guidelines which surround Financial Sector i.e. Credit Risk, Market Risk, Liquidity Risk and Operational Risk. These risks are elaborated here under:

i. Credit Risk

This is the risk incurred in case of a counter-party default. It arises from lending activities, investing activities and from buying and selling financial assets on behalf of others. This risk is associated with financing transactions i.e.:

a. Default in repayment by the borrower and

b. Default in obliging the commitment by another Financial Institution in case of syndicated arrangements.

It is the most critical risk in banking and one that must be managed carefully. It is also the risk that requires the most subjective judgment despite constant efforts to improve and quantify the credit decision process.


ii. Market Risk:

Market risk is defined as the volatility of income or market value due to fluctuations in underlying market factors such as currency, interest rates, or credit spreads. For commercial banks, the market risk of the stable liquidity investment portfolio arises from mismatches between the risk profile of the assets and their funding. This risk involves interest rate risk in all of its components: equity risk, exchange risk and commodity risk.

iii. Liquidity Risk:

The liquidity risk is defined as the risk of not being able to meet its commitments or not being able to unwind or offset a position by an organization in a timely fashion because it cannot liquidate assets at reasonable prices when required.

iv. Operational Risk:

This risk results from inadequacies in the conception, organization, or implementation of procedures for recording any events concerning bank's operations in the accounting system/information systems.

Global Scenario

Delloite is the market leader for risk consulting service because of its deep technical knowledge and PricewaterhouseCoopers (PwC), Ernst & Young, and Accenture are also on the way due to their security expertise, breadth of services, and global reach. KPMG provides excellent strategic work and boasts great client feedback. Verizon Business has been


quickly catching up to the Leaders due to its focused strategy around security services and flawless execution.

Risk Consulting market for financial services is mainly divided into the North American Market, European Market and Africa Asia Pacific Market, and Latin America.

North America: USA and Canada

Aon Corporation

Delivers independent advice and solutions for complex risk issues. Offers consultants experienced in disciplines including risk financing and alternative risk transfer, transaction management services, actuarial and analytical, and enterprise risk management.

Deloitte

Services include strategy, process, education, training, tax, organization, and technology assistance. Helps clients with risk identification, assessment, and measurement, and risk response identification, implementation, and monitoring. Also assists with wide range of compliance understanding, design, and implementation services.

Ernst & Young

Offers clients a full suite of risk advisory solutions built around a common service delivery framework of Assess, Improve, and Monitor (AIM). Solution sets include enterprise risk management, internal audit, process & controls, IT effectiveness, ERP, information security, program advisory, third-party reporting, corporate compliance, fraud prevention, investigation & disputes, treasury, actuarial, transactions, and tax.

KPMG


Helps organizations balance risk and performance management, with the goal of maintaining complianceand achieving sustainable value over time.

McKinsey & Company

Management consulting firm that advises businesses, governments, and institutions. Helps leaders makedistinctive, lasting, and substantial improvements to the performance of their organizations.

Mercer Oliver Wyman

Works with CFOs and other senior finance and risk management executives of leading corporations with substantial risk exposures. Offers three practice areas — enterprise risk consulting, actuarial, and strategic finance — each grounded in Mercer Oliver Wyman’s modeling and analytic framework.

Pricewaterhouse Coopers

Provides professional services to improve governance, risk management, and compliance by integrating people, process, technology, and information. Also provides support during and after a crisis, assists to stabilize the environment, remediates as necessary, and puts sustainable changes in place.

Protiviti

Helps clients identify, assess, measure, and manage financial, operational, and technology-related risks, and assists clients with processes and controls to monitor risk. Helps improve internal audit functions, including full outsourcing, co-sourcing, technology, and tool implementation, as well as quality assessment and readiness reviews.


European, Middle-East & Africa

Aon, Capgemini,CSC,Deloitte,E&Y,HP,KPMG, McKinsey & Company, PricewaterhouseCoopers, Navigant Consulting.

Asia Pacific and South America also have the same major companies in risk consulting.

Indian Scenario

Today, The Indian Economy is in the process of becoming a world class economy. The Indian banking industry is making great advancement in terms of quality, quantity, expansion and diversification and is keeping up with the updated technology, ability, stability and thrust of a financial system, where the commercial banks play a very important role, emphasize the very special need of a strong and effective control system with extra concern for the risk involved in the business.

Rising global competition, increasing deregulation, introduction of innovative products and delivery channels have pushed risk management to the forefront of today's financial landscape. Ability to gauge the risks and take appropriate position will be the key to success. The risk arises due to uncertainties, which in turn arise due to changes taking place in prevailing economic, social and political environment and lack of non-availability of information concerning such changes. In financial institutions risk result from variations and fluctuations in assets or liability or both in incomes from assets or payments and on liabilities or in outflows and inflows of cash. Today, banks are facing various types of risks that financial intermediaries are exposed to, in the course of their business.


PracticesRisk Assessment – a process of evaluation including the

identification of the attendant uncertainties, of the likelihood and severity of an adverse effect(s)/event(s) occurring to man or the environment following exposure under defined conditions to a risk source(s). This includes:

Risk Analysis

Risk Identification

Risk Description

Risk Estimation

Some Important Risk Assessment tools:

Elementary Risk Audits for identification of good risks from bad risks- usually adopted by the insurance companies for underwriting.

Safety related Audits – i.e. Fire Safety Audit, Electrical Safety Audit, Comprehensive Safety Audits etc. has become a tool more than a statutory compliance to the safety improvements for the organization and minimization of hazard level.

Risk Based Audits like Machinery Breakdown Risk and ensuing Business interruption Audits have become very important to power plants, Wind energy mill, Cement Industry etc to improve the maintenance practices as well as for Risk financing i.e. insurance coverage, risk pooling etc.

Customer Expectations

When companies go to risk management firms they want to reduce the losses due to various risks discussed like the Credit Risk, market risk. Even individuals for investing in markets put


their money in mutual funds so that these specialists will reduce the losses by investing in the right share. The goal is to effectively mitigate or avoid damage to the organization while seizing the maximum return on opportunities.

Companies in India

CRISIL

They are India's leading ratings agency. They are also the foremost provider of high-end research to the world's largest banks and leading corporations. With sustainable competitive advantage arising from our strong brand, unmatched credibility, market leadership across businesses, and large customer base, CRISIL delivers analysis, opinions, and solutions that make markets function better.

Intuit-consulting Pvt Ltd:

Provides advisory services with regards in insurance, mutual funds, cross border investments, securities market and corporate governance with regards to policy advisory services and market advisory services.

Axis Risk Consulting Services:

Axis Risk Consulting is a risk consulting firm offering services to clients across globe. They mainly identify key business risks, asses and determine risk mitigation strategies. They apply strategic setting and across the enterprise, design to identify potential events that may affect the entity, and manage risks to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives. Reduce cost of risk management by improved sharing of risk information and integration of existing risk management functions. Provide Fraud Risk Assessment and investigations.


Towerswatson-india:

Towers Watson is a leading global professional services company that helps organisations improve performance through effective people, risk and financial management. With 14,000 associates around the world, we offer solutions in the areas of employee benefits, talent management, rewards, and risk and capital management.

HDFCergo Risk consulting services:

Risk Management Services as an offering is along with insurance products and solutions is relatively new to the Indian General Insurance Industry. Risk Management has assumed importance with entry of private general insurance companies in the Indian market. This company has been one of the pioneers in offering this service in the Indian Insurance Market to our Corporate Clientele.

KPMG:

Risk management, capital reserves, credit portfolios, investment policies and capital and debt profiles all demand constant scrutiny to adequately manage and mitigate risk. KPMG provides such a service.

Ernst & Young:

1. Rapid assessment and identification of opportunities to integrate and improve risk practices

2. Diagnostic — a broad and systematic approach to assessing organization-wide global compliance and reporting capabilities, together with a potential future state, a business case and a roadmap.


Deloittee Consulting:

Deloitte brings a business mindset combined with deep technical knowledge and extensive industry experience to assist clients to address business issues across the broad spectrum of accounting, financial instrument valuation, security and privacy, governance, process improvement, data analytics and risk advisory disciplines

PWC Consulting:

financial services risk management experts can help you to develop the risk strategy, risk insight and underlying infrastructure of risk identification, evaluation and communication that will give you the edge in a complex and uncertain business environment.

Risk Pro:

Provides governance risk and compliance in the financial service industry. Governance, risk and compliance are a well defined term and refer to multiple overlapping activities of risk and compliance which include: risk governance, financial operational and IT risk management, audit and control activities, compliance efforts and processes, policies, documentation associated with these functions. The goal of the governance, risk and compliance initiative is to integrate these elements and ensure that information collected is relevant to risk management. The objective of this integration is to achieve a more comprehensive and transparent view of risk in an organization which reports on the effectiveness of risk and governance in an organization and enforces compliance within lines of business.

Issues and Challenges


Credit Risk: It is the potential that the bank borrower fails to meet the obligatons on agreed terms. Thus the default is the risk to the bank. The challenge here is to minimize the quantity of risk ie the loan balance on the date of default and the quality of risk ie the probability of default and the recoveries that could be made in the event of default.

Risk consulting companies thus try to find out the default risk and exposure risk. They do a portfolio analysis which help in identifying concentration of the credit risk default/migration statistics, recovery data.

The credit risk includes the credit rating measurement, quantification of expected losses and controlling through effective loan review mechanism and portfolio management. To offset risks Consulting services advice to take generally undertake Foreign exchange forward contracts, swaps, options and classify them into low risk, medium risk and high risk category.

Market Risk: This arises due to the possibility of loss to the lending institutions caused due to changes in market conditions. Thus the challenges here are the changes in the interest rates currency exchange rates, commodity prices. Thus predictions are a major threat and any deviations causes losses.It is the risk to the bank’s earnings and capital due to these changes.

Financial risk management also consists of liquidity risks and firms generally are advised to maintain liquidity to ensure efficient cash flow.

The major things likely to go wrong if a finance company fails to instill a robust risk-management culture:

Undisciplined introduction of new products- A failure to fully review the risks associated with new products prior to their introduction may result in an inefficient use of capital, reputation risk, and increased liabilities.


Stakeholder value not optimized; opportunities missed- Stakeholder value should be enhanced through the dissemination of the knowledge that a company has in place a risk culture that will allow it to identify issues at earlier stages. Further, a robust risk culture will allow for faster identification and pursuit of opportunities in line with the company's defined risk appetite.

Inefficient and ineffective use of capital- A risk culture assumes that business opportunities can be "risk weighted," bringing into the decision-making process a risk-adjusted decision about which opportunities would offer the greater possible returns given a firm's capital structure.

Risk appetite unknown- Not knowing what a firm is willing to do in terms of risk acceptance will lead to uncertainty and a lack of guidance for the organization, possibly resulting in poor or inefficient decision-making.

Poorly understood or estimated risk limits- A lack of certainty will cause confusion as to what a company is willing to accept in terms of, for example, counterparty risk or trading limits.

Risk models unchallenged- Overconfidence in models and their output contributed to the current financial crisis. A risk culture will require that model inputs and assumptions are regularly challenged and the results questioned.

Risks remain hidden Internal control policies are incomplete or not documented or followed. An effective audit of risks and consequences will not take place, exposing the organization to losses it could have mitigated or avoided with proper due diligence.

No check and balance for risk-takers- The review and decision-making process surrounding the assessment of


risks, in particular the oversight function relating to risk-takers, needs to be robust and independent. A failure to objectively assess risks and risk-taking can lead to catastrophic results.

Incentives focused on short-term returns- Taking a short-term view of results can lead to poor decision-making at the expense of hoped-for immediate positive returns and the taking of unwarranted or inappropriate risks not in the best long-term interests of stakeholders or the company.

Risk unnecessarily avoided- Profits are derived from risk-taking. A failure to take risk or avoiding risk even though it would be within the organization's assumed risk appetite will lead to underperformance and a failure to optimize stakeholder value.

Communication and reporting fails- Organizations should strive to understand their risks from an enterprise perspective, which includes the reporting or communication of risks and risk-taking, as well as opportunities presented by dealing with risks in an efficient and optimal way. A failure to develop a risk culture that provides for the communication of risks, risk-taking, and their consequences, either positive or negative, is not in the best interests of any organization.

Growth Drivers


The process of financial risk management comprises strategies that enable an organization to manage the risks associated with financial markets. Risk management is a dynamic process that should evolve with an organization and its business. It involves and impacts many parts of Hedging and Correlation Hedging is the business of seeking assets or events that offset, or have weak or negative correlation to, an organization’s financial exposures.

Correlation measures the tendency of two assets to move, or not move, together. This tendency is quantified by a coefficient between –1 and +1. Correlation of +1.0 signifies perfect positive correlation and means that two assets can be expected to move together. Correlation of –1.0 signifies perfect negative correlation, which means that two assets can be expected to move together but in opposite directions.

The concept of negative correlation is central to hedging and risk management. Risk management involves pairing a financial exposure with an instrument or strategy that is negatively correlated to the exposure.

A long futures contract used to hedge a short underlying exposure employs the concept of negative correlation. If the price of the underlying (short) exposure begins to rise, the value of the (long) futures contract will also increase, offsetting some or all of the losses that occur. The extent of the protection offered by the hedge depends on the degree of negative correlation between the two.

The risk management process involves both internal and external analysis. The first part of the process involves identifying and prioritizing the financial risks facing an organization and understanding their relevance.

It may be necessary to examine the organization and its products, management, customers, suppliers, competitors,


pricing, industry trends, balance sheet structure, and position in the industry. It is also necessary to consider stakeholders and their objectives and tolerance for risk.

Once a clear understanding of the risks emerges, appropriate strategies can be implemented in conjunction with risk management policy. For example, it might be possible to change where and how business is done, thereby reducing the organization’s exposure and risk. Alternatively, existing exposures may be managed with derivatives. Another strategy for managing risk is to accept all risks and the possibility of losses.

Factors that Impact Financial Rates and Prices Financial rates and prices are affected by a number of factors. It is essential to understand the factors that impact markets because those factors, in turn, impact the potential risk of an organization.

Factors that Affect Interest Rates

Interest rates are a key component in many market prices and an important economic barometer. They are comprised of the real rate plus a component for expected inflation, since inflation reduces the purchasing power of a lender’s assets. The greater the term to maturity, the greater the uncertainty. Interest rates are also reflective of supply and demand for funds and credit risk.

Factors that influence the level of market interest rates include

Expected levels of inflation

General economic conditions

Monetary policy and the stance of the central bank


Foreign exchange market activity

Foreign investor demand for debt securities

Levels of sovereign debt outstanding

Financial and political stability

Factors that Affect Foreign Exchange Rates

Foreign exchange rates are determined by supply and demand for currencies. Supply and demand, in turn, are influenced by factors in the economy, foreign trade, and the activities of international investors.

Capital flows, given their size and mobility, are of great importance in determining exchange rates.

Factors that influence the level of interest rates also influence exchange rates among floating or market-determined currencies. Currencies are very sensitive to changes or anticipated changes in interest rates and to sovereign risk factors. Some of the key drivers that affect exchange rates include:

Interest rate differentials net of expected inflation

Trading activity in other currencies

International capital and trade flows


International institutional investor sentiment

Financial and political stability

Monetary policy and the central bank

Domestic debt levels (e.g., debt-to-GDP ratio)

Economic fundamentals

Key Drivers of Exchange Rates

When trade in goods and services with other countries was the major determinant of exchange-rate fluctuations, market participants monitored trade flow statistics closely for information about the currency’s future direction. Today, capital flows are also very important and are monitored closely.

When other risk issues are considered equal, those currencies with higher short-term real interest rates will be more attractive to international investors than lower interest rate currencies. Currencies that are more attractive to foreign investors are the beneficiaries of capital mobility.

The freedom of capital that permits an organization to invest and divest internationally also permits capital to seek a safe, opportunistic return. Some currencies are particularly attractive during times of financial turmoil. Safe-haven currencies have, at various times, included the Swiss franc, the Canadian dollar, and the U.S. dollar.

Foreign exchange forward markets are tightly linked to interest markets. In freely traded currencies, traders arbitrage between the forward currency markets and the interest rate markets, ensuring interest rate parity.


Factors that Affect Commodity Prices:

Physical commodity prices are influenced by supply and demand. Unlike financial assets, the value of commodities is also affected by attributes such as physical quality and location.

Commodity prices may be affected by a number of factors, including:

Expected levels of inflation, particularly for precious metals

Interest rates

Exchange rates, depending on how prices are determined

General economic conditions

Costs of production and ability to deliver to buyers

Availability of substitutes and shifts in taste and consumption patterns

Weather, particularly for agricultural commodities and energy

Political stability, particularly for energy and precious metals

Commodity traders are sensitive to the inclination of certain commodity prices to vary according to the stage of the economic cycle. For example, base metals prices may rise late in the economic cycle as a result of increased economic demand and expansion. Prices of these commodities are monitored as a form of leading indicator.

Best Practices, Quality Measurements

As the primary risk absorbers in the economy, insurance companies must have a high degree of confidence that they can


meet their obligations. Risk management helps companies estimate the financial impact of these organization-threatening results, gain an understanding of which risk factors cause them, and point the way to effective risk containment solutions.

Risk management strategy work on the key business processes:

Risk appetite & control — ascertain the boundaries for risk taking and ensuring that the business stays within those borders.

Risk-based performance — appropriately allowing for risk in measuring, monitoring and targeting business performance.

Capital requirement — understanding basic or minimum capital requirements and efficiently deploying capital resources, consistent with the strategic goals.

Need for Risk Management and Monitoring

There are a number of reasons as to why there is so much emphasis given to Risk Management in Financial Sector now a day. Some of them are listed below: -

Present structure of joint stock companies, wherein owners are not the mangers, hence risks increase; therefore proper tools are required to achieve the desired results by covering the risks.

The financial sector has come out of simple deposit and lending function.

The world has become very complex so the financial transactions and instruments.


Increase in the number of cross border transactions which caries its own risks.

Emerging markets

Terrorism Remittances

Risk management model offering

DFA modelling/ tool: Modelling and Management of Nonlinear Dependencies– Copulas in Dynamic Financial Analysis, Dynamic Financial Analysis as the untrodden path for company risk measurement under Solvency-II - Dynamic

Financial Analysis (DFA) is the most advance modeling process in today's property and casualty industry-allowing us to develop financial forecasts that integrate the variability and interrelationships of critical factors affecting our results. Through the modeling of DFA, we see the company's relevant random variables is based on the categorization of risks which is generated solvency testing where the financial position of the company is evaluated from the perspective of the customers. The central idea is to quantify in probabilistic terms whether the company will be able tomeet its commitments in the future. DFA is in the capital budgeting decision process of a company launching a new invention and predicting the impact of the strategic decision on the balance sheet in a horizon of few years.

To recognize the few factors that will affect the asset liability cash flow are demand uncertainty, sales volatility, credit risk, volatility in the price of raw materials cost of capital to name a few. Each of these random variables can be stochastically simulated either based on the distribution of retrospective data or under strategic assumptions. When simulated in a combined way the future cash flows can be predicted which in return would dictate the capital requirements in the future.


Depending on the capital structure of the company and simulated interest rate in the capital market the final earnings volatility of the company can be predicted to identify the return and associated risks.

Being possess a unique characteristic called ‘non-subjective to risk manager’s preferences’, risk model will possibly be least governed by human bias. Although critics may argue that any search for a single ‘best’ risk measure – one that is best in all conceivable circumstances – would appear to be futile, our modification on VaR will necessarily widen the scope of tail related risk models in institutional and regulatory policymaking.

Govt Policies present (drivers/ retarders)

Risk monitoring in financial sector is very crucial and an inevitable part of risk management. Risk Monitoring is important in the financial sector due to the following reasons:

Deals in others' money

Direct stake of deposit holder.

Much riskier sector than trading and manufacturing.

Previous / Recent problems faced by banks i.e. stuck portfolio that is credit risk.

Bankruptcy of Barings Bank due to short selling / long position that is market risk.

Operational risk does not has immediate impact, but important for continuity and progress of organization.

Appetite of a financial institution to take risk is related with the capital base of the institute so it carries a huge risk of over exposure.


Components of Risk Management Frame Work

Risk Management Frame Work has five components. First of all risk is Identified, then it is Assessed to classify, seek solution and management, after assessing quick Response and implementation of solution and the last phase is Monitoring of the risk management progress and Learning from this experience that such problem never occur again. Whole process is to be well communicated during the entire process of risk management if it is to be managed efficiently.

Financial Risk management policies are as follows:

All business decisions will be made with the prior information and acceptance of risk involved.

The Risk Management Policy shall provide for the enhancement and protection of business value from uncertainties and consequent losses.

All employees of the company shall be made aware of risks in their respective domains and their mitigation measures.

The risk mitigation measures adopted by the company shall be effective in the long-term and to the extent possible be embedded in the business processes of the company.

Risk tolerance levels will be regularly reviewed and decided upon depending on the change in company’s strategy.

The occurrence, progress and status of all risks will be promptly reported and appropriate actions be taken thereof.

The International Organization for Standardization (ISO) has defined risk management as the identification, analysis, evaluation, treatment (control), monitoring, review and communication of risk. These activities can be applied in a systematic or ad hoc manner. The presumption is that systematic


application of these activities will result in improved decision-making and, most likely, improved outcomes.

Future Outlook/ 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 no organization can survive in long run.

Financial risk management is not a contemporary issue. Financial risk management has been a challenge for as long as there have been markets and price fluctuations.

Future areas of research

A comprehensive research should be made in the light of risk consulting financial sector reforms:

Feasibility and viability of E-banking in the Rural Sector of India – Problems & Prospects and risk elimination in the same,

Implications of Computerization & IT in the Banking Sector of India,

Feasibility of Banking Sector Reforms in the Regime of WTO and the risk analysis,

Merger & Acquisition – Its Implications – Challenges Ahead,

FDI & Indian Banking Sector risk analysis for the Indian Government,

Management of NPAs (Non performing Assets).


Financial risks arise from an organization’s exposure to financial markets, its transactions with others, and its reliance on processes, systems, and people.

To understand financial risks, it is useful to consider the factors that affect financial prices and rates, including interest rates, exchange rates, and commodities prices.

Since financial decisions are made by humans, a little financial history is useful in understanding the nature of financial risk.


Consulting_In_Risk_Management.docx

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