Enterprise Risk Management: From Incentives to Controls, 2nd Edition

CHAPTER 4

What Is ERM?

In the last chapter, we reviewed the concepts and processes applicable to almost all of the risks that a company will face. We also argued that all risks can be thought of as a bell curve. Certainly, it is a prerequisite that a company develop an effective process for each of its significant risks. But it is not enough to build a separate process for each risk in isolation.

Risks are by their very nature dynamic, fluid, and highly interdependent. As such, they cannot be broken into separate components and managed independently. Enterprises operating in today's volatile environment require a much more integrated approach to managing their portfolio of risks.

This has not always been recognized. Traditionally, companies managed risk in organizational silos. Market, credit, and operational risks were treated separately and often dealt with by different individuals or functions within an institution. For example, credit experts evaluated the risk of default, mortgage specialists analyzed prepayment risk, traders were responsible for market risks, and actuaries handled liability, mortality, and other insurance-related risks. Corporate functions such as finance and audit handled other operational risks, and senior line managers addressed business risks.

However, it has become increasingly apparent that such a fragmented approach simply doesn't work, because risks are highly interdependent and cannot be segmented and managed by entirely independent units. The risks ...