Risk Management Technology in Financial Services

Elsevier UK Jobcode:RTF Chapter:CH02-H8304 22-3-2007 5:09p.m. Page:35 Trimsize:165×234MM

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What is meant by risk management? 35

risk is usually incurred by not adhering to applicable laws, rules and regulations –

local or international.

Tax risk results from tax authorities opposing the institution’s position on tax

issues. Security risk is the risk of loss of confidentiality, integrity or availability of

information or assets, through accident or fraud. This type of risk divides into physical

security and information security.

The legal fees themselves may be crippling. WorldCom’s bankruptcy in 2002 has

been the largest ever in the United States. In the case of MCI, WorldCom’s suc-

cessor entity which came out of Chapter 11 protection, legal fees connected to the

bankruptcy were high. Some 45 firms of lawyers and consultants have been claiming

over $600 million at a New York court, for guiding the communications company

through the bankruptcy process.

The board, chief executive officer and senior management should personally follow

the aforementioned risk types. They should be provided with prognostication of

worse cases made possible through stress testing, targeting losses that could arise from

extreme, but plausible, major events.

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In matters concerning credit, market, liquidity

and legal risk, stress test results should be gauged against the institution’s capacity

to bear losses expressed as maximum loss the entity could withstand without going

under or urgently seeking for a white knight.

The identification of stress events and scenarios to which the institution is vulner-

able should be followed by an assessment of their potential impact. Well-managed

institutions extensively implement stress measures and limits for their activities, using

a number of methods and techniques, which they continue to refine in order to better

identify:

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Areas of risk concentration,

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Potential vulnerability to stress, and

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Likely damage to reputation or business viability.

In conclusion, risk management and risk control are integral parts of the board’s

commitment to providing consistent, high quality results from operations. Assisted by

his risk manager(s) the CEO should aim to achieve an appropriate balance between

risk and return, both in ongoing business activities and in longer-term strategic

management of the institution’s capital.

2.5 Internal control. The feedback channel

Military organizations learned long ago that orders which are not followed up have

little chance of being executed. Therefore, they have organized a feedback system to

check on their execution and the execution’s aftermath. The feedback channel is very

important with all entities whose CEO is removed from the scene of action. Short of

a reliable feedback, he or she:

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Will be divorced from reality, and

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Have no means to assure that the job is done.