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Ten steps to effective risk management

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31st Mar 2009
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A new report has been launched analysing the effects of risk and suggesting practical measures to accelerate economic recovery.

Key points
  • Risk should have greater authority
  • Risk management needs to be carried out at the top level of management
  • Risk data needs to be combined with human judgement
  • Incentives should promote long term stability, not short term goals
  • Don’t rely too heavily on data from external sources

The Economist Intelligence Unit’s report, entitled ‘Managing risk in perilous times: Practical steps to accelerate recovery’, explores current thinking around risk management and proposes ten practical steps that financial institutions could take to strengthen their governance and management of risk.

“Our research suggests that a consensus is gradually emerging around the steps that are required to strengthen risk management in the world’s financial institutions,” says Rob Mitchell, editor of the report. “From governance and leadership to a greater focus on communication and organisational structure, the changes required are widespread and far-reaching, but essential to strengthen the overall resilience of the financial system.”

The report identifies the following ten steps to address current weaknesses in risk management.

Risk management must be given greater authority
Even if risk managers have the right tools, information and expertise at their disposal, this counts for nothing if they do not have sufficient authority to escalate concerns and curb excessive risk-taking. To address this problem, senior executives should ensure that risk managers have appropriate stature within the organisation, and that this is thoroughly understood by those at the sharp end of the business.

Senior executives must lead risk management from the top
Leadership and tone from the most senior level is essential. There should be appropriate board oversight of risk, usually through the audit committee or a risk committee. The chief executive, as the ‘owner’ of risk in the institution, must be seen to elevate the authority of risk management and build a robust, pervasive risk culture.

Institutions need to review the level of risk expertise in their organisation, particularly at the highest levels
Financial institutions must be confident that they have sufficient risk expertise at the most senior level. Both executives and non-executives should have the tools and information at their disposal to understand the institution’s risk appetite and positions.

Institutions should pay more attention to the data that populate risk models, and must combine this output with human judgment
No matter how sophisticated, models are limited by the quality of the data feeding them. Even with the best available data, no risk management tool should be used in isolation, and quantitative methods should always be backed up with qualitative approaches and the vital inputs of human judgment and dialogue.

Stress testing and scenario planning can arm executives with an appropriate response to events
Stress testing must be integrated with the firm’s overall risk management processes, and mechanisms developed to ensure that the results are communicated to senior management in such a way that it is possible for them to formulate a clear response.

Incentive systems must be constructed so that they reward long-term stability, not short-term profit
Certain aspects of the bonus culture and remuneration models for senior banking executives will need to be overhauled, with some of the rewards being withheld to match the maturity of the underlying business.

Want to know more? Read the full version of this story on AccountingWEB.co.uk's sister site Finance Week.
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