Effective Risk Management: Look before you Leap
Chief Risk Officer
Risk is inherent in everything we do. Whether it be choosing to leave the house, turning on a burner, bungee jumping from a cliff, every action has the potential for something to go wrong. The same is true in business: business decisions carry risk. Sometimes it’s the expansion or growth that drives risk – but doing nothing is often a risk as well. A competitor could be leaping ahead while you are standing still. Inevitably there’s money that could have been made, if you had taken a chance.
Thus, strong risk management isn’t about stopping risk; it’s about managing risk effectively.
Effective risk management is a term that’s often thrown about as a sound bite. What does it really mean, and how do you get there?
- Balance risk and reward: Ensure you are getting paid (or value) commensurate with the risk. In finance this means setting pricing and fees at a point that balances future risk; in a casino, this means driving volume to offset wins or regulatory hassle; in health care this means driving enough timely value and customer satisfaction to offset the cost and regulatory headache.
- Measure small, miss small: Develop reporting and data infrastructure to measure and monitor the risk short term. Reporting at a more granular / marginal level soon after implementation drives faster response to problems and greater long-term savings. Many banks responded far too late during the Great Recession, primarily because they were monitoring the long-term blended performance. The short-term marginal performance gave early warning signals that were missed by many due to inadequate measures and reporting.
- Open Discussion and Debate: Robust discussion and debate of risks allows decision makers to be fully informed in making the risk / reward decisions. Hiding potential negatives may smooth the path to approval today, but they will usually come back to hurt the company (and your career) long-term. Identifying risks and mitigations before implementation ensures that risk management is effective. This process cannot be a rote repetition of last month’s risks. Critically thinking about what risks apply and what makes this decision or action different than others is just as important as thinking about how the decision and actions are the same. Reporting and measurements must be matched up to risks as mitigating factors that drive successful early identification and action on issues as they arise.
- Triggers: Of particular use in tracking performance vs. expectations, triggers are metrics that are established prior to implementation and set at expected levels with a small cushion. The cushion should consider the standard deviation / seasonal movement of the metric within normal conditions and be set to ensure that any unusual movement triggers for a response. Most often, these are established with red, yellow, and green indicators to show if a metric is within tolerance. Measures that go above the limit will be flagged for deeper analysis or explanation to management. This ensures that decisions are followed and monitored to ensure they perform as expected.
- Opportunity Cost: Decision making must also consider opportunity costs associated with taking or not taking an action. If you commit resources to this project, what other projects or needs are sidelined? If you don’t act on this opportunity, will your competitors steal market share? Will you lose customers?
In Ben Franklin’s words: “An ounce of prevention is worth a pound of cure.”
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