A Risk Management Program for a Financial Institution

Introduction 

There has been an increasing need for pragmatic approach for managing a growing plethora of risks facing banks globally. Therefore, the banks have understood the significance of risk management in sustaining their organizations. There are two perspectives from which organizations view risk; traditional risk management and enterprise risk management. Traditional risk management offers the mechanisms that facilitate reaction to risk, classification of risks as well as providing control over the effectiveness of actions, compliance with regulations and reality. However, the traditional risk management approach is no longer sufficient because it views risk as a necessary evil, which must be removed. As such, the enterprise risk management has been considered by organizations, particularly banks, as an effective way of handling risks. ERM refers to the process that enables banks to deal with a variety of risks and opportunities effectively in order to increase stakeholder value (Grace et al., 2015). Additionally, what makes enterprising so compelling is that it expresses risk not only as a threat but also as an opportunity. Therefore, banks have to come up with effective strategies that will not only help them to eliminate the threats associated with the risks but to also convert the risks into opportunities. 

Traditional Risk Management Perspective 

Traditional risk management is a reactive model that can be regarded as either a managerial process or decision-making process. Regarded as a managerial process, traditional risk management encompasses the four functions of management: organizing, planning, controlling, and leading the activities of the organization with the objective of minimizing the adverse effects of business or accidental losses at a reasonable cost. When regarded as a decision making process, traditional risk management involves a sequence of five steps used to manage risk. 

The five steps include identification and analysis of the exposures to accidental losses, examination of the potential risk management mechanisms for dealing with the exposures, selection of the best risk management mechanisms, implementing the selected risk management technique, and monitoring the outcomes of the selected risk management techniques (Marcelino-Sadaba et al., 2015). Additionally, traditional risk management is an approach that is fragmented. Therefore, the approach is managed by the various functional departments in an organization. Traditional risk management focuses on pure risks and consequently refers to the respective risk as if they do not interact. The risks under traditional risk management include moral hazard, morale hazard, physical hazard, and legal hazard. 

Moral Hazard 

The local bank will have to consider the threat posed by moral hazard risks to the business. Moral hazard refers to the risk that a party to a particular transaction has not entered the contract in good faith. This can happen when a customer seeking a credit facility provides misleading information about his or her assets and liabilities in order to take advantage of the other party. This happens mostly to banks because customers may ignore the moral implications of their choices. As such, the customers may focus on doing what benefits them the most instead of doing what is right. 

Therefore, investigations regarding to the loan applications made to the bank should be carried in order to identify the presence of moral hazard risks. Additionally, the employees in charge of approving loans will be trained on how to reduce moral hazard risks by carrying out thorough customer due diligence. This can be done by extending the duration required to approve the loans in order to get sufficient time for verifying the customer documents presented during loan application. Additionally, the bank will communicate with the employers and former banks of the customers to ascertain the credibility of the documents provided. This will be followed with regular monitoring and evaluation of the measures to determine their effectiveness in eliminating moral hazard risks. 

Morale Hazard 

Morale hazard risks refer to risks that occur as a result of indifference attitude to loss among bank employees. Moral hazard risk may exist in the bank and there is need to stem them. As such, the bank should investigate the existence of morale hazards in the bank. This can happen when employees fail to take the necessary measures to prevent losses. 

As the chief risk officer of the bank, employees should adhere to all risk management techniques developed by the bank to prevent or reduce accidental business losses (Aven & Krohn, 2014). Morale risks happen when employees lack the motivation to contribute their best to the organization as a result of poor compensation or poor work place conditions. For instance, the employees may collude with customers to steal from the bank because they are poorly paid. To prevent such morale hazard risk from occurring, employees should be compensated well and the work place conditions made good. Moreover, the employees will be incorporated into the decision making process so that they can identify themselves with the objectives of the bank. 

Physical Hazard 

Physical hazard risks arise from factors within the bank, which can harm employees. Physical hazards include but not limited to electricity faults, pressure, noise, and heights. The bank should therefore carry out a safety audit of its building in order to identify the various physical hazards that may affect employees and customers. Electrical devices that are not properly installed should be identified and corrected by trained electricians to ensure safety. The walk up ATM machine should be relocated to the ground floor for easy access and prevention of injuries as a result of fall. The bank needs to realize that safety is paramount because it enhances the image of the bank among current and potential customers as well as improving employee motivation. 

Legal Hazard 

Legal hazard risks refer to risks caused by disregard of legal regulations, prescribed practices, agreements, ethical standards, contracts, and legal documents. Legal hazard may occur as a result of actions taken by the bank or its employees that are not in line with the legal framework, uncertainty of the effects that may be caused by the implementation of the legislation and the apparent inefficiency of the country’s legal system. 

Generally, the staff and the management of the bank are considered the main causes of the legal hazard risks. As such, the bank should ensure that the employees and the management are properly trained about legal issues and how they impact the bank’s business. Additionally, measures should be taken to ensure that employee do not deceive customers or engage in fraud by putting the appropriate measures in place. The legal hazard risks should therefore be professionally managed by identifying, measuring, controlling, insuring and eliminating (Bromiley et al., 2015). The bank should determine where the legal hazard risk is likely to occur, when, why and how the risks can impact on the bank. 

In order to effectively manage legal hazard risks, I would oversee the senior management to ensure that policies, processes, and systems are effectively implemented at all levels of the organization. I would also develop appropriate information system for legal hazard risks as well as implementing and fostering a culture of risk in the organization. 

Enterprise Risk Management 

Enterprise risk management has attracted much interest from organizations in the last several years, especially after the great global financial crisis. Currently, organizations exist in an uncertain world of interrelated and complex risks and they have found it necessary to develop an enterprise risk management system. As such, enterprise risk management reflects an organization’s ability to understand, control, and even articulate the level and nature of risks taken in the pursuit of business strategies. Additionally, organizations have the responsibility for accounting for risks taken as well as the activities it engages in to increase the confidence of stakeholders. 

The basic concepts of the enterprise risk management model have been applied in various industries for a considerable length of time. The growing complexity of risks, economic turmoil, and the changing regulatory environment among other influences has contributed to the adoption of enterprise risk management in the banking industry. Additionally, the business of banking exposes organizations to a plethora of risks. Therefore, enterprise risk management provides a structured approach for identifying, measuring, controlling, and reporting on the major risks faced in order to support the depth and breadth of activities in the organizations. 

The Risk Management Process 

To ensure the success of the enterprise risk management process, there are five steps that should be followed. Therefore, the five steps combine to deliver a simple but effective risk management process for the bank. 

Scanning the Environment 

Scanning the environment involves acquiring and using the information about the risks, the organization is exposed to, their impact and the interrelationship of the risks in order to develop an effective risk management program (Aven & Krohn, 2014). Therefore, it is important to identify the various risks and their respective sources so that the bank can appropriately prepare and respond to them. Scanning the environment is important because it will help in defining the scope of the risk management process as well as the resources needed. 

Identifying the Risk 

The bank’s risk management team should be involved in uncovering, recognizing, and describing the particular risks that may affect the bank’s business (Rampini & Viswanathan, 2013). A risk register can be used in the process of identifying and describing risks. The risk register assists in not only identifying the level of risk exposure but it also helps in classifying risks. Therefore, the risk identification phase of the risk management process is important because it guides the whole process. 

Analyzing the Risks 

Once the risks that the bank is exposed to are identified, the likelihood and the consequence of each risk should be determined in order to develop appropriate approaches for managing them. Additionally, the risk management team should develop a good understanding of the nature of the risks as well as their potential to affect the business goals of the bank. The risks should also be ranked based on their magnitude. The risk magnitude is determined by evaluating the combination of consequence and likelihood of the individual risks. As such, a decision can be made as to whether the risk is acceptable or should be treated by the bank. 

Treatment of the Risks 

Treatment of the risks is also referred to as risk response planning. This stage involves assessment of the highest ranked risks and setting out a plan for treating or modifying the risks to achieve the acceptable risk levels. The risk treatment plan should articulate how the probability of the negative risks can be minimized as well as enhancing the opportunities (Rampini & Viswanathan, 2014). Additionally, this step involves creation of preventive plans, mitigation strategies, and contingency plans. Therefore, this step of the risk management process represents the hallmark of all activities because it is where the preventive and treatment strategies are developed. 

Enterprise Risk Management Goals 

The enterprise risk management process seeks to meet various business goals of the bank. Therefore, the success of an enterprise risk management program is determined by whether the goals set are achieved or not. Therefore, achievement of the risk management goals represents the hallmark of the enterprise risk management. 

Tolerable Uncertainty 

The economic circumstances currently facing banks are characterized by high levels of uncertainty. Therefore, appropriate policy decisions need to be made in the face of various uncertainties that impact on the banking business. Tolerable uncertainties are normally occasioned by changes in the regulatory environment that impact significantly on the operations of banks. The most appropriate measures that should be taken need to be focused on policy development and culture change. Changes in the regulatory environment means that compliance costs may increase and the probability of regulatory breaches may increase significantly. Therefore, appropriate policies should be developed and implemented to reduce the impact of the uncertainties. Additionally, a positive culture should be enhanced in order to maintain accountability and drive behaviors that enhance the bank’s brand. 

Legal and Regulatory Compliance 

Banking organizations have significantly expanded the scope and complexity of their activities. As a result, they face an ever changing and as well as an increasingly complex regulatory environment. Furthermore, the increased emphasis on customer protection and consumer credit crisis has made the regulatory agencies and the general public to focus on the bank’s regulatory compliance performance and customer practices. 

Therefore, compliance failure can lead to financial penalties, regulatory constraints, litigation, and reputational damage (Gatzert & Martin, 2015). Therefore, the bank will improve the effectiveness and reduce the cost of regulatory programs by designing enterprise-wide compliance risk management frameworks that are consistent with the bank’s objectives and the regulatory requirements. Additionally, the bank will facilitate regulatory readiness reviews and risk control assessments. 

Survival 

During worst times, financial institutions face a steeper climb because sales usually dip. However, small financial institutions can grow irrespective of the financial downturn if they manage the risks that impact on their survival. Interestingly, the bank can turn the seemingly threatening risks into lucrative opportunities. In order to ensure survival, the bank should keep the costs down as much as possible and prices competitive. The bank should also introduce new products that differentiate it with competitors and expand into new markets in order to increase the chances for survival. The bank should establish more branches as opposed to the single branch it currently owns. 

Business Continuity 

The threats are becoming more complicated as the due the continually changing risk landscape. Therefore, the bank should consider developing strategies that will make it impervious to incidents rather than focusing on preventive strategies. As such, the bank needs to develop capacity to immediately respond to an incident, protecting the staff, and allow for the continuation of services. Therefore, the bank will select a different location for its systems to avoid loss of important information in case of fire. This will ensure that the bank will continue operating even if the current branch is damaged by fire. Additionally, the bank should have an objective and effective succession plan for the top management. This will ensure that the death of the leader of the organization does not lead to the closure of the business. 

Earning Stability 

Earning stability refers to how consistently an organization’s earnings have been generated. Earning stability is achieved where the growth of an organization is more predictable (Grace et al., 2015). In order to ensure that the bank achieves earning stability, the expenses should be cut in order to increase earnings. Unnecessary expenses should be eliminated to facilitate a steady growth pattern. The bank will also continue to develop new products and segment its market in order to increase its revenue. 

Social Responsibility 

Particular emphasis has been placed on financial institutions’ corporate social responsibility over the past few years. Social responsibility promotes the bank’s profile in the community it serves, facilitates community development, and strengthens its profitability. Therefore the bank should recognize its responsibility to limit social and environmental harm that may have been caused by the activities it may have financed. Therefore, the bank should facilitate community involvement and promote awareness and transparency. This can be done through community support programs and publishing of sustainability reports on social responsibility. 

Conclusion 

In conclusion, successful risk management processes ensure that the risks taken by the bank are compensated by a commensurate level of reward. Additionally, the bank will be completely aware of the amount and types of risks it wants to take on. The traditional risk management approach is no longer sufficient because it views risk as a necessary evil, which must be removed. As such, the enterprise risk management has been considered by organizations, particularly banks, as an effective way of handling risks. Furthermore, banks are currently use enterprise risk management to integrate risk and risk control techniques in order to create a common framework for evaluating and monitoring all kinds of risks. 

References  

Aven, T., & Krohn, B. S. (2014). A new perspective on how to understand, assess and manage risk and the unforeseen. Reliability Engineering & System Safety , 121 , 1-10. 

Bromiley, P., McShane, M., Nair, A., & Rustambekov, E. (2015). Enterprise risk management: Review, critique, and research directions. Long range planning , 48 (4), 265-276. 

Gatzert, N., & Martin, M. (2015). Determinants and value of enterprise risk management: empirical evidence from the literature. Risk Management and Insurance Review , 18 (1), 29-53. 

Grace, M. F., Leverty, J. T., Phillips, R. D., & Shimpi, P. (2015). The value of investing in enterprise risk management. Journal of Risk and Insurance , 82 (2), 289-316. 

Marcelino-Sádaba, S., Pérez-Ezcurdia, A., Lazcano, A. M. E., & Villanueva, P. (2014). Project risk management methodology for small firms. International Journal of Project Management , 32 (2), 327-340 

Rampini, A. A., & Viswanathan, S. (2013). Collateral and capital structure. Journal of Financial Economics , 109 (2), 466-492. 

Rampini, A. A., Sufi, A., & Viswanathan, S. (2014). Dynamic risk management. Journal of Financial Economics , 111 (2), 271-296.