Nature and sources of Risk

One of the paradoxes of the recent global nancial crisis is that the crisis erupted
in an era when risk management was at the heart of the management of the largest and
most sophisticated nancial institutions. For institutions that see their role as making
money by taking judicious risks, the management of those risks is pivotal in their daily
operations. The risk manager quoted above was merely re-a rming the rms goals.
The risk managers task is to enable the rm to fulll its purpose by providing the
framework for measuring risks accurately, enabling the rm to take advantage of greater
precision so as to extract the last ounce of return from the rms portfolio. Financial risk
is endogenous due in large part to the reasoning embedded in the opening quote.
Endogenous risk refers to risks that are generated and amplied within the nancial
system, rather than risks from shocks that arrive from outside the nancial system. The
precondition for endogenous risk is the conjunction of circumstances where individual
actors react to changes in their environment and where those individuals actions a ect
their environment.
Risk identification sets out to identify an organisations exposure to uncertainty.
This requires an intimate knowledge of the organisation, the market in which it operates,
the legal, social, political and cultural environment in which it exists, as well as the
development of a sound understanding of its strategic and operational objectives,
including factors critical to its success and the threats and opportunities related to the
achievement of these objectives. Risk identification should be approached in a
methodical way to ensure that all significant activities within the organization have been
identified and all the risks flowing from these activities defined. All associated volatility
related to these activities should be identified and categorized.

Business activities and decisions can be classified in a range of ways, examples of

which include:
Strategic - This concern the long-term strategic objectives of the organization. They
can be affected by such areas as capital availability, sovereign and political risks, legal
and regulatory changes, reputation and changes in the physical environment.
making poor market decisions

Focused on the wrong target market

Incorrectly estimated demand (way too optimistic)
Priced the product/service incorrectly
Failed to study/understand customer needs

 Unaware of technological changes in manufacturing or innovations in

service delivery
Ignored competitor actions that impact demand, pricing, marketing
strategy or new product/service development

Operational - These concern the day-today issues that the organization is confronted
with as it strives to deliver its strategic objectives.
-is exposure to loss due to poor systems and controls (poor
management)

A poor business plan

Unfavorable lease arrangements
Poor supply chain controls and disruptions
Ineffective quality assurance program
Information system data loss (viruses and corruption)
Dependence on independent contractors
Poor security and inventory control (theft)
Employee incompetence

Financial - These concern the effective management and control of the finances of
the organization and the effects of external factors such as availability of credit, foreign
exchange rates, interest rate movement and other market exposures.
Interest rate changes, which affect the cost of capital for a growing
company
Foreign exchange rates when the company is doing business
globally
The availability of credit
Product liability and warranty claims
Cash flow/liquidity problems
Loss of revenues

Knowledge management - These concern the effective management and control of

the knowledge resources, the production, protection and communication thereof.
External factors might include:

 the unauthorized use or abuse of intellectual property,

area power failures,
Competitive technology.
Internal factors might be:
System malfunction or loss of key staff.

Some common sources of risk

o

The strategic decisions you make (or fail to make)

o Economic/Financial risks
o Technological changes
o Nonpayment of debts by customers