Firms are faced with numerous risks in their daily course of operation. However, the complexity of risks has increased tremendously over the past few decades. Some of the main reasons for the increase include the high rate of globalization and technological innovation. Enterprise Risk Management is one of the strategic management processes which are aimed at identifying potentially unfavorable outcomes which may negatively affect a firm’s operation (Acharyya 2010).
Through the ERM, a firm is able to manage risks that occur in the course of its operation so as to maintain them within the acceptable degree of risk. Effective risk management increases a firm’s probability of attaining its objectives. It is the objective of ERM to increase the value of the stakeholder’s investment. Considering the volatile nature of the financial services industry, it is vital for firms in the industry to formulate and implement an effective ERM process. According to Cooper (2010), financial institution regulators have over the recent past increased their emphasis on the importance of financial institutions developing an effective analysis of the firm’s daily operation.
According to Cooper (2010), the need for increased risk analysis amongst financial institutions arises from the fact that there are numerous financial risks, strategic risks such as increased competition and fluctuation in demand, operational risks, and hazard risks such as increased liability claims facing these firms. An example of these risks includes fluctuation in the interest rate and changes in other changes in the macro-environment such as economic recession (Casualty Actuarial Society 2003).
Effective risk analysis can be attained by ensuring that the entire firm’s personnel adhere to the firm’s regulatory requirements. In order for financial institutions to be effective in their risk management, a well-defined process should be followed. The aim of this paper is to analyze the risk management processes which financial institutions should implement. The paper also evaluates the role of management accountants in the enterprise risk management process.
Enterprise risk management processes should be implemented in financial institutions.
In the process of risk management, a comprehensive process should be adopted. The framework below gives an illustration of the steps which financial should be followed.
Establishing the context
The financial institution’s management team should define the relationship existing between the firm and its environment. Both internal and external environments should be considered in the process. One of the ways through which a firm can establish the context is through the conduction of an enterprise SWOT analysis which will enable the firm to identify its strengths, weaknesses, opportunities, and threats(Casualty Actuarial Society 2003).
In addition, context-setting would also enable the financial institution to develop communication policies with the key stakeholders. About internal analysis, the financial institution management team should develop a comprehensive understanding of its objectives, strategies, and key performance indicators. This will play a significant role in the process of identifying various risk categories which are of paramount importance to the firm. As a result, it will be possible for the firm’s management team to determine the common risk metric to adopt.
Identifying the risk
In order to be effective in identifying the risk, the firm’s management team should document all the events and conditions which pose a threat to the firm’s future operation. Various methods should such as internal audits and surveys be employed.
Analysis and risk quantification
The firm’s management team should develop a probability distribution so as to be effective in risk appraisal. In addition, risk analysis will play a vital role in the firm’s risk management team to determine the outcome of the various material risks identified. This will play a significant role in prioritizing the risks identified and hence developing effective mechanisms to eliminate their occurrence (Mikes 2009). Various risk analysis techniques such as simulation and sensitivity analysis should be integrated. For example, financial institutions such as banks should conduct credit analyses on their customers before advancing the credit.
Integrating the risks
The various risks distribution developed should be aggregated. This will enable the firm to determine the degree of correlation between the various risks identified. The results obtained should be used to determine the impact on the firm’s key performance indicators. This will play a significant role in developing an aggregate risk profile.
Assessing and prioritizing the risks
Assessing the risks entails the process of determining individual risk contribution to the aggregate profile. This will enable the firm to prioritize the risk and make decisions that are appropriate to treat the risk. In order to be effective in prioritizing the risks, the firm’s management team should develop a risk map based on the various risks faced (Fabozzi & Drake 2010).
Exploiting the risks
This process entails the incorporation of several strategies aimed at managing risks. The various strategies which should be considered include risk avoidance, risk transfer, reduction, and risk retention.
Monitoring and reviewing
After effective exploitation of the risk, the firm’s management team should ensure that continuously evaluate the risk environment. This will play a significant role in determining the effectiveness of the strategies implemented. According to the Committee of Sponsoring Organizations (COSO), monitoring the ERM process is important since it enables the firm to identify areas that require improvement.
The role of the management accountant in the enterprise risk management processes
Analyzing and modeling risk
Management accountants play a significant role in the process of analyzing and modeling the risks facing the firm. This is undertaken through evaluation of the existing and potential risks. In addition, management accountants help in the quantification of conducting an assessment regarding the effect of the risk to the firm. According to Alnoor (2009), management accountants are experts in identifying qualitative issues from the risk environment. As a result of their acumen in analyzing data, management accountants can formulate effective formulae to be used in risk analysis. This means that management accountants are vital copartners to risk managers.
Development of internal control systems
Internal control systems entail the various procedures and policies which are adopted by a firm’s management team to attain its organizational goals. Some of the internal policies entail the detection and prevention of errors. Financial institutions are faced with numerous risks associated with fraud and errors (Collier 2009). Management accountants have professional training in relation to the analysis of various information systems. Information analysis is vital in a firm’s effort to develop an internal analysis system.
According to Collier and Agyei-Ampomah (2009), the success of an organization’s ERM process is dependent on the effectiveness of an effective internal control system. Management accountants in financial institutions ensure that the firm’s financial statements and other accounting records are complete, produced in time, and accurate so as to be a reliable source of information. Production of unreliable reports can be a source of risk to financial institutions such as reduction in demand for the firm’s products and services (Collier 2009).
Developing risk strategy
The risk management process amongst financial institutions is aimed at managing risks that face the firms. For the ERM to be effective, it is vital for an effective risk culture to be integrated into the firm (Mikes 2009). Management accountants are important in the development of strategic decisions to be adopted in formulating ERM policies and procedures. In addition, management accountants play a significant role in monitoring events that may be a source of risk and assessing the associated consequences.
Financial institutions are faced with numerous risks in their operation. The risks threaten their long-term survival. These risks originate from both internal and external sources. In order to eliminate the numerous risks faced; it is vital for the financial institution management team to incorporate enterprise risk management. However, the success of ERM is dependent on the formulation of an effective ERM process.
Management accountants play a vital role in the development and implementation of the ERM process. Some of the key roles played include analyzing and modeling risk. In addition, management accountants also help in the development of internal control systems which are a vital component of the ERM process. Management accountants are also vital in the formulation and development of strategic decisions to be adopted in formulating ERM policies and procedures.
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