Every bank must contend with risks. When we use the work risk in our daily lives it is usually a bad thing. We may tell someone to not do something because there is a risk attached. Businesses, however, think of the work risk differently. Risk isn’t something to be avoided, it is something that is inevitable and the only thing that businesses can do is manage and mitigate risks. This may seem like a strange approach to risks but when you think about it from the context of inherent risk it all makes sense.
In enterprise risk management there is a concept called inherent risk. Inherent risk is the risk which is present in any action or process inherently, as the name suggests. This is a far more accurate description of risks than the one we use in personal conversations because when you think about it, there is nothing we can do which does not have a certain element of risk. Whenever we leave homes there is a slight risk attached – staying home also has a slight risk attached. If we see on the news that there is a chance of rain we take our umbrellas with us when going out – that is basically what enterprise risk management does. It looks at the current risk indicators to understand the steps that businesses need to take to minimize the damage caused by risks.
The weather analogy works for how businesses predicts risks too. The weather experts can tell us about how the weather will be in the near future based on many different sources of data. They look at the data coming in from sensors telling them about the current weather. They look at historical patterns of weather of the area to assess how the weather performs in different seasons. They also look at the weather of adjoining areas to detect trends. They track major storms that may come near the area and affect the weather in the coming few days. Similarly, risk managers in businesses look at multiple sources of data to determine how a risk will evolve and affect the business in the coming few weeks or months.
The first thing that risk managers look at is the current data metrics. They look at both internal and external data. The internal data is derived from internal processes and reports. The external data is related to markets and government publications. This data is used to determine the current level of risk that the bank is exposed to and must manage. Once the baseline of current risk has been created the risk managers then move on to looking at how the risks will evolve.
Historical patterns of risks are also very important when it comes to risk management. Every area is different because of different factors in the economy and consumer behavior. Thus, risk managers look at the current situation and look for a similar situation in the past to create trends and expected patterns which can help predict risks. Once a risk model has been created based on historical data, risk managers look at how the metrics will change in the coming few months.
Like weather experts look at storms, risk managers look at major events. The Covid-19 pandemic was unprecedented because it is a global event – most such things are not global and move area to area. Businesses look at new economic patterns, disruptions, and anything out of the ordinary happening in the areas that are similar in profile to the area where the business operates. This helps them determine the effects of the event on the business itself.
Why Predictions are So Important
Risk Predictions are essential in risk management because they allow a business to succeed even in the face of adversity. Businesses can survive risks if they are aware of the effects the risk will have on the business. They can create plans and make investments which will keep the business safe from the fallout of the emerging risk. If a risk is not predicted the business will have to quickly move to minimize the damage caused by the risk but usually this reactive approach is not enough.
Think of risks as an iceberg and a business as the ship. If the person who is looking for icebergs detects the iceberg in time the ship can change course and avoid the iceberg immediately. The damage to the ship will be non-existent. The only difference will be that the business will go off-course temporarily but that can be corrected quickly without any major losses. However, if the iceberg is not detected in time then it will hit the ship and cause damage. The ship’s crew can then work urgently to minimize the damage and protect the ship but there will still be a lot of damage incurred.
Risk predictions help businesses in the same way. They give the executive board the opportunity to change the course of the business so it never hits the iceberg. There are now many risk prediction tools available online that can automatically parse data from multiple sources and provide warnings for upcoming risks. Such tools will be a necessity in the future for businesses because the businesses that do use such tools are performing better than the businesses that do not. Thus, it is important for businesses to use risk prediction tools if they want to stay competitive.