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Who is the owner of risk in an organisation?

In Banking, CRO, Finance, Insurance, Legal, Risk Management on July 17, 2016 at 5:10 pm

In this blog, I indulge in a debate that who is the owner of risk – Is it CEO, CRO or different parties and how organisational risk is linked to society?

Chief Executives such as CEO and CRO provide foundation to a firm’s sustainability with their generic, specific capabilities, expertise and leadership to control and administer resources in current dynamic business environment. Role of CEO and CRO in relation to risk have presented greater ambiguity in practice and questioned the existence of widespread myth “CRO is the owner of risk and is the ultimate risk manager of the company.

Roles of CEO and CRO are significantly different however, often it is considered that CEO is expected to make risk based decision making while ownership of risk lies with CRO and accountabilities is set to the board.

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An actor is not implementer, an implementer is not decision maker and a decision maker is not held accountable.

During practice, a CEO acts as a ‘Risk Manager’, ‘Decision maker’ and ‘Influence of risk culture’.  To become a successful CEO, a CEO has to demonstrate his/her abilities to cope up with failures while gaining strategic leverage by exploiting opportunities.  A CEO influences significantly the risk culture of an organisation. Consider an organisation with Japanese, Chinese, British or American CEO, you may imagine the difference in culture as different expectations are set. A CEO style should complement with Company’s culture. If a company is relationship focused, and believes in shared decision making, its CEO should promote collaborative efforts. Another CEO may bring a ‘PUSH-PUSH BACK’ culture by enforcing rules without understanding the difficulties of ground staff.

A CRO acts as ‘Implementer and reporter of risks’, ‘Risk Advisor’ and ‘Communicator of risk culture’. CRO implements risk management policy and reports integrated risks to CEO. He/she also advises on critical risks for important projects, supports in formulation of risk policy when needed by the board and further to CEO on risk related matters. Expectations are set by the board, Chairman and CEO in risk related matters such as how much and what kind of risk the company is willing to take.

Other than CEO, CRO and board, there are other contender of ‘ownership of risk’ in the company.

  • Each and every person working in the organisation are the owners of their own risk.
  • Head of Departments are owners of their department’s risk
  • Shareholders are the owners of the company’s entire risk
  • Stakeholders are the owners of company’s entire risk
  • Risk and uncertainty is beyond the capacity of ownership

This week, I attended International Sociological Association (ISA) conference in Vienna which impacted my thought process of linking risk with society. A business success cannot be determined by its profit/loss or share market price without thinking of impact of its actions on society. Roots of organisations emerge from sociology as organisations are considered as ‘social entities’. Thinking about only economic benefits leaving society apart, may not be a sustainable long term strategy. This is perhaps the reason why ‘reputation risk’ has become one of the challenge for companies in global markets. Companies have burnt their fingers and learnt several lessons in recent financial crisis. The need of clear ownership, roles and responsibility of risk have been clearly known to companies and require attention in risk policy formulation and implementation. Michael Porter, a Professor of Harvard known for his highest influence on executives and countries, highlighted that businesses need to focus upon ‘shared value’ by integrating their economic interest with interest of the society to promote sustainability.  This raised a question “Should companies bother about ‘social interest’ in their risk related decision making process?”

Risk management based on ‘shared value’ for all stakeholders considering social interest has a great potential in promoting sustainable practices. Perhaps, this can deal with the issues of ownership of risk. It is usually debated who owns the risk but it is hardly discussed to whom this risk belongs to.

Reference:

http://aom.org/Multi-Media/Academy-of-Management-Perspectives/Interview-with-Professor-Michael-E–Porter-from-Harvard-University-.aspx).

 

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A Simple understanding of Complex Risk

In Banking, Insurance, Risk Management on July 5, 2015 at 5:43 pm

Many of us in our daily life struggle with understanding of risks.  A well-known risk among our community is easily understood by all of us because potential negative consequences are obvious to us.  We also support that the risk which have potential low uncertainty, can be called simple risks. There is hardly any issues in understanding such kind of risk. For example construction of a road, driving a motor vehicle. Also for these risk statistics for long timeframe is available such as some accident in last 50 years in particular region. Based on this understanding, we can drive conclusions very easily such as State A is more accident prone than B. But what if risk is not simple, it is rather complex.

A complex risk is commonly understood as the risk which is not simple risk. Think if same risk is understood differently by many people who lead to many interpretation. It may be called situation of ambiguity where no conclusion can be drawn. Will you call it simple risk? Professor Otwin Renn defined ambiguity arise when there is an existence of multiple values. So, if a same building is inspected by three engineers and all of them provided different risk ranking such as low risk, medium risk and high risk. How conclusions can be drawn about the risk profile of the building. It can be said that there is difficulty in understanding the risk of this particular building.

Another situation where a single risk may affect a large population. It generally comes to the mind that it may be some natural disaster such earthquake or flood. What if two different risks occur separately such as default of securities and natural disaster but with no interaction. The effects will be severe in each case. If interaction between two or more risk affects the large society and risk is embedded for long time so it is difficult to find how risk originates and who is responsible for this. This is certainly called a complex risk with ambiguity. Such type of risk is known as Systemic risk (don’t get confused with Systematic risk).  

Systemic risk does not confined to a particular state or region but it may accelerate across national boundaries and may result in crisis. Its analysis is dependent upon the interdependencies among risks in holistic manner and Ripple and Spill over effects. Can anybody outsider/stranger attempt to understand the risk within organisation, houses or societies? Is there any short cut to understanding of risks? It is difficult to answer because it requires deeper understanding of risk which requires time and flexibility.  A risk in-house A to F could be different than Risk of house G to N as “Not all risks are equal”stated by Dutch Health Council, 1995

Therefore, there is a greater need to understand our own risk, risks where we work and in our societies. A deeper understanding of risk can untangle the complex bunch of interconnected risks and simplify our problems. 

Owner of my own Risk – Me or others ?

In Banking, Finance, Insurance, Risk Management on February 25, 2013 at 8:11 am

When an individual see the Risk – it looks 4 letter words. It is well said “This will not happen to me”, it is unusual not to avoid it. Actually what is the risk? It is a threat, loss of opportunity, unexpected happening of loss. Who is the owner of the risk – individuals themselves? It is the duty of risk owner is to prevent, reduce, transfer and control the risk.

 

It is just a Four letter word – RISK

Corporates also own the risk; risk manager owns the risk of each department. He/she may set procedures/systems to prevent/reduce the risk, he may transfer the risk to the insurance companies. Insurance companies owns the risk of various corporates and individuals but here the system works little different. Although insurance companies manage the risk however the risk lies in the hands of insured, It is also in the hand of GOD which can be seen any time in floods, earthquake. Its invisible based on set of calculations and predictions.

These insurance companies retain certain part of the risk in their hand and transfer the risk to the Reinsurance companies. Now situation changes dramatically – Reinsurance companies accepts the risk of same individuals/corporates from Insurance companies without knowing who actually they are, only based on set of terms and conditions and documentation submitted by insurance companies. The ownership of the risk is still in the hands of insured.

The reinsurance companies transfers this risk to Retrocession companies who practically don’t know the country of origin of the insured at the time of acceptance of risk, only a set of group risk based on certain conditions are accepted. The ownership does not change hands, insured still can increase or reduce own risk. Finally the set of risk reached through derivative market eg; CAT bond to the public. Individual own their own risk. “its better not to avoid risk rather deal with that”

James bond or CAT bond, who is our saviour from catastrophic losses

In Banking, Finance, Insurance, Risk Management on October 22, 2012 at 7:17 am

 

“Shocking! Positively shocking!” – Sean Connery as James Bond in Goldfinger

In show business, it is easy to save humankind from catastrophe by James Bond. He can avert nuclear disasters, stop tsunamis and change course of meteorites. The real life is different. Catastrophe means loss to people, society and economy.

The biggest challenge today to the insurance companies is not mere fraud risk, low reserves or depression of the economy – it is the risk arising out of catastrophes, which can severely affect their solvency position.  In last 10 years, catastrophes like 9/11 attacks on WTC, hurricane Andrew, Katrina and Wilma have shaken the reserve and stability of the insurance industry in United States. According to Swiss-Re, a leading reinsurance firm, year 2011 witnessed losses from catastrophes totalled $35.9 billion, greatly surpassing the average of $23.8 billion for the years 2000 to 2010. The insurance company solvency is endangered, when losses increase up to a substantial level – to safeguard either insurance company has to raise the premium or its reserves will be gobbled up by single big catastrophe.

In past 36 years, catastrophic losses have hit the insurance companies’ very hard and resulted in insolvencies of small and large insurers (Stipp, 1997; Swiss Re, 2000; Mills et al., 2001). Between the year 1969 and 1998, nearly 650 U.S. insurers became insolvent (Matthews et al., 1999). According to Guy Carpenter (2007), if one considers the 20 most costly insured catastrophes that occurred in the world (1970–2006) – half of them happened in the United States. Thus, it does not come as a surprise that the Gulf of Mexico has become a world peak zone for the insurability challenge.

Insurers use many tools for reducing their financial vulnerability to losses (Mooney, 1998; Berz, 1999; Bruce et al., 1999; Unnewehr, 1999; III, 2000). These tools include raising prices, nonrenewal of existing policies, cessation of writing new policies, limiting maximum losses claimable, paying for the depreciated value of damaged property, non-actuarially based discounts instead of new-replacement value, or raising deductibles, better pricing & claim handling (Dlugolecki et al., 1996 & Born et al.,2006 ). The catastrophe events will also effect insurer’s pricing policies, shift the default risk indicator and change the risk assessment methods. Sometimes, insurance firms also face regulatory intervention to reduce insolvencies (eg: Solvency II, SOX).

Currently, few Insurance firms hedge their portfolio by catastrophe risk financing by going into equity market. Catastrophe risk securities are of two types – catastrophe bonds (CAT bonds) and catastrophe insurance options. Both types benefit insurers by making money available to offset catastrophic losses. Insurance companies issue CAT bonds to transfer extreme losses from natural catastrophes such as windstorm, earthquake and floods. Property and casualty insurers typically develop catastrophe risk management strategies that combine determination of risk appetite, measurement of exposures, pricing considerations, processes to limit exposure and utilization of reinsurance or capital markets to transfer risk to third parties.  Due to massive increase in insured losses from natural catastrophe, catastrophe bonds (CAT bonds) played a vital role in increasing the underwriting capacity and reducing probability of default for the insurance companies.  There is a wider chance that insurance companies who use securitization methods will be able to reduce or completely avoid the default risk.

There are many similarities between James Bond and CAT bonds. Like James Bond, CAT bond is the hero of Insurance and reinsurance world to save average person from natural catastrophes losses like flood, storms and typhoons etc. James bond will complete his mission by using modern gadgets; CAT bond use advanced equity market financial tools to get success. No doubt, the CAT bond is James Bond of financial world.

But ofcourse nobody entertains the way James Bond 007 does. Like you I am eagerly waiting for the new movie Skyfall. Comments welcome !

What is interest rate?

In Banking, Finance on July 2, 2012 at 3:56 pm

Interest rate is the amount payable to creditor by the debtor for the use of money for the certain period or the money earned by an investor on a debt instrument for specific time. Here creditor is the person who gives the loan or makes investment in a debt instrument while debtor is a person who takes the loan or an institution who float a debt instrument like debentures, debt securities etc. Interest rate is very widely used terms and it is not only charged only for loans but also charged for mortgages, credit cards and unpaid bills.

Interest rate is dependent upon the amount of loan, duration, financial position on debtor, type of loan (e.g.: secured/unsecured), economic condition of the country and the economic policy of the country. It is very simple to understand such as a person takes a home loan for 8% interest rate or 18% interest rate, in first condition he will be able to repay the loan very early than the second condition assuming the EMI (every monthly instalment) in both the conditions are the same.

Interest rate can be expressed in monthly, quarterly, half-yearly and annual rate which is sometimes described as mode of payment for annual interest payments. For example: 18% annual interest rate can be paid through different mode of payment – monthly 1.5%, quarterly 4.5%, half-yearly 9% and annually 18% at one time.

 

Basically, interest is of 2 types – simple interest and compound interest. Simple Interest is paid on amount of money taken as loan or mortgage and can be calculated by using the formula:

Simple Interest

I = P * r * t

Here:

‘I’ stands for Interest

‘P’ stands for principal

‘r’ stands for rate and

‘t’ stands for Time.

For example, if I invest $1000 (the Principal) at a 5% annual rate for 1 year the simple interest calculation

I=P * r * t

$50 = $1000 x 5 % x 1 yr

Compound Interest

Compound interest is interest that is paid on both the principal and on any interest from past years. It’s often used when someone reinvest any interest they gained back into the original investment. For example, if I got 15% interest on my $1000 investment, the first year and I reinvested the money back into the original investment, then in the second year, I would get 15% interest on $1000 and the $150 I reinvested. Over time, compound interest will make much more money than simple interest. The formula used to calculate compound interest is:

M = P( 1 + i )n

M is the final amount including the principal.

P is the principal amount.

i is the rate of interest per year.

n is the number of years invested.

Applying the Formula

Let’s say that I have $1000.00 to invest for 3 years at rate of 5% compound interest.

M = 1000 (1 + 0.05)3 = $1157.62.

You can see that my $1000.00 is worth $1157.62.

Notes: With the simple interest, my worth would have been just 1000*.05*3 = $1150, therefore I gained $7.62 more due to compound interest.

These topics will be covered in other blogs:

  • How interest rates are decided in different countries?
  • Why interest rates are different in different banks, different types of loans?
  • Why Credit cards charge very heavy interest rates like 35% or 40%?
  • How Interest rates are linked with country economy – what will happen if it will go too up or too low?
  • What is NPA?

What are the factors which affect the buyer to take loan?

In Banking, Finance on June 22, 2012 at 12:56 am

This is the third blog in the series – do read earlier ones Understanding Types of Loan and How Banks Categorized Whom to Give Loan .

In this blog, I will talk about the factors which affect the buyer while he is about to take the loan.

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The first and foremost step in taking a loan is to understand the purpose of loan e.g.: home loan or student loan.  Then think about most suitable loan for the purpose for example should we take home loan by making payment through credit card – it will look most unsuitable method as home loan is long term loan and credit card payment is made after a very short period of time. Then the loan should be according to your income level eg: how much you are in actual capacity to pay monthly for such loans. It should be rather the amount which you are in position to pay with very comfort every month. Then you need to make it adjusted with your future planning eg: repayment in 6 months or 6 years. The next important step would be to take decision on fee and interest you would like to pay under the loan (eg:  Personal loans have high fee and interest rates than home loan). In the last, you need to take information from many banks or financial institution to get the best interest rates and fees. The bank policies for repayment and other conditions also need to be considered.

In short, the major factors which affect the borrower’s decision are purpose of loan, type of loan which is suitable according to purpose of loan, repayment time period of the loan, actual capacity to pay the loan according to income level, adjusted loan according to future planning, fee and interest rates offered by the different banks.

How banks categorize whom to give loan?

In Banking, Finance on June 7, 2012 at 10:57 pm

In continuation of my earlier blog Understanding Types of Loan ……..

Now days, most of the banks use their own software to rate and assess the risk of its clients (people, group or corporates).This you can see by some professional working in top IT companies and working in senior management get loans very easily than person with same qualification working under a small company. Why this is so – it is due to his better credibility and stability to repay the loan.

Income level and the employment history are the major factors which affects the loans. However, the bank considers the major questions and rate or give a score according to its appropriateness.

I.         Do you make payments on time?  They check the borrower’s payment history through scrutinizing their credit card details, car payments, mortgages, student loans or other types of loan. ( such as bank gives 35% score to the perfect borrower under this category)

II.         How many other loans have been taken and its balance remaining?  They check about how many other loans like home loan, car loan etc. borrower has already taken and what is the balance remaining and link it to the borrower’s annual income. ( for example: bank gives 30% score to the perfect borrower under this category)

III.         From how many years you have opened these accounts and usage? They check the borrower’s credibility in case of payment e.g. a fresher who has applied for credit card usually get very low credit limit on his credit card than a professional working from 10 year with good bank records. ( for example: bank gives 10% score to the perfect borrower under this category)

IV.         How often you have applied for loan? They check whether you are not taking many loans at one time such as once you have taken home loan, for a year or so, you will be denied to take car loan. ( for example: bank gives 10% score to the perfect borrower under this category)

V.         How many types of accounts are reported for ATM cards, car loans, credit cards, travel accounts, or any other type of account where payments are being made? ( for example: bank gives 10% score to the perfect borrower under this category)

The higher the score, higher the chances of getting the loan. Each and every bank has its own risk assessment method and risk scoring that’s why different bank gives same loans at different rates to same borrower. Till now, we have considered, the bank or financial institutions factors which affect the loans.  See my next blogs on factors affects borrower’s decision to take loan from a bank or institution.

Understanding types of Loan

In Banking, Finance on May 28, 2012 at 9:58 am

Money requirement changes over a period of time, some individuals require money to build house, some for marriage, buying an expensive car or it may be for kid’s education. Corporate houses have different requirements like starting a new business, expansion of existing business etc. These requirements can be fulfilled by selection of few options. First option is to self – fund, second option is to take loan (debt), third option is to raise equity and last is through partnership/joint venture and strategic arrangements. When self-funding is not available, corporate mostly avail a mix of debt and equity. Equity has lots of entry barrier and required large capital, individual go for taking a loan.

A loan is given by one party to another party with the agreement that money will be repaid after a certain period of time. In a loan contract, borrower (who takes the loan) pays certain percentage of the principal amount to lender (who gives the loan) as compensation for borrowing. Maturity date of the loan is the date by which the borrower must have paid the loan.

There are 2 types of loan – secured loans and unsecured loan.

When a loan which is guaranteed by collateral, it is termed as secured loan. Its best example is home loan – when a person buys a home, he/she make some amount as down payment to the builder and for rest amount he/she may take as home loan from a bank or financial institution. In case of default of the assets, lender (bank or financial institution) has right to seize home.

When borrower does not deposit any kind of asset against the loan, it is termed as unsecured loan. Personal loans, bank overdraft and corporate bonds are good example of this.

They are other very popular loans like business loans (type of secured loan) where borrower need to present a business plan, education loan (unsecured loan up to a specific amount) where borrower is a student and take this loan for higher education.

Now an interesting question arise in the mind how banks categorize whom to give loan or not. See my next blog on this.