Risk Management Framework And Why It Matters In Business

An effective risk management framework is crucial for any organization. The framework endeavors to protect the organization’s capital base and revenue generation capability without hindering growth. A risk management framework (RMF) allows businesses to strike a balance between taking risks and reducing them.

Understanding a risk management framework

This is achieved by balancing risk-taking that ultimately leads to reward and risk-taking that fails.

The RMF is a structured process that:

  • Identifies potential threats.
  • Defines a strategy for eliminating or reducing the impact of these threats.
  • Provides mechanisms to monitor and evaluate the strategy once implemented.

The five components of a risk management strategy

To help clarify risk management requirements, the RMF framework follows six steps.

1 – Establish the context

Businesses must start by establishing context. What impacts have the potential to affect strategic objectives? Broadly speaking, these impacts may relate to the operational environment, regulatory policy, politics, and domestic or global market conditions.

2 – Identify the risks

Risks are determined by examining strategy or operations and then brainstorming potential events that would impact their successful completion.

Core risks should first be identified, or those that must be taken to drive growth and high performance.

Non-core risks, which should be eliminated or minimized, should then be prioritized according to:

  • Threats – or events that could harm an organization through destruction, disclosure, or intrusion.
  • Vulnerabilities – or weaknesses in systems, security, controls, or procedures that could be exploited by internal or external players.
  • Impact – how severe would the impact be on an organization if a threat or vulnerability were exploited?
  • Likelihood – or the probability of a risk occurring.
  • Predisposing conditions – are there factors inside an organization that increases or decreases the likelihood that a vulnerability will be exploited?

3 – Risk measurement and assessment

Using the prioritization factors in step 2, the business can identify risks that it will most likely be exposed to. 

Here, it’s important to measure exposure to a specific risk in terms of the overall risk profile of the organization. This is often hard to measure, but many businesses use aggregate risk measures such as profit and loss impact, value-at-risk (VaR), and earnings-at-risk (EaR).

4 – Risk mitigation

Risks deemed important enough to address must then be mitigated. Risk mitigation can be achieved through the sale of assets or liabilities or the purchasing of insurance. Ceasing certain activities or making crucial changes to human resource management practices are also effective risk mitigation strategies.

A decision must also be made on which risks to retain or absorb as part of normal operations.

5 – Risk reporting and monitoring

To ensure that risk remains at a manageable level, the risk management framework should continually be evaluated.

For high-impact risks, it is good practice to evaluate more frequently with a focus on the progress (or efficacy) of controls or treatment plans. Decision making on high-impact risks should only be undertaken by those with seniority within an organization.

6 – Risk governance

In the last step, systematically arrange the information into a standard risk governance system. Governance involves defining the roles of employees and segregating duties where required. 

Committees comprising upper management should also be created to mediate and manage risk long-term.

Key takeaways

  • A risk management framework supports businesses in achieving their strategic objectives while minimizing detrimental risk.
  • A risk management framework identifies potential threats and then defines a strategy for minimizing or reducing them. Once strategies are implemented, the framework advocates continuously monitoring and evaluation.
  • To create an overarching risk governance system, a business must follow the six steps of the risk management framework. Importantly, the process clarifies threats that should be taken seriously and how they might be mitigated.

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