Risk Management Policy

The policy of risk management is unique to every organization. Practices that may be considered acceptable in one organization may not be considered acceptable in another organization. Just like the vision and mission of any company, its risk management policy is also unique. This is a basic document, which is drawn up when the risk management policy of a company is being put into place. It can be considered to be like a constitution since all decisions related to the risk management practices in any company emanate from this document.

Since an organization is made up of several stakeholders, it is important for all those stakeholders to get aligned on the same path so that the risk management policy can be drawn up. This article explains what a risk management policy is as well as the different steps that need to be taken to draw up a risk management policy.

Drawing up a Risk Management Framework

The primary purpose of a risk policy is to ensure that the organization has a commonly agreed-upon risk management framework in place. This framework has to be developed after due consultation by all stakeholders. The risk appetite of all stakeholders needs to be matched with the probable outcomes of different risk levels. It is the job of the organization to do a thorough scan of the various risks that an organization faces during this time. The operational and regulatory framework needs to be thoroughly studied before reaching any final conclusions.

Framework For Measuring Risks

Risk management is an imperfect science. This means that there are several different ways that can be used to measure risks. These different methods are likely to give different results. Hence, if there is no consensus about the mechanisms which have to be used in order to value risk and control it, there will be chaos. It is likely that the management will change the methods repeatedly based on what suits their decisions. Hence, just like accounting policy decisions, changes in the decisions regarding measurement and valuation of receipt need to be vetted carefully. The valuation methods used for tracking, measuring, and subsequent reporting of risks should be the same to ensure that the results are comparable across the years.

Defining Success

In the previous articles, we have repeatedly mentioned that risk management is not a perfect activity. This means that it is not possible to completely eliminate risk. Since the whole process is about dealing with imperfection, it is important to define what success means and codify it in the risk management policy. In the absence of such codification, different stakeholders in the risk management policy will have different interpretations of success. The communication of performance goals and then the subsequent measurement of performance will become vague if the concept of success is not aligned and codified.

It is possible that the definition of success may change over the period of time. Hence, it is recommended that the definition be revised from time to time.

Defining Failure

In the previous step, the company defined certain outcomes that they would be in their interests. At the same time, it is also important to clearly define the outcomes and situations which would not be acceptable to the company. This lack of acceptability could be due to the core cultural values of the company or due to financial constraints. Regardless, it is important to clarify particular situations such as catastrophe risks, brand risks, and other such risks which must be avoided at all costs. These definitions define the priority areas for the risk management team. They now know that these risks are the most critical ones and need to be managed carefully in any case.

Identify Factors that Would Limit Application of Risk Management

The risk management policy also needs to clearly outline the possible constraints that a company is likely to face while applying its risk management strategies. These could be constraints related to finances, personnel, or even culture. This step will ensure that the risk management strategy prepared is practical and can be strictly implemented. It is important for the risk management team to know the boundaries inside which they need to operate.

Define Baseline Risk Level

The end result of the entire process is to define a baseline risk level. This baseline level will be defined using valuations that will remain consistent across the company and across different time periods. This definition will be used as a guide to mediate between conflicting goals of stakeholders. For instance, equity shareholders might want the company to take more risks so that their return is increased. However, debt holders get a constant rate of return. Hence, they may see the additional risk as jeopardizing their interest without adding any value to them. The risk management policy should be able to mediate between such disputes. It should clearly define the baseline level of risk using which such disputes can be objectively settled.

The bottom line is that the risk management policy is the central policy document that needs to be put into place before a risk management department is set up. This document should guide the organization through difficult decisions and should serve as a bible for actions related to risk management.