Thursday, August 9, 2012

What is Risk Assessment? Benefits of Risk Assessment

Typically, risk assessment involves two variables:

  • impact
  • Probability

Risk assessment framework has four quadrants.

 

1) High Impact/ High Probability

The risk can result in big losses and has high likelihood of occurring.

 

2) High Impact/ Low Probability

The risk that can result in big losses and unlikely to occur frequently.

 

3) Low Impact/ High Probability

The risk that can result in small losses and has high likelihood of occurring.

 

4) Low Impact/ Low Probability

The risk that can result in small losses and unlikely to occur frequently.

Benefits of Risk Assessment

  • Risk assessment leads to identification of risk associated with particular strategy or opportunity.
  • Risk assessment can discover new opportunities.
  • Risk assessment can lead to increased communication and improved motivation among employees because of involving them in risk assessment process. Increased communication will lead to coordination of organizational operations and improved motivation will lead to increased efficiency.
  • Risk assessment can eliminate or reduce losses associated with particular activity.
  • Risk assessment helps in effective allocation of resources.
  • Risk assessment ensures that organizational objectives will be achieved efficiently.
  • Risk assessment ensures that risk remains within risk appetite of the board and shareholders.
  • Risk assessment increases investors’ confidence and increases shareholders wealth by reducing cost of capital. Organization giving disclosures on risk assessment are perceived as low risk investment. Therefore, investors may agree on low return by taking account of lower risk.

Risk Response Strategies (TARA Framework)

1) Transfer

High impact/ low probability risk should be transferred.

It would not worth spent time controlling risk if it is not likely to occur frequently. In addition, organization may not have sufficient expertise to control that risk. Therefore, it should be transferred to external organization.

 

2) Accept

Low impact/ low probability would be accepted because cost of controlling risk may not exceed benefits.

To earn profit some risk needs to be accepted.

Benefits from accepting risk must exceed losses expected from that risk if risk has to be accepted.

Non-financial aspects of risk are equally important.

 

3) Reduce

Low impact/high probability risk should be reduced.

Cost of paying to external organization may not exceed benefit as it has low impact. These risks are likely to materialise more frequently, so these risk should be constantly monitored.

These risks can be reduced by implementing sound system of internal control159 such as segregation of duties between CEO and chairperson.

 

4) Avoid

High impact / high probability risk should be avoided.

Cost of avoiding risk must justify the benefits.

If risk cannot be avoided, organization would consider withdrawing the investment or activity at all.