Risk Management

Risk management is a term that can be applied to many aspects of a business, but on a fundamental level it involves protecting a company from negative events.

For example:

The insurance industry uses the term to broadly describe services and products its corporate and business clients use to help protect themselves from potential losses. The insurance industry also has risk professionals on staff - including those on the underwriting side or the actuarial end - monitoring the exposures the company itself might suffer related to policy coverage and its own investment decisions.

In corporate Information Technology departments, risk managers are charged with ensuring the business can continue to function in the event of computer system failure, terrorist attack, or even natural disaster. They may also be charged with tracking employee activities to prevent a fraudulent event.

In the banking sector, risk managers strive to make sure a bank isn't overexposed to plummeting stock markets, regulatory flaws, or other financial pressures that could jeopardize the strength of its balance sheet. Similarly, in the asset management and the investment banking fields, risk management helps ensure the overall health of a firm's portfolio and, sometimes, manages regulatory risk.

The Breakdown by Sector

Banking executives try to manage three principal risks as defined by a series of international agreements known as the Basel Accords. These are a set of recommendations on banking laws and regulations promulgated by the Basel Committee on Banking Supervision, which is part of the Bank of International Settlements based in Basel, Switzerland. Central bank representatives from the Group of 10 nations are members, including the U.S. Although the committee can only advise (and not order) what regulations should be put into place, most member countries implement its recommendations through national laws.

Of course, there can be a gap between when recommendations are made and when they are actually implemented by member countries. Nonetheless, there's widespread agreement that banks need to protect themselves against certain specific types of risks.

First there's market risk, also known as systemic risk. This is the hazard that a whole group of traded financial products - such as stocks, bonds, or commodities - will fall in value simultaneously. Market risk is caused by outside events, such as fluctuations in the market due to rising oil prices, terrorist threats, a major physical disaster, shifts in foreign exchange rates or sudden hikes in interest rates.

Credit risk is the risk that a particular company or individual will default on its obligation to repay its debts. As new credit derivative products allow banks to trade the risk a company will fail to repay a loan, credit risk is becoming increasingly complex. Now, after the crash in the sub-prime mortgage markets and the ripple effect felt by the entire banking and investment community, financial institutions are expected to beef up staffing related to this aspect of risk management.

Operational risk is the risk something might go wrong in the day-to-day running of a bank, such as through the direct impact of a serious physical disaster or large-scale fraudulent activity committed by employees or management. Reputational risk - sometimes considered a sub-sector of operational risk - is the risk something will happen to damage a firm's reputation.

Following a succession of financial scandals, such as the much-publicized collapse of Enron and the accounting problems at MCI Worldcom, banks are increasingly sensitive to the need for reputation management.

Roles and Career Paths

Individuals working in an area specifically devoted to market risk at a large bank or investment house are typically situated on or close to the trading floor. Market risk specialists use mathematical value-at-risk (VaR) models to work out the maximum amount of money their bank or investment firm would lose in the case of a particular event. They also work closely with traders to calculate the risk associated with specific transactions. These individuals possess mathematical modeling skills, in addition to tech skills related to the field. Smaller investment firms may combine the market risk activities with asset and liability management.

Professionals in credit risk analyze company balance sheets and meet with directors to determine an organization's financial health. By comparison, operational risk experts review the likelihood of particular events taking place and formulate plans in case they do. They define and design the internal controls needed in case of a catastrophic event, and must follow through to make sure these policies are implemented.

Reputational risk specialists attempt to present the bank's best side in public. They generally play a very passive role, unless an adverse event occurs, and then they're often working around the clock. Few banks employ reputational risk specialists, per se. The role is typically dealt with by in-house and external public relations specialists, the human resource department, or in-house counsel and outside lawyers skilled in the field.

If you want a career in risk management, it's a good idea to join a bank's or brokerage firm's graduate training program. At some banks, risk management training is covered by the IT or operations department. Additionally, many of the top investment banking firms and brokerage houses offer their analyst and associate recruits broad training, which generally provides classes in risk management, in addition to courses on corporate finance and the markets. With industry specific knowledge and risk management skills under your belt, it will be easier to climb advance in the risk world.

Risk management training classes and certifications are also offered by a number of professional trade organizations for those working in the field, including the Risk Management Association's accreditation program for credit risk managers and the enterprise-wide and insurance risk classes and training courses provided by the Risk and Insurance Management Society.

Skills and Qualities

- Analytical ability and statistical aptitude

- Strong skills in mathematics and finance

- Good problem-solving and decision-making abilities

- An understanding of the bigger picture