Common Challenges in Risk Management
It is almost impossible for lenders to measure and manage credit risk, based on the disruptive patterns in consumer behavior in the last 2 months. How can large banks ensure that their digital transformation programs are working perfectly?
Managing risks is becoming tougher in today’s time, and businesses from all over the globe are implementing new methods.
Managing Risk Models in a Crisis
One of the biggest problems faced by risk leaders worldwide involves changes in consumer risk. Leaders also need to know how to measure these risks to be able to better decisions.
Every major change in the economy brings up the issue of risk model performance. The current models are based on risk models prior to Covid.
Robust risk management models will keep performing well even when the situation in the financial industry has changed. But the actual level of risk will change, making the model monitoring and governance more critical.
Biggest Challenges in Risk Management Today
There are 5 major challenges in risk management as of today, including:
1. Failure to Use Appropriate Risk Metrics
Value-at-risk or VaR is a common risk metric, but it only tells the largest loss a firm has incurred at any given time. VaR gives no idea about the distribution of losses that exceed VaR.
This would suggest the application of VaR doesn’t guarantee the success of risk management. The effectiveness of implementing VaR also depends on the liquidity of the financial market.
2. Measurement of Known Risks
Risk managers sometimes mistake accurately depicting the probability and the size of the losses. They could also use the wrong distribution channel. For a financial institution with endless positions, although they may properly estimate the distribution associated with every position.
Unable to measure, or wrongly measure a known risk is a big challenge in risk management.
3. Failure to Take Known Risks into Consideration
Sometimes, risk managers face challenges in considering all the risks in a risk management system. Sometimes it’s because of neglect, and sometimes it’s because of the additional expense. This happens because it’s impossible to forecast future events.
4. Unable to Communicate Risks to Top Management
Risk managers have to share information about the risk position of the organization with the top management. The management and the board have to take this information into account and come up with a risk management strategy.
If a risk manager is unable to provide this information to the top, they won’t be able to come up with a risk management strategy. The strategy they do come up with is based on ill information. This leaves the firm vulnerable and unable to manage risks properly.
5. Failure in Monitoring and Managing Risks
The last challenge for risk managers is to capture all the changes in the risk characteristics of securities to adjust strategies accordingly. As a result, risk managers often fail to monitor or get rid of risks simply because the risk characteristics of security may change too quickly to allow them to assess them, and put on risk-preventing methods accordingly.
