ORM Assignment
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HullRMFI5eCh27.pptxRisk Management and Financial Institutions 5e, Chapter 27, Copyright © John C. Hull 2018
Enterprise Risk Management
Chapter 27
1
Definition (COSO)
“Enterprise risk management is a process, effected by an entity’s board of directors, management, and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.”
Risk Management and Financial Institutions 5e, Chapter 27, Copyright © John C. Hull 2018
2
Key Elements
Board involvement
Part of company’s strategy and helps a company achieve its objectives
Identify adverse events
Manage risks consistently with risk appetite
Risk Management and Financial Institutions 5e, Chapter 27, Copyright © John C. Hull 2018
3
Risk Appetite
Regulators require banks to develop risk appetite frameworks
How much loss at what confidence level are we prepared to risk?
What reputation risk are we prepared to take?
What credit rating risk are we prepared to take?
How concentrated should we allow our risks to become?
Etc.
Risk Management and Financial Institutions 5e, Chapter 27, Copyright © John C. Hull 2018
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Risk Culture
Decisions should be made in a disciplined way
Both short-term and long-term consequences should be considered
Sometimes decisions that are profitable in the short run can have adverse reputational and legal consequences in the long run
Examples:
Bankers Trust
Santander rail deal
Abacus
Risk Management and Financial Institutions 5e, Chapter 27, Copyright © John C. Hull 2018
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Improving Risk Culture
Goldman Sachs showed in the aftermath of Abacus that it is possible to change the risk culture
Risk Management and Financial Institutions 5e, Chapter 27, Copyright © John C. Hull 2018
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Major Risks
Important to identify major risks and decide what action, if any, should be taken
Alternatives:
Exit activity giving rise to risk
Reduce probability of adverse event
Modify plans to reduce risk
Transfer all or part of risk
Take no action
Risk Management and Financial Institutions 5e, Chapter 27, Copyright © John C. Hull 2018
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Avoid Cognitive Biases When Considering Risks
Wishful thinking
Anchoring on to first estimate
Availability (recent information given too much weight)
Representativeness (too much reliance on previous experiences)
Inverting conditionality
Sunk costs bias
Risk Management and Financial Institutions 5e, Chapter 27, Copyright © John C. Hull 2018
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