Risk management is the process of figuring out the risks in a certain situation, and hence reducing the possibility of its occurrence. In some cases, the amount of risk that is acceptable is nil, whereas sometimes it can be higher. These risks could be due to natural causes such as accident or even deliberate attacks.
In the corporate world, risk management is an organized activity that reduces uncertainty in the business. However, there are procedures that must be followed by people who are responsible for this risk management task in order to reduce the risk as much as possible.
In the public sector, risk management is used to figure out where the risks for the public and basic infrastructure lie and what measures should be taken in order to reduce or to avoid it at all. However, to be able to do this, in both the corporate and the public sector, following steps are to be taken.
Firstly, it is necessary to figure out which are the most important things that need protection. Then the threats to these must be understood after which it is important to understand the likelihood of each threat, which could possibly turn into reality. Once the likelihood is determined, the risk factor can be calculated. After the risk has been calculated, people who work on risk management can easily figure out ways to reduce the risk and prioritize the risk reduction measures based on strategy that is developed. These strategies can include transferring the risk to another person, avoiding the risk completely, taking measures to reduce the impact of the risk, or accepting the consequences of the risk.
Transferring of risk is what is done every day when you buy car insurance. You understand that there is a risk of an accident, but you transfer the risk onto the insurance company and they pay for your losses. Avoiding the risk means diminishing the activity, for instance not allowing a flight to take off in bad weather due to risk of an accident. Risk reduction is what is done every day in factories where sprinklers are installed to reduce the damage from fire. Finally, accepting the risk means understanding the risk, but accepting the possible losses since the cost of avoiding it could be higher.
Traditional risk management programs are focused on figuring out the risks that result from physical or legal factors like natural disasters, fire, death or lawsuits. The financial risk management programs focus on risks that can be managed through financial tools.
When managing risks, the most common process is to first take care of the risks with the greatest loss and the greatest probability of happening. After this, the risks with lower probability and lower loss are handled. However, it can be difficult to determine these costs and probability, so the chances of mismanagement in this field usually remain high.
It is also very difficult to figure out how much resources must be allocated into risk management. On one side, this has the potential to save money and/or lives should the risk become a reality, but on the other hand it seems that the money spent on this can be spent on activities that can help in earning money for the company or government. Therefore, there is an opportunity cost to risk management, and it is very important to figure out how much expenses it requires.
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