Financial Risk management as Strategic Tool

Narendra Kumar

21 Dec, 2020

In today’s world of Finance, the process of risk management involved identifying risk in advance, analyzing them and take precautionary measure to overcome such risks. When any entity thinks of making Investment, it also calculates the risks involved in it. The significance of such risks depends on the type of financial instrument in which the entity wants to invest. Hence to minimize the risk, fund managers and investors use financial risk management as Strategic Tool. Without risk, there can no gain. Everyone loves to gain more profit considering low risk. However, risk and return are often two sides of the same coin. Any event which causes loss to an entity is called as a risk.

Types of Financial Risk

• Market risk: This link arises from exposure to the financial markets and this risk is linked with the uncertainties of the market.
• Credit Risk: When any lender lent money to the credit-unworthy entity and such entities are not able to repay the lent money, it gives rise to Credit Risk.
• Liquidity Risk: When an entity is not able to meet the fund requirement for daily working capital, then it gives rise to Liquidity risk.
• Operational Risk: operational risk arises due to human errors, system errors or legal issue. This type of risk impacts the entity but it is not covered in the usual part of the operational

Financial Risk management as Strategic Tool

Financial Risk Management is nothing but identifying the pitfalls, analysis and mitigating of uncertainty in the business. It occurs when an investor buys low-risk bonds over more risky bonds when a bank performs a credit check before issuing a personal line of credit. The financial risk management process involves the following steps while mitigating the risk.

• Risk Identification: The entity first identifies the risk and the negative impact of such risk on business. This is the most important step to mitigate risk.
• Risk Analysis: Once the risk is identified, the entity determines the odds of occurring and its impact on the business. Risk analysis helps to understand each aspect of risk and how it can influence the company’s project and objective.
• Risk evaluation: The risk is further evaluated and its impact is determined. The entity then decides whether the risk is acceptable and whether the entity can go ahead considering the risk for the project.
• Risk Mitigation: Risk mitigation helps to reduce the impact of the risk. Entities assess their highest-ranked risks and develop a plan to improve them using specific risk controls. This plan includes risk mitigation process, risk prevention, contingency plan.
• Risk Monitoring: Once the overall plan is set up to reduce the risk or eradicate the risk, the plan should be implemented and monitored. The process of monitoring should be continuous and it should be changed as per the changing economic condition.

 Risk Management strategies

• Risk avoidance: When it is not possible to eliminate the risk, a risk avoidance strategic is used. Risk avoidance strategic is design to deflect as many threats as possible.
• Risk reduction: Entities can reduce the amount of risk on processes. This is achieved by adjusting a certain aspect of the overall business plan.
• Risk Sharing: Sometimes, the risk involved in the project is shared or distributed among several participates or business department. This type of risk can be shared with 3^rd party also.