What just happened? “The news of a bank collapse always sends shockwaves through the financial world, stirring up concerns and triggering memories of the 2008 Global Financial Crisis. While the collapse of Silicon Valley Bank may seem like an isolated event caused by unique circumstances, it serves as a massive wake-up call for all businesses.” - Dr Andrew Aziz, Chief Strategy Officer, SS&C Algorithmics
"It’s just bad risk management,” said Danny Moses, an investor known for his role in predicting the 2008 financial crisis. “It was complete and utter bad risk management on the part of Silicon Valley Bank.”
Why manage financial risk?
Where management and risk functions are not keeping pace with developments in the real economy, issues can and will be identified late and the implications can be significant. Firms can benefit from financial risk management in many ways, but perhaps the most important benefit is to protect the firm’s ability to attend to its core business and achieve its strategic objectives. Other benefits include enhancement of firm’s reputation and brand, stability of earnings and dividend policy, enhanced credit ratings and so on.
Key risk management process
Below is a summary of key risk management process for your organisation to consider:
1. Establish the scope, context and criteria
- Understand your entity’s objectives for both internal and operating environment
2. Risk identification
- Map out financial risks including key elements such as the potential cause and consequence should the risk be realised
- Common financial risks include market risk (e.g., equity risk, interest rate risk, currency risk, commodity risk), credit risk (e.g.,
customer risk, supplier risk), and liquidity risks (e.g., funding liquidity risk, market liquidity risk)
3. Risk analysis
- Rates the potential impact of each risk and its likelihood of occurrence, utilising ‘matrix’ or ‘risk heat map’
4. Risk evaluation
- Determines the tolerability of each risk (e.g., determine risk treatment with their relative priority by comparing the severity of the risk against the level of risk willing to accept)
5. Risk treatment
- Decide how to deal with the identified risk
6. Communication and consultation
- Communicate with stakeholders (e.g., risk reporting, stakeholder engagement, accountability)
7. Monitoring and review
- Articulate who is responsible for conducting monitoring and review activities
8. Recording and reporting
- Well documented and shared.
Practical tips
There is no single, ideal answer to the question: ‘how do we manage financial risk?’. Management needs to consider (a) the organisational risk appetite, (b) the likelihood that a risk will materialise and the scale of the resulting impact, and (c) the cost of alternative strategies. More generally, governance regulations place risk management responsibility firmly in the hands of boards of directors.
To mitigate identified risks, many businesses take out insurance to help protect themselves against financial risk. Carefully consider what types of insurance you buy, and what risks it covers, as it will be an additional cost.
Find out how further investment, such as a cash injection to increase or improve your assets, may affect specific areas of your business. If your return on assets ratio is less than the rate of return on an alternative risk-free investment, you may need to work with an accountant or financial adviser to consider other investment options.
Please reach out to your local PKF Audit and Assurance team for further insights or guidance on how to identify and manage your financial risk.
