Risk Management Framework (RMF) Definition - Investopedia

An effective risk management framework seeks to protect an organization's capital base and earnings without hindering growth. TableofContents Expand TableofContents WhatIsRMF? UnderstandingRMF The5ComponentsofRMF Investopedia Business WhatIsRiskManagementFramework(RMF)? Allcompaniesfacerisk;withoutrisk,rewardsarelesslikely.Theflipsideofthisisthattoomuchriskcanleadtobusinessfailure.Riskmanagementallows abalancetobestruckbetweentakingrisksandreducingthem. Effectiveriskmanagementcanaddvaluetoanyorganization.Inparticular,companiesoperatingintheinvestmentindustryrelyheavilyonriskmanagementasthefoundationthatallowsthemtowithstandmarketcrashes. Aneffectiveriskmanagementframeworkseekstoprotectan organization'scapitalbaseandearningswithouthinderinggrowth.Furthermore,investorsaremorewillingtoinvestincompanieswithgoodriskmanagementpractices.Thisgenerallyresultsinlowerborrowingcosts,easieraccesstocapitalforthefirm,andimprovedlong-termperformance. KeyTakeaways Riskisarealityforbusinessownersandmanagersregardlessoftheindustrysectororsizeofthecompany.Well-runcompanieswillhaveacomprehensiveriskmanagementframeworkinplacetoidentifyexistingandpotentialrisksandassesshowtodealwiththemiftheyarise.Riskidentification,measurement,mitigation,reportingandmonitoring,andgovernancearethesixkeypiecesofaneffectiveframework. UnderstandingRiskManagementFramework(RMF) Effectiveriskmanagementplaysacrucialroleinanycompany'spursuitoffinancialstabilityandsuperiorperformance.Theadoptionofariskmanagementframeworkthatembedsbestpracticesintothefirm'sriskculture canbethecornerstoneofanorganizations' financialfuture. The5ComponentsofRMF Thereareatleastfivecrucialcomponentsthatmustbeconsideredwhencreatingariskmanagementframework.Theyincluderiskidentification;riskmeasurementandassessment;riskmitigation;riskreportingandmonitoring;andriskgovernance. RiskIdentification Thefirststepinidentifyingtherisksacompanyfacesistodefinetheriskuniverse.Theriskuniverse issimplyalistofallpossiblerisks.ExamplesincludeITrisk,operationalrisk,regulatoryrisk,legalrisk,politicalrisk,strategic risk,andcreditrisk. Afterlistingallpossiblerisks,thecompanycanthenselecttheriskstowhichitisexposedandcategorizethemintocoreandnon-corerisks.Corerisksarethosethatthecompanymusttakeinordertodriveperformanceandlong-termgrowth.Non-corerisksareoftennotessentialandcanbeminimizedoreliminatedcompletely. RiskMeasurement Riskmeasurementprovidesinformationonthequantumofeitheraspecificriskexposureoranaggregateriskexposureandtheprobabilityofaloss occurringduetothoseexposures. Whenmeasuringspecificriskexposureitisimportanttoconsidertheeffectofthatriskontheoverallriskprofileoftheorganization. Somerisksmayprovidediversificationbenefitswhileothersmaynot.Anotherimportantconsiderationistheabilitytomeasureanexposure. Somerisksmaybeeasiertomeasurethanothers.Forexample,marketriskcanbemeasuredusingobservedmarketprices,butmeasuringoperationalriskisconsideredbothanartandascience. Specificriskmeasuresoftengivetheprofitandloss("P/L")impactthatcanbeexpectedifthereisasmall changeinthatrisk.TheymayalsoprovideinformationonhowvolatiletheP/Lcanbe.Forexample,theequityriskofastockinvestmentcanbemeasuredastheP/Limpactof thestockasaresultofa1unitchangein,say,theS&P500index orasthestandarddeviationoftheparticularstock. Commonaggregateriskmeasuresincludevalue-at-risk(VaR),earnings-at-risk(EaR),andeconomiccapital.Techniquessuchasscenarioanalysisandstresstestingcanbeusedto supplementthesemeasures.  RiskMitigation Havingcategorizedandmeasureditsrisks,acompanycanthendecideonwhichriskstoeliminateorminimize,andhowmuchofitscoreriskstoretain.Riskmitigationcanbeachievedthroughanoutrightsaleofassetsorliabilities,buyinginsurance,hedgingwithderivatives,ordiversification. RiskReportingandMonitoring Itisimportanttoreportregularlyonspecificandaggregateriskmeasures inordertoensurethatrisklevelsremainatanoptimallevel.Financialinstitutionsthattradedailywillproducedailyriskreports.Otherinstitutionsmayrequirelessfrequentreporting.Riskreportsmustbesenttoriskpersonnelwhohavetheauthoritytoadjust(orinstructotherstoadjust)riskexposures. RiskGovernance Riskgovernanceistheprocessthatensuresallcompanyemployeesperformtheirdutiesinaccordancewiththeriskmanagementframework.Riskgovernanceinvolvesdefiningtherolesofallemployees,segregatingduties,andassigningauthoritytoindividuals,committees,andtheboardforapprovalofcorerisks,risklimits, exceptionstolimits,andriskreports,andalsoforgeneraloversight. CompareAccounts AdvertiserDisclosure × TheoffersthatappearinthistablearefrompartnershipsfromwhichInvestopediareceivescompensation.Thiscompensationmayimpacthowandwherelistingsappear.Investopediadoesnotincludealloffersavailableinthemarketplace. 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