What is Financial Risk Management?

They say there is no gain without risk. In an ideal world, we would all love to have maximum returns for zero risk. However, risk and return are too often two sides of the same coin. Any event or situation that can potentially cause a loss (financial / reputational etc.) to a firm is termed as a risk. Broadly, Financial Risk can be categorized into:

  1. Market Risk: This is the risk arising from exposure to the financial markets and is linked to the uncertainties inherent in the markets
  2. Credit Risk: This is the risk arising from having lent money to a credit-unworthy entity or not being able to recover the loan lent out to an entity
  3. Liquidity Risk: This is the risk of not being able to meet your funding needs, not being able to liquidate assets whenever required
  4. Operational Risk: Any sort of risk that could potentially cause a loss to the firm but is not covered above is usually part of Operational Risk. Having said that, Operational Risk is often linked to the mistakes made by people, errors in systems or legal issues. Fraud and misdemeanor also fall under this umbrella

Risk Management is nothing but identifying the potential pitfalls called risks, prioritizing them and finding solutions to minimize or completely do away with such risks.
The global recession around 2008 showed the world how Risk Management is an essential, important part of any ongoing business. Many of the risks that a firm faces can be minimized or even fully controlled by proper systems and checkpoints in place. Consequently, several firms have their own Risk Management teams that track, estimate and try to minimize various risks.

Risk Management executives are hired across several types of firms:

  1. Banks and Financial Institutions: Apart from the fact that these firms directly work with market fluctuations and manage huge assets, they are also mandated by regulatory authorities to stay within well-defined risk benchmarks. Hence, they need extensive Risk Management across divisions.
  2. Consultants: Firms that find it difficult to have their own in-house Risk team often rely on consultants.
  3. Large or Diversified conglomerates: Large or diversified firms have several divisions sometimes spread over many geographies, so it becomes essential to have a Risk team that keeps a watch over the entire gamut of operations.
    Risk teams of any other firm looking to minimize risks.