Understanding integrated risk management

Integrated risk management also popularly called Enterprisewide Risk Management (ERM), looks at various kinds of risk - market risk, credit risk, liquidity risk, operational risk and business risk in a holistic fashion. An integrated view generates a better picture of the risk climate of the organization and also helps in making the risk management process more efficient. Considerable cost savings can be achieved by aggregating and netting out positions. A firmwide approach can reveal natural hedges and guide the firm’s strategy towards activities that are less risky when taken as a whole. ERM also acts as a check on risk migration, i.e., movement towards other types of risk that are less visible but may be more dangerous. Last but not the least, by providing an aggregate measure of risk, ERM helps companies to decide what is the optimal level of capital they must hold. Too little capital means the company is taking risks which it cannot afford to take. Too much capital means the company is being too conservative and may fail to generate adequate returns for shareholders.
While the integration of market and credit risk in banks has made impressive strides in recent years, the same cannot be said about the integration of business and financial risks in non banking corporations. Traditionally, the two kinds of risk have been handled in two different silos by two types of people, the business managers and the finance managers respectively. Business people bring in a strong intuitive dimension to risk management but often lack the tools to quantify risk. The finance people are data driven and swear by quantification. But often they do not understand the business adequately enough to bring in the necessary element of intuition and judgment. ERM can help bridge the silos by striking the right balance between intuition and quantification.