Importance of ERM
ERM is a process that is designed to identify any potential happenings that might affect a business entity and provides assurance regarding mitigation, avoidance and management of all risk factors. It is a process that promotes opportunities with the aim of capitalizing on risk management and thresholds across the whole enterprise (Hitchcox, 2011). ERM is applied in strategy setting for business in instilling a culture that controls the structure of an organization while improving its risk management capabilities within the changing business environment. According to Pramod and Gao (2012), ERM is very important in promoting consistence and communication of risks within then specific organization. ERM promotes a more cost effective management, monitoring of risks, improved focus, attention and more effective activities in the banking sector. It also promotes analysis of perspective to risk data, activities related to regulatory, compliance and audit matters together with enhanced reporting of business matters (Yazid et al, 2011).
Real importance and significance of ERM in banking sector
In the banking sector, ERM ensures that there is standard terminology and conceptual framework for all workers in the banking sector (Simkins, 2008). This is clearly evident through then increased consistency and communication that is provided by the ERM to banks (Rubino & Vitolla, 2014). Improved communication opportunities in the banks have resulted from the establishment of consistency and communication where workers can air their own views concerning the bank. This has facilitated good coordination of activities that are carried by the bank.
Enhanced reporting, implementing ERM
ERM has shown high significance in ensuring that it supports a better enterprise structure, reporting of risk matters, and analysing of risk that is affecting the banking sector at any given time. Consolidation of risk in the bank increases the focus of directors and executives, enabling them to make a sound decision regarding the risk at hand (Linderber & Seifert, 2011). Reporting has better categorization and classification of risk data and this gives various departments in the banking sector to give their reporting (Lai & Azizan, 2012). ERM help in the unblocking of all the synergies and the assessment of risks, evaluating them all in the right basis in order to regulate risks associated with the enterprise (Koutoupis & Tsamis, 2009). It also increases potential for analysis in the banking sector and ensures that all corporate risk data factors are shared with all departments to reduce risks (Liu, 2012).
Creation of a more risk focused culture
The use of ERM in the banks is evident where it permits a more effective and complete viewpoints of risks while ensuring that the traditional practices of risks focus more on the avoidance, mitigation and acceptance perspective. When ERM is effective; it helps the banking management to choose the right framework of evaluating risks as an opportunity of increasing competitive positions in the sector (Pagach & Warr, 2011). This will also increase chances of exploiting the markets where they can get more customers to serve. All the operational and related condition in the banking sector will be improved through a clear and a mandated ERM (Lambie-Mumford, 2013).
Standardized risk reporting
ERM has programs that include monitoring of activities and reporting of matters, a strategy which is very useful to the bank risk mananagement. This is the reason as to why most banks decided to inquire, test, leverage and utilize all the monitoring and reporting of data from the ERM (Koutoupis & Tsamis, 2009). The ERM data is comprised of identifying, mitigations, and monitoring controls, which are relevant to various risks in the organisation. When well used in the bank, the information can provide a leveraging and reduce the much effort used in costs of audits and bank reviews.
Cost management of risks
Cost management of risks is well facilitated through use of ERM in a bank; since, better cost management and cost effective issues related to audit activities are well handled. ERM allows for better management of markets, economic conditions in the banking sector, and the creation of a competitive environment, which has led to an increased leverage and consolidation of disparate risk management functions (Jalal-Karim, 2013). Investments are well coordinated using ERM such that banks can better manage their own investment decisions and make more timely decision that will help strengthen then banking sector in whole. According to Hitcox (2011), ERM ensures that the overall cost of the risk management process is totally reduced as well as the audit cost and resource usage. This means that ERM has high capability of reducing all the cost of existing processes in the banking sector and all the functions of the respective components.
4.2 How banks take advantage of efficient ERM system
Bank that takes advantage of the effective ERM to make sure that it identifies, solves and protects any future problem that it might face. This is done where the bank management has the ability to understand and manage all the risks associated with their enterprise. The banks can create models to analyze potential outcomes and probabilities, which were based on past performance. Currently the outcomes given through ERM help in identification of risks and how it should be reduced and be prevented in the future (Hoyt & Liebenberg, 2011).
Redefining of risk
Redefining risk is one of the strategies that were used by banks to identify the risk that it is facing so that it can come up with mehanisms that will help to manage such risks (Cummins, 2005). This is because financial risks is not the only risk that the bank could have faced and this is the reason that drives then motive of identifying all risks that are taking place. The bank risk managers would advise then bank to pull back when the losses were too high in order to avoid operating under unnecessary high risks. The Global financial crisis of the year 2008 really affected the financial status of the banks, almost leaving most of them bankrupt (Elkhouly et al, 2014). In looking at the potential for loss, the risk managers of the bank knew that their focus was to view the integration for risk that focus on the type of risk a bank was taking. The bank later realized the type of risk that was taking place through the help of ERM that helped the management in realizing the type of risks taken in by the bank.
Understanding of risk
In solving the risk that they had faced, the bank had to take advantage of the ERM efficient system in understanding and making of clear decision that could determine the type of risk taken in the future . At Lehman Brothers, it was the responsibility of the bank managers to ensure that risk taken could pay off and they also had to evaluate the entire outcome from each risk. They ensured that they took risks under their own core capabilities and this entailed a good clear understanding of the risks taken through use of ERM. Use of ERM, as earlier stated, ensures that bank managers have the right understanding of then risk that they involve in and how much it will pay off in return (Elkhouly et al, 2015). They had to make decisions in a moderate mode to avoid making uncertain information that earlier cost the bank huge financial loss. This helped the bank to move beyond traditional and all the internally focused risk management practices in trying to identify what could lead to increased bank exposure risk. The bank solved it risk issue by concentrating on its potential probabilities, impacts and all the independences among upcoming issues. Through employing workers with a broader perspective and who were also willing to challenge assumptions about the future, the bank solved its problems. This was facilitated through taking advantage of the efficient ERM system in the banking sector. The bank management took advantage of the ERM in ensuring that they not only look at the already known issues and probabilities, but they as well examine the links and independences among issues to have a smooth running. ERM ensures that the workers with a broader perspective employ the use of new technologies that can be used to improve visibility across the whole bank (Hitchcox et al, 2011). Taking advantage of the ERM efficient system ensured that the bank, not only focused on its performance, but monitored all risks both internally and externally to avoid any future misfortunes.
ERM has been applied to help in decision making in business enterprises (Elkhouly et al, 2015). ERM ensures good decision making within the banking sector with regards to what steps needs to be taken in relation to the various situations. According to Hitchcox (2011), the ERM efficient system guarantees a good decision making process that help the banks to reduce the challenge of moving beyond reliance on numbers that is mostly generated by the models and to look beneath the surface of the models (Bharathy & McShane, 2014). The use of ERM ensures that the bank management takes the right proactive steps in making the right decision concerning the risk that they are about to take either financially or through any other way. This gives them a chance to make a more risk-informed decision on financial matters of their bank (Elkhouly et al, 2014). In capturing incoming risks, the bank uses a well specified assessment in understanding the all the operating environment, both in its eternal and external sources. They also consider the level of risk that they are about to take or even needed to take in relation to particular risk. Through the use of the efficient ERM, the bank is better positioned in making strategic decisions that require a better understanding of the banking industry and how much risk the enterprise is subjected to. It is well evident that risk management is the central part of managing an enterprise and the management should focus on having a risk management mind-set together with a model result that help them to manage their institutions in a better manner.
Efficient use of resources
According to Cummins (2005), an organization should take advantage of the ERM efficient system to ensure that its resources are well used. This is mostly evident where managing and reporting of risks is clearly transacted within the management by ensuring that all activities are well coordinated. Use of ERM does not entail risk for day to day management, but it mostly focuses on the critical framework and the tools used to manage functions in a more consistent manner to guarantee a good future for the bank. However, this leads to the elimination of redundant processes with the aim of improving the efficiency of the bank through allocation of the right amount of resources to mitigating the risks involved. Elimination proves to be one of the ways that the bank can use in ensuring that its resources are efficiently used (Pramod & Gao, 2012).
ERM has several importance’s, which include; understanding of risk, re-defining of risk, cost management risks, standardized risk reporting, creation of a more risk focused culture, enhanced reporting implementing ERM, efficient use of resources and a good decision making. ERM is much useful in the decision making process that is very crucial in matters to do with the high risks facing financial institutions. A clear and a sound decision will prevent the bank from taking a big risk that it will not be able to handle on its own. ERM creates a more risk focused culture and this is evident where it permits a more effective and complete viewpoints of risks. It also ensures that the traditional practices of risks focus more on the avoidance, mitigation and acceptance perspective. The banking sector is more advanced in using the standardized risk reporting activities that come along through the use of the ERM. These activities include monitoring of activities and reporting of all risk matters that might affect the performance of the banking sector. In terms of cost management, risk ensures better management of markets, economic conditions in the banking sector through the creation of a more competitive environment (Rubino & Votolla, 2014). An increased leverage, consolidation of disparate risk management functions in the whole sector is all evident, thus reducing chances of a fall to the bank. Lehman Brothers took advantage of the efficient ERM system to identify, solve and protect risk problems in future. They were careful to ensure that they take the right type of decision in taking a risk that the bank could handle. They re-defined their risk in making sure that the loss that they incurred could never happen again in future. Initially, the Lehman Brothers did not take the advantage of the ERM system in developing its activities, leading to liquidy probems seen during the financial crisis (Wu, & Olson, 2010). This is the reason as to why the global financial crisis made it bankrupt because it had ignored all its credit risk and put its whole focus on profit making initiatives (Arnold, Benford, Hampton, & Sutton, 2012. In return, the bank had decided to take a huge taxpayer-financial-bail-out in order to remain relevant in the financial industry. Earlier they thought that the property markets in different cities of America would rise and fall independently of one another, leading to massive losses due to the credit crunch.
Castanheira, N., Lúcia, L. R., & Russell, C. (2010). Factors associated with the adoption of risk-based internal auditing. Managerial Auditing Journal, 25(1), 79-98
Chadha, B., Masson, P. R., & Meredith, G. (1992). Models of inflation and the costs of disinflation. International Monetary Fund.Staff Papers – International Monetary Fund, 39(2), 395. Retrieved from http://search.proquest.com/docview/214766175?accountid=45049
Chen, J., & Chen, C. (2012). The study of contagious paces of financial crises. Quality and Quantity, 46(6), 1825-1846
Chong, Y. Y. (2003). How to achieve realistic risk management. Balance Sheet, 11(4), 44-64. Retrieved from http://search.proquest.com/docview/204698337?accountid=45049
Cooper, T., Faseruk, A., & Khan, S. (2013). Examining practitioner studies to explore ERM and organizational culture. Journal of Management Policy and Practice, 14(1), 53-68. Retrieved from http://search.proquest.com/docview/1429682635?accountid=45049
Cummins, J. D. (2005). Convergence in wholesale financial services: Reinsurance and investment banking. Geneva Papers on Risk & Insurance, 30(2), 187-222. doi:http://dx.doi.org/10.1057/palgrave.gpp.2510031
El Khouly, S.,M., Ibrahim, M. M., El Frargy, M.,M., & Kotb, A. S. (2014). Measuring the effectiveness of banking risk balanced scorecard in enhancing bank value. Competition Forum, 12(1), 114-124.
Elkhouly, S. M., Ibrahim, M. M., El Frargy, M.,M., & Kotb, A. S. (2015). Measuring the effectiveness of banking risk balanced scorecard in enhancing bank value. International Journal of Economics and Finance, 7(6), 139-152.
Hitchcox, A. (2011). ERM for insurance companies – adding the investor’s point of view; abstract of the london discussion. British Actuarial Journal, 16(2), 385-404
Hitchcox, A. N., Klumpes, P. J. M., McGaughey, K. W., Smith, A. D., & Taverner, N. H. (2011). ERM for insurance companies – adding the investor’s point of view. British Actuarial Journal, 16(2), 341-384
Hoyt, R. E., & Liebenberg, A. P. (2011). The Value of Enterprise Risk Management. Journal of Risk and Insurance, 78(4), 795-822.
Jalal-Karim, A. (2013). Leveraging enterprise risk management (ERM) for boosting competitive business advantages in bahrain. World Journal of Entrepreneurship, Management and Sustainable Development, 9(1), 65-75
Koutoupis, A. G., & Tsamis, A. (2009). Risk based internal auditing within Greek banks: A case study approach. Journal of Management & Governance, 13(1-2), 101-130
Lai, F. & Azizan, N.A. 2012, “Critical review of literature on enterprise risk management and the cost of capital: The value creation perspective”, African Journal of Business Management, vol. 6, no. 9, pp. 3126-3133.
LAMBIE-MUMFORD, H. (2013). ‘Every town should have one’: Emergency food banking in the UK. Journal of Social Policy, 42, 73-89
Lindberg, D. L., & Seifert, D. L. (2011). Enterprise risk management (ERM) can assist insurers in complying with the dodd-frank act*. Journal of Insurance Regulation, 30(1), 319-337.
Liu, J. 2012, “The Enterprise Risk Management and the Risk Oriented Internal Audit”, I – Business, vol. 4, no. 3, pp. 287-292
Pagach, D., & Warr, R. (2011). The Characteristics of Firms That Hire Chief Risk Officer. Journal of Risk and Insurance, 78(1), 185-211.
Pramod, V., Li, J., & Gao, P. (2012). A framework for preventing money laundering in banks. Information Management & Computer Security, 20(3), 170-183
Rubino, M., & Vitolla, F. (2014). Corporate governance and the information system: How a framework for IT governance supports ERM. Corporate Governance, 14(3), 320.
Simkins, B. 2008, “Enterprise Risk Management: Current Initiatives and Issues Journal of Applied Finance Roundtable”, Journal of Applied Finance, vol. 18, no. 1, pp. 115-132.
Wu, D. & Olson, D.L. 2010, “Enterprise risk management: coping with model risk in a large bank”, The Journal of the Operational Research Society, vol. 61, no. 2, pp. 179-190.
Yazid, A. S., Hussin, M. R., & Daud, W. N. W. (2011). An examination of enterprise risk management (ERM) practices among the government-linked companies (GLCs) in Malaysia. International Business Research, 4(4), 94-103
Zhao, X., Hwang, B. & Pheng Low, S. 2014, “Enterprise risk management implementation in construction firms”, Management Decision, vol. 52, no. 5, pp. 814.