Definition
Enterprise Risk Management (ERM) is a business strategy designed to identify, assess and prepare for any potential dangers, hazards, or other losses that may have a significant impact on an organization’s operations and objectives. It goes beyond individual risks and looks at the bigger, interconnected risk picture. ERM includes methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives.
Key Takeaways
- Enterprise Risk Management (ERM) is a comprehensive approach to risk management that addresses all types of potential risks – financial, strategic, operational, and other risks.
- ERM involves identifying, assessing, quantifying, and addressing risks that might impact an organization’s objectives. It’s an ongoing process that should be an integral part of an organization’s culture and strategic planning.
- ERM is not about avoiding risks completely; it’s about understanding and managing risks appropriately, framing risks as potential opportunities, and making informed decisions to create value.
Importance
Enterprise Risk Management (ERM) is vitally important in finance as it provides a comprehensive framework for identifying, assessing, and managing a wide range of potential risks that might impede an organization’s objectives.
It ensures that all levels of the organization understand and manage the risks they assume while conducting business.
With a well-structured ERM process, organizations can achieve their strategic and operational goals more effectively, as it helps in better decision-making, increased operational efficiency, and regulatory compliance.
Moreover, it encourages proactive risk management, thus mitigating any potential damage from unexpected events or risks, adding significant value to the organization’s future growth and stability.
Explanation
Enterprise Risk Management (ERM) is essentially deployed by organizations to deal with several types of potential risks or threats that might hinder them from accomplishing their objectives. The main purpose of this strategy is to plan, control, organize, and lead the activities of an organization in order to minimize the effects of potential risk on its capital and earnings.
Through ERM, organizations can identify and assess numerous risks such as operational risk, strategic risk, financial risk, and reputational risk that could negatively impact their operations. The use of ERM is primarily to fortify risk-related decisions through a solid, well-integrated risk framework and to foster an informed risk-taking culture within an organization.
It enables firms to make strategic decisions that consider the full range of risks, balancing the desire for growth with the need for preserving stakeholder value. Furthermore, it gives senior management and decision-makers a holistic view of the organization’s risk profile and risk appetite, enabling them to keep the organization’s risk levels within its pre-defined limits.
So, ERM doesn’t just help in mitigating risks; it also assists organizations in understanding opportunities associated with these risks, hence providing a competitive advantage.
Examples of Enterprise Risk Management
Enterprise Risk Management (ERM) encompasses a wide range of risk management strategies that companies employ to identify and handle potential risks. Here are three real-world examples:
JP Morgan Chase’s “London Whale” Incident: In 2012, JP Morgan Chase & Co., one of the largest global financial services firms, lost approximately $
2 billion through unauthorized derivative trading by an employee named Bruno Iksil, nicknamed the “London Whale”. This incident underlines the importance of ERM in understanding and managing complex risks associated with financial transactions. After the event, the bank reinforced its ERM system, introducing improved risk models and improved governance.
BP Deepwater Horizon Oil Spill: The BP oil spill that occurred in the Gulf of Mexico in 2010 is an example of operational risk, one aspect of ERM. The explosion and resulting oil spill led to significant financial losses, legal ramifications, and reputation damage for the petroleum company. Following the incident, BP had to improve its risk management protocols to account for environmental and safety risks.
Toyota’s Recall Scandal: From 2009 to 2011, Toyota faced significant recalls due to issues with unintended acceleration in several of their models, resulting in multiple accidents and fatalities. This showcases risks that can arise from manufacturing defects and lack of quality control, a part of operational risk. The significant reputational damage and financial loss consequent, necessitated Toyota to strengthen their ERM, improve quality control and better anticipate potential risks.Each of these examples underlines the necessity of an effective ERM system to identify potential risks, determine how much risk is acceptable, and implement measures to mitigate those risks.
FAQs on Enterprise Risk Management
What is Enterprise Risk Management?
Enterprise Risk Management (ERM) is a plan-based business strategy that aims to identify, assess, and prepare for any dangers, hazards, and other potentials for disaster—both physical and figurative—that may interfere with an organization’s operations and objectives.
What is the importance of Enterprise Risk Management?
ERM is important because it provides a framework for risk management, which typically involves identifying particular events or circumstances relevant to the organization’s objectives, assessing them in terms of likelihood and magnitude of impact, determining a response strategy, and monitoring progress.
How is Enterprise Risk Management different from Traditional Risk Management?
Unlike traditional risk management, Enterprise Risk Management is a comprehensive, organization-wide approach to handling risks and uncertainties. While traditional risk management focuses on protecting tangible assets, ERM deals with more abstract risks such as strategic, reputational, operational, financial, and other risks.
What are the steps involved in Enterprise Risk Management?
The steps involved in ERM are setting the context, identifying risks, analyzing risks, evaluating risks, risk treatment, and monitoring and reviewing the risk management activities.
What roles do different employees play in Enterprise Risk Management?
ERM involves the participation of everyone within an organization. The board of directors and senior management set the tone and the strategic direction. Managers and supervisors are responsible for executing the strategies and processes in their operations. Employees at every level are responsible for following procedures, and communicating any observed risks or failures to the appropriate level of management.
Related Entrepreneurship Terms
- Risk Assessment
- Risk Mitigation
- Operational Risk Management
- Financial Risk Management
- Strategic Risk Management
Sources for More Information
- Committee of Sponsoring Organizations of the Treadway Commission (COSO): A joint initiative of five private sector organizations, COSO provides thought leadership through the development of frameworks and guidance on enterprise risk management.
- Risk Management Association (RMA): An organization that promotes sound risk principles in the financial services industry; provides substantial resources on enterprise risk management.
- Gartner, Inc.: A global research and advisory firm providing insights, advice, and tools for businesses in various sectors, including finance and risk management.
- PricewaterhouseCoopers (PwC): A global network of firms delivering world-class assurance, tax, and consulting services for businesses; hosts various resources on enterprise risk management.
