What is risk management?

17 January 2025

Authors

Amanda McGrath

Writer

Alexandra Jonker

Editorial Content Lead

What is risk management?

Risk management is the process of identifying, assessing and addressing any financial, legal, strategic and security risks to an organization.
 

Business risks stem from many sources, including financial uncertainty, legal liabilities, technology use, strategic management errors, accidents and natural disasters. Risk management practices aim to anticipate these threats and their potential impact and establish plans to address them when they arise.

Why is risk management important?

Risk management is an integral component of any business strategy. It helps businesses and individuals protect against financial expenses, inefficiencies, reputational damage and other potential losses.

The root causes of risks are both internal (such as human error or system failures) and external circumstances (such as global crises, climate change or technological advancements). When unforeseen events occur, organizations must bear the consequences.

The possible risks might be minor, such as a temporary cost increase. However, they could also be catastrophic and lead to serious ramifications, including major financial burdens, loss of reputation or even business closure.

By adopting a comprehensive and proactive approach to risk management, businesses can protect themselves and respond when threats are present.

In essence, risk management is not just about preventing negative outcomes but also about enabling positive ones to support the overall success and sustainability of a business.

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Benefits of risk management

Risk management has several benefits, including:

Reduces financial losses

Identifying and managing risks can help organizations avoid financial losses from costly litigation or reputational damage. By mitigating risks, they can support compliance with industry regulations and build confidence among stakeholders, including investors, employees and consumers.

Avoids reputational damage

By anticipating problems and addressing them quickly, organizations can avoid reputation-damaging incidents such as product failures or data breaches.

Improves strategic decision-making

Effective risk management processes also deliver valuable insights into the potential implications of different business decisions. As a result, they help leaders improve their strategic decision-making and can lead to improvements in operations, such as better quality control or streamlined workflows.

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Types of risk

Businesses face various risks, including:

  • Financial risk
  • Operational risk
  • Cybersecurity risk
  • Strategic risk
  • Compliance risk
  • Reputational risk

Financial risk

Financial risk includes issues that are related to changes in market conditions, interest rates, exchange rates and other factors. Credit risk (the chance of a borrower defaulting) and liquidity risk (the inability to meet short-term financial demands) are also examples of financial risk.

Operational risk

Operational risk as a category includes both internal and external threats. Internal problems such as human error, technology and system failures, and operational inefficiencies can hurt an organization’s ability to meet its obligations and goals.

External events such as natural disasters or geopolitical instability can disrupt supply chain operations and cause physical damage.

Cybersecurity risk

Cybersecurity risks include data breaches, cyberattacks, phishing attempts and issues of unauthorized access to company systems or information. Technology-related threats are expanding to include safety issues with artificial intelligence (AI) and AI-powered tools and processes.

Strategic risk

Strategic risk is associated with poor business decisions, ineffective strategies or inadequate responses to technological changes or shifts in customer behavior.

Project risks related to market competition, including mergers and acquisitions, entry into new markets or the launch of new products, are considered strategic risks.

Compliance risk

Compliance risk involves issues with following laws, regulations and standards. Failure to keep up with evolving regulatory rules or monitor internal processes can lead to legal and financial problems.

Reputational risk

Reputational risk includes anything that damages an organization's public face, such as negative publicity, customer dissatisfaction or ethical issues. Changes in public sentiment can lead to operational and financial consequences for businesses.

Common responses to risk

Organizations can respond to risks in various ways. Some of the most common risk treatment options include:

  • Risk avoidance
  • Risk reduction
  • Risk sharing
  • Risk transfer
  • Risk acceptance and retention

Risk avoidance

Risk avoidance means not participating in activities that might negatively affect the organization. For example, an organization might decline to make an investment or decide not to start a new product line to avoid the risk of losses.

Risk reduction

Risk reduction accepts risk but aims to minimize it and its impacts. Risk reduction accepts the risk but focuses on keeping any loss from spreading. It is similar to preventive care benefits in health insurance policies.

Risk sharing

Risk sharing involves transferring some or all of the risk to another party. A corporation is a good example of risk sharing—several investors pool their capital and each bears only a portion of the risk that the enterprise will fail.

Risk transfer

Risk transfer involves contracting a third party to absorb the risk. For example, this method might include purchasing insurance to cover possible property damage or injury.

Risk acceptance and retention

Eliminating all risk is not possible. After taking steps to avoid, reduce, share or transfer risk, organizations face whatever concerns remain (also known as residual risk). Risk acceptance and risk retention involve accepting the potential consequences of risk and preparing to manage them if they occur.

Steps of the risk management process

Risk management processes involve the people, technology and behaviors that help an organization to address risks and reach its objectives. 4 key steps in any risk management plan include:

  • Risk identification
  • Risk assessment
  • Risk mitigation
  • Risk monitoring

Risk identification

Risk identification is the process of recognizing potential threats to an organization, its operations and its workforce. It can include practices such as assessing IT security threats (such as malware or ransomware) or monitoring the weather for natural disasters and other events that might disrupt business operations. Organizations might choose to record their findings in a risk register.

Risk assessment

Risk assessment focuses on analyzing and evaluating potential risk factors. Risk analysis involves establishing the probability that a risk event might occur and the potential outcome of each event.

Risk evaluation compares the magnitude of each risk and ranks them according to prominence and consequence. To assess risks, the risk management team might employ prioritization based on how much of a threat the risks pose to the organization and its objectives.

Risk mitigation

Risk mitigation involves developing and implementing strategies to address and control an organization’s risk. It entails risk control actions that are put into place to deal with risk factors and the effects of those actions on the advancement of projects or goals.

Mitigation strategies might include common risk responses, such as risk avoidance, reduction, sharing, transfer and acceptance.

Risk monitoring

Risk management is a nonstop process that adapts and changes over time. Repeating and monitoring the process can help organizations keep up to date on new risks.

By continuously monitoring risks and adapting risk management strategies, organizations can better protect their assets, reputation and profitability in the long term.

Types of risk management

Several specialties exist within risk management.

Cyber risk management

Cyber risk management, also called cybersecurity risk management, involves protecting an organization's digital assets and information technology.

Cybercriminals, employee mistakes and other digital and physical threats can knock critical systems offline or lead to data or revenue losses.

Cybersecurity risk management helps companies pinpoint their most critical threats and select the right IT security measures to protect information systems.

AI risk management

AI risk management addresses the potential risks that are associated with artificial intelligence technologies. As AI tools become more widely used, organizations that develop and use them need to make sure that they are reliable, transparent and ethical.

AI risk management can enhance an organization’s cybersecurity and use of AI security. It can also help ensure regulatory compliance and stakeholder trust as the technology evolves.

Model risk management

Organizations use complex mathematical models for decision-making, such as financial forecasting or customer segmentation. If models perform inadequately, the organizations can suffer lost revenue or legal liabilities.

Model risk management (MRM) involves validating models and tools before and after they are implemented and making adjustments throughout their lifecycle to protect their integrity.

Supply chain risk management

Supply chain risk management (SCRM) aims to identify vulnerabilities in the supply chain and minimize their impact on a company's operations, reputation and financial performance.

Internal and external supply chain risks can come from various sources, including natural disasters, geopolitical events, supplier bankruptcy, quality issues and cyberattacks. Effective SCRM can build operational resilience, identify areas of waste or inefficiency and protect the company's reputation.

Third-party risk management

Third-party risk management (TPRM) addresses risks associated with outsourcing tasks to outside vendors or service providers. These third-party partnerships might be involved in functions, such as IT services, supply chain management or customer support.

TPRM helps organizations understand their third-party business relationships and the safeguards that these vendors employ. This helps prevent problems such as operational disruptions, security breaches and compliance failures.

TPRM is a subset of supply chain risk management and is also sometimes referred to as vendor risk management (VRM).

Artificial intelligence in risk management

Artificial intelligence (AI) and machine learning (ML) technologies support risk management programs by helping organizations proactively identify and mitigate potential threats.

Risk management specialists and other risk professionals can use AI tools and systems to better detect problems and automate solutions.

  • Predictive analytics: Machine learning algorithms can analyze vast amounts of data to identify patterns and anticipate potential risks. For example, a financial institution or insurance company might use AI tools to detect anomalies and suspicious patterns in transactions or user behavior to mitigate fraud risks.

  • Natural language processing (NLP): NLP tools can be used to analyze unstructured data sources, such as news articles, social media or customer interactions, and identify any risks that might impact an organization. AI-powered sentiment analysis, for example, might help customer service agents better understand how to address a caller’s needs in real time.

  • Cybersecurity: Organizations can also use AI to strengthen the safety of their operations. For example, AI-powered systems can monitor network traffic for potential threats or recognize new types of malware.

  • Efficiency and optimization: AI can also be useful in supply chain risk management. Its data analysis capabilities might identify potential disruptions, such as supplier inconsistencies or transportation delays, or improve demand forecasting. This proactive monitoring and automatic response can reduce overall risk and improve efficiency.

Common risk management standards and frameworks

Several international standards and initiatives provide guidance on risk management. These risk management standards include a specific set of processes that aim to develop a risk management strategy based on an organization’s objectives and needs.

Among the most widely used international standards are:

  •  ISO 31000: Developed by the International Organization for Standardization (ISO), it provides principles, frameworks and processes for managing identified risks. 

  • COSO Enterprise Risk Management (ERM) Framework: Developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), this risk management framework provides guidance on integrating risk management into an organization's strategy and performance.

  • NIST Cybersecurity Framework: Developed by the US Department of Commerce’s National Institute of Standards and Technology (NIST), it provides guidance on managing cybersecurity risks.

  • GRC Capability Model: Developed by the Open Compliance and Ethics Group (OCEG), it provides guidelines for integrated governance and compliance. It’s sometimes known as the OCEG Red Book.

These risk management standards offer the benefit of a structured approach. Their use can help with benchmarking and comparison with competitors or industry peers.

However, these standards might be costly or time-consuming for some organizations to implement and they might not be flexible enough to meet some organization’s unique requirements.

Therefore, the decision to adopt an international risk management standard depends on the organization's specific needs, risk tolerance and risk appetite.

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