ACHIEVING KPIs ACHIEVING KPIs THROUGH RISK THROUGH RISK MANAGEMENTMANAGEMENT

: THE CHALLENGES : THE CHALLENGES AHEADAHEAD

(I) INTRODUCTION(I) INTRODUCTIONWHAT IS ENTERPRISE RISK MANAGEMENT WHAT IS ENTERPRISE RISK MANAGEMENT

(ERM) ?(ERM) ?

Holistic, proactive approach that identify and Holistic, proactive approach that identify and measure all of the enterprise’s risk exposures and measure all of the enterprise’s risk exposures and manage them within a unified framework;manage them within a unified framework;

A fundamental shift in the way business must A fundamental shift in the way business must approach risk;approach risk;

Growing interest in ERM in recent years, more Growing interest in ERM in recent years, more so with heavily publicized cases such as so with heavily publicized cases such as Enron, World Com and the passage of Enron, World Com and the passage of compliance mandate such as the Sarbanes-compliance mandate such as the Sarbanes-Oxley Act of 2002, Basel II and industry-wide Oxley Act of 2002, Basel II and industry-wide initiatives;initiatives;

According to the Committee of Sponsoring According to the Committee of Sponsoring Organizations of the Treadway Commision Organizations of the Treadway Commision (COSO), ERM deals with risks and (COSO), ERM deals with risks and opportunities affecting value creation or opportunities affecting value creation or preservation and is defined as follow:preservation and is defined as follow:

““Enterprise risk management is a process, Enterprise risk management is a process, effected by an entity’s board of directors, effected by an entity’s board of directors, management and other personnel, applied management and other personnel, applied in strategy setting and across the in strategy setting and across the enterprise, designed to identify potential enterprise, designed to identify potential events that may affect the entity, and events that may affect the entity, and manage risk to be within its risk appetite manage risk to be within its risk appetite to provide reasonable assurance regarding to provide reasonable assurance regarding the achievement of entity objectives”the achievement of entity objectives”

Relationship between ERM and Relationship between ERM and traditional methods of treating risk:traditional methods of treating risk:

Traditionally risk is being handled through the Traditionally risk is being handled through the silo approach;silo approach;

Corporate losses or those due to pure risk such Corporate losses or those due to pure risk such as property losses, liability suits, workmen as property losses, liability suits, workmen compensations and others are being handled compensations and others are being handled through insurance contracts and others;through insurance contracts and others;

Financial losses or those due to speculative Financial losses or those due to speculative risk such as credit risk, operational risk, risk such as credit risk, operational risk, liquidity risk and others are being handled liquidity risk and others are being handled through derivative contracts such as options, through derivative contracts such as options, swaps, futures or forwards;swaps, futures or forwards;

In short ERM consist of :In short ERM consist of :

Enterprise risk management

Corporate risk management/pure risk

Financial risk management/speculative risk

Total Risk Management+

ERM Consists Of Eight Interrelated ERM Consists Of Eight Interrelated Components:Components: InternalInternal ObjectiveObjective Event IdentificationEvent Identification Risk ManagementRisk Management Risk ResponseRisk Response Control ActivitiesControl Activities Information & CommunicationInformation & Communication MonitoringMonitoring

(II) KEY PERFORMANCE (II) KEY PERFORMANCE INDICATORS (KPIs) INDICATORS (KPIs)

KPIs of an organization can be viewed from fourKPIs of an organization can be viewed from fourperspective namely:perspective namely:

Financial perspectiveFinancial perspective Customer perspectiveCustomer perspective Internal Business Process PerspectiveInternal Business Process Perspective Learning and Growth (Human Resource) Learning and Growth (Human Resource)

PerspectivePerspective

The four perspective will be attachedThe four perspective will be attachedto the organization as follows:to the organization as follows:

Vision and Strategy

Learning and Growth (HR)

CustomerInternal Business

Process

Financial

(Kaplan & Norton)

Under the different perspective; the Under the different perspective; the objectives and initiatives are:objectives and initiatives are:PerspectivePerspective ObjectivesObjectives InitiativeInitiative

FinancialFinancial - Enhance revenue stream- Enhance revenue stream

- Improve utilization of assets- Improve utilization of assets

- New pricing programNew pricing program- Benchmarking;Benchmarking;- Just in time manufacturingJust in time manufacturing

CustomerCustomer - Find new partnersFind new partners- Increase customer loyaltyIncrease customer loyalty- Grow market shareGrow market share

- Partner programPartner program- Frequent purchase programFrequent purchase program- Frequent purchase programFrequent purchase program

Internal Business Internal Business ProcessProcess

- Develop customer profileDevelop customer profile- Eliminate defects Eliminate defects

- IT tools and trainingIT tools and training- Maintenance overhaul;Maintenance overhaul;- ISO 9002ISO 9002

Employee Learning Employee Learning & Growth& Growth

- Close our skills gapClose our skills gap- Increase empowermentIncrease empowerment

- Critical skills trainingCritical skills training- 360 degree feedback360 degree feedback- Decision trainingDecision training

(Paul R. Niven)

(III) ERM’s ROLE IN ACHIEVING KPIs(III) ERM’s ROLE IN ACHIEVING KPIs

a)a) Financial Perspectives:Financial Perspectives:

Guaranteeing insofar as possible that an Guaranteeing insofar as possible that an organization will not be prevented from organization will not be prevented from pursuing its other goals as a result of losses pursuing its other goals as a result of losses associated with pure risks;associated with pure risks;

It can contribute directly to profit by It can contribute directly to profit by controlling the cost of risk; since the profit controlling the cost of risk; since the profit depends on the level relative to income to the depends on the level relative to income to the extent that ERM activities can reduce expenses extent that ERM activities can reduce expenses they directly increase profits;they directly increase profits;

ERM can also reduce expenses through risk ERM can also reduce expenses through risk control measures; if the cost of loss prevention control measures; if the cost of loss prevention and control measures is less than the amount and control measures is less than the amount of losses prevented, the expense of uninsured of losses prevented, the expense of uninsured loss is reduced; loss prevention and control loss is reduced; loss prevention and control measures could also reduce the cost of measures could also reduce the cost of insurance;insurance;

Since the effect of losses from pure risk can be Since the effect of losses from pure risk can be minimized the organization has greater latitude minimized the organization has greater latitude in the speculative risk activities; there will be in the speculative risk activities; there will be inevitable trade-off between pure and inevitable trade-off between pure and speculative risks; by managing the amount of speculative risks; by managing the amount of pure risk with which the organization must pure risk with which the organization must contend, ERM increases the organization’s contend, ERM increases the organization’s ability to engage in speculative risk;ability to engage in speculative risk;

b) Customer Perspective :b) Customer Perspective :

By adopting the partner programs, frequent By adopting the partner programs, frequent purchase programs the organization will be purchase programs the organization will be able to increase customer loyalty and market able to increase customer loyalty and market share; this can be viewed as increasing the share; this can be viewed as increasing the number of risk exposures which is in line with number of risk exposures which is in line with the effort to reduce risk;the effort to reduce risk;

c) Internal Business Process :c) Internal Business Process :

By developing customer profile, the By developing customer profile, the organization would be able to identify the organization would be able to identify the targeted or segmented preferred customers targeted or segmented preferred customers with the least risk possible;with the least risk possible;

By eliminating defects through a maintenance By eliminating defects through a maintenance overhaul program the organization would be overhaul program the organization would be able to produce better products which in turn able to produce better products which in turn will attract more customers as well as reduce will attract more customers as well as reduce cost eventually;cost eventually;

d) Employee Learning & Growth Perspective :d) Employee Learning & Growth Perspective :

By conducting more training and other skill By conducting more training and other skill enhancing programs, the knowledge and enhancing programs, the knowledge and expertise of employees will be increased and expertise of employees will be increased and this will finally improve quality in the this will finally improve quality in the organization, reduce errors and reduce cost of organization, reduce errors and reduce cost of operation.operation.

Apart from the above mentioned KPIs, ERM canApart from the above mentioned KPIs, ERM can

be utilized in many other situations such as:be utilized in many other situations such as:

Financial type risks;Financial type risks; Credit riskCredit risk Liquidity riskLiquidity risk Interest rate riskInterest rate risk Currency exchange riskCurrency exchange risk

Risks related to Systems;Risks related to Systems;

Issues related to Shareholder Wealth;Issues related to Shareholder Wealth; Opportunity cost of capital;Opportunity cost of capital; Expected cash flow;Expected cash flow;

(IV) ANALYTICAL TOOL(IV) ANALYTICAL TOOL

Among the analysis tools used in corporate Among the analysis tools used in corporate risk management are :risk management are :

Constructing the frequency and severity of Constructing the frequency and severity of losses from historical data;losses from historical data;

Constructing the total loss distribution;Constructing the total loss distribution;

Computer simulation of loss distributions;Computer simulation of loss distributions;

Regression and correlation analysis;Regression and correlation analysis;

Use of discounted cash flow analysis;Use of discounted cash flow analysis;

Other more sophisticated analysis such as Other more sophisticated analysis such as multivariate and factor analysis multivariate and factor analysis nonparametric statistics and others.nonparametric statistics and others.

(V) CONCLUSION(V) CONCLUSION

It is natural for the evolution of enterprise risk It is natural for the evolution of enterprise risk management to take place because it would management to take place because it would bring together the management of all risks-bring together the management of all risks-financial, operational, strategic and financial, operational, strategic and traditionally insured hazards – into a single traditionally insured hazards – into a single portfolio. The convergence of responsibility portfolio. The convergence of responsibility for managing pure risks and other risks is a for managing pure risks and other risks is a foregone conclusion and that the responsibility foregone conclusion and that the responsibility

of risk managers should be expanded to of risk managers should be expanded to include other risks especially those relating to include other risks especially those relating to other facets of finance. However, the concepts other facets of finance. However, the concepts of enterprise risk management is still of enterprise risk management is still relatively new. What remains unclear is who relatively new. What remains unclear is who will have ultimate responsibility for managing will have ultimate responsibility for managing a company’s enterprise risk portfolio. The a company’s enterprise risk portfolio. The disagreement is not about whether financial disagreement is not about whether financial risks susceptible to treatment by derivatives risks susceptible to treatment by derivatives futures and options should be managed, futures and options should be managed,

but whether they should be managed by the but whether they should be managed by the same person who manages the risks of fires, same person who manages the risks of fires, explosions, embezzlements and legal liability.explosions, embezzlements and legal liability.

THANK YOUTHANK YOU