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7 Steps to an Effective Risk

Management Process
 By AFP Staff
 Published: 12/18/2023

A risk management process is the means by which an organization identifies, assesses

and mitigates any threats or uncertainties that may negatively impact it.

Through the risk management process, the likelihood and potential impact of the
identified risk are analyzed, and leadership develops strategies to lessen harm and
monitor the effectiveness of any preventative actions taken.

There is risk involved in the operation of any business or organization. What’s

important is to figure out how and why these risks arise — and how to avoid (or at least
minimize) them.

Here are the seven steps of a risk management process:

1. Determine the organization’s risk tolerance/appetite.

2. Identify potential exposures.
3. Quantify each exposure.
4. Compare current levels of risk to the target level of risk.
5. Develop and implement an appropriate risk management strategy to
manage the differences between the two.
6. Monitor the exposures and evaluate the effectiveness of the strategy.
7. Review and modify the strategy as needed.
Step 1: Determine the organization’s risk
tolerance/appetite.
The initial step in the risk management process is to determine the business’s
risk tolerance, which is based on its risk appetite.

 Risk appetite is defined as the level of risk a business is willing to take on in

order to achieve its objectives.
 Risk tolerance is how much a business is willing to deviate from the level set by
its risk appetite.

The degree of risk tolerance varies across organizations. For example, a new company
may be more aggressive when it comes to taking risks in order to gain a competitive
advantage, whereas an established company might be more risk-averse with an eye
toward maintaining its competitive advantage.

Once the organization’s risk tolerance has been established, it should be

communicated through an official risk appetite policy or statement, which typically
needs to be approved by the board of directors and should include a governance model
for risk oversight.

Step 2: Identify potential exposures (=Risk Identification

[Business Impact Analysis (BIA1)] by Risk Assessment By
Valter Cartella).

It’s important to identify risk exposures in all areas of the organization . Adherence to
three key factors — likelihood, potential impact and velocity — will help you accomplish
this.

As with risk tolerance, risk exposure differs from organization to organization according
to the type of risk. For example, for some, financial risks such as interest rate variations
and fluctuations in commodity prices will be considerable, and for others, it may be
operational risk that concerns them. In order to effectively manage risk, timely and
accurate information regarding the exposure is critical.

Once the risk exposures are identified, a risk profile can be created. The risk profile
provides a quantitative analysis of the types of threats the company faces. The goal is
to create an awareness of risk by assigning numerical values to variables that depict
categories of threats and their associated hazards. Each risk profile is unique as it’s
1
The first step of a risk assessment is to identify the factors that have the potential to
impact the business (BIA). This includes identifying the risks and threats that the
organization may face, such as natural disasters, cyber-attacks, and human errors. This
step is also known as risk identification, it's important as it helps to understand the
organization's risk profile and where to focus the risk management efforts. By identifying
the factors that have potential to impact the business, it allows the organization to
prioritize the risks that need to be addressed and to allocate resources accordingly.
based on the assets the company wants to protect, the goals it wants to achieve, and
its ability and willingness to handle risk. Plus, it can be used to evaluate the
effectiveness of the risk reduction measures utilized.

Step 3: Quantify each exposure (=Risk Analysis by Risk

Assessment By Valter Cartella).
At this point the risk exposures have been identified, and now they need to be
measured quantitatively and qualitatively. Once that information is available, senior
management will decide if the company can tolerate the risk. If not, it will need to be
reduced, transferred or eliminated.

The quantitative assessment is important because it measures the level of exposure

and determines the likelihood of loss. The process can also provide more intricate
details, such as the estimated timing and velocity of the risk, and the identity of the
factors that can cause the risk to materialize. It can also provide you with a benchmark
for assessing your risk mitigation strategies.

The qualitative assessment drills down even further into the strategy. When performing
the qualitative assessment, you should examine the company’s basic operating
procedures to help you figure out where mitigation strategies could be useful.
Fundamental business processes should be reviewed to determine how they contribute
to risk — and to help identify potential solutions. And finally, derivatives should be
addressed. Are they structured and sized appropriately? And are proper accounting
procedures and regulations being followed when they’re used as part of a financial risk
mitigation strategy?

Step 4: Compare current levels of risk to the target level

of risk (=Risk Evaluation by Risk Assessment By Valter Cartella).
Every organization, by virtue of being in operation, assumes a level of risk. The target
risk is the pre-determined level of acceptable exposure. This level may be above or
below the level of risk the company is currently assuming.

Inherent risk is the level of risk that exists before any controls are put in place to
mitigate the risk. When controls are in place, the level of risk left is known as
the residual risk:

Inherent risk – Controls = Residual Risk

When managing risk, your goal is to manage the gap between the residual risk and the
target risk.
Step 5: Develop and implement an appropriate risk
management strategy to manage the differences
between the two (=Risk Treatment Strategy By Valter Cartella).
Now you’re ready to develop your risk management strategy. For each exposure, there
are four essential risk management approaches: retain, avoid, mitigate or transfer.

1. Retain. There are always going to be some risk exposures over which you have
no control, e.g., weather, geopolitical events, global pandemic. In those cases,
you have to have contingency and recovery plans in place. For example, an
electrical utility company operating in a hurricane-prone area has to include
disaster recovery and contingency planning in its risk management strategy
because the risk of loss is non-transferable.
2. Avoid. A certain line of business, vendor or manufacturing process can hold
certain risks, in which case a business might simply choose not to utilize them,
thus avoiding the risk.
3. Mitigate. To mitigate a risk, you put certain controls in place to limit your risk
exposure. This could look like the use of derivatives or balance sheet hedges to
create a financial position that offsets the risk from an ongoing business process.
Other approaches include supplier diversification, process and facility design,
project management, education and compliance management.
4. Transfer. There is also the option of transferring the risk to another party, which
is most commonly done through insurance. It can also be done by contractually
requiring another party in your supply chain to bear the risk.

Using a mixture of these approaches in your overall risk management strategy is

common, as is using a combination when managing a single risk, or you could even
enter into a joint venture and share the risk.

Step 6: Monitor the exposures and evaluate the

effectiveness of the strategy.
Each material risk exposure needs to be monitored. The most efficient way to achieve
this is to assign ownership (the responsibility of monitoring it) to a department or
individual.

The frequency at which it is monitored depends on four factors: likelihood, materiality,

velocity and appetite for risk. Frequency can be increased or decreased, for example, if
the underlying asset’s volatility increases or decreases — the same applies if
management’s risk tolerance changes.
Step 7: Review and modify the strategy as needed.
Time changes everything — even the risks a business faces, or its tolerance for risk.
For a risk management strategy to be effective, it needs to be able to adapt to these
changes.

With the company’s overall risk tolerance level in mind, the risk strategy should be
reviewed periodically to determine if any changes are needed. For example, if the
company decides to transfer risk through the use of insurance, you will need to review
its insurance coverage to ensure the coverage matches the current level of risk.

By Valter Cartella