Key Risk Indicators
The fourth and last step for risk management suggested by the Bank of International Settlements in its Basel Norms is the continuous monitoring of key risk indicators. Key risk indicators are important metrics that can track the business environment and internal control factors. They can help an organization keep track of a rapidly changing internal and external environment. Risk management is all about continuous scanning and monitoring of the environment and key risk indicators are the best way to do so. In this article, we will have a closer look at what key risk indicators are and how they impact the risk management process.
What are Key Risk Indicators?
In simple words, key risk indicators can be understood to be predictors of adverse events which are likely to impact organizations. Organizations are impacted when their environment changes. Hence, if the changes in the environment are continuously monitored then the changes in the risk exposure can be spotted early. This would help organizations to identify, report and manage risks better than other companies. The best way to think about the key risk indicators is to think about them as the dashboard of a car. The dashboard conveys important information which must be tracked numerically in order to ensure the smooth functioning of the organization from an operational risk point of view.
The main feature of the key risk indicator is that it should be expressed numerically. This also means that there should be a predefined level for these numbers and then when they vary from the predefined level, they should be immediately reported to the risk management team.
Designing the Key Risk Indicators
Key risk indicators can be considered to be the lens through which the company views its internal and external environment. This means that choosing the key risk indicators correctly is of utmost importance while designing the risk management system.
The designing of key risk indicators is quite complex since it requires an understanding of the various objectives of the organization as well as the environmental factors which can hinder the achievement of these organizational goals.
The first step in designing a key risk indicator is to understand the cause-effect relationship between the organization's goals and some root cause factors. The next step is to understand the relative significance that each of these root cause factors has on the overall achievement of the goals. The next step is to create a system that collects high-quality data about these indicators. The data collected must be genuine and there must not be too much time lag between the collection of the data and the passing of this data to the risk management decision-making process.
Also, it is important to ensure that only meaningful indicators are incorporated into the key performance indicator process. If too many metrics are simultaneously tracked, it dilutes focus and the company is not able to pay attention to what is really important. It is also important to determine the trigger levels of the key risk indicators in accordance with the risk appetite of the company that has been aligned during the creation of the risk policy.
Difference Between KRIs and KPIs
Key performance indicators or KPIs are also tools that are used by organizations to manage their day-to-day operations. For instance, revenue being generated, costs being incurred, etc are examples of key performance indicators. However, key performance indicators are not the same as key risk indicators.
Key risk indicators can be thought of as being the precursor to the key performance indicators. The objective of the company is to ensure that the performance indicators are never affected. This is the reason that a separate set of indicators called the key risk indicators are used. The effect of the risk should ideally be shown first in the risk indicators before it starts showing up in performance indicators. If that is not the case, then the system has been designed poorly.
Key Control Indicators
An effective operational risk management system also has key control indicators in place. These indicators help an organization determine the success of its key risk indicators. If the risk indicators are able to catch risks early and maintain control over the operational performance, then that will be reflected in the key control indicators. Key control indicators help a company decide whether its risk indicators are accurate or whether they need to be changed.
Challenges of Key Risk Indicators
The key risk indicator approach is not free from challenges. Some of the commonly faced challenges have been mentioned below:
It may be difficult to identify the key risk indicators for all risks which are faced by an organization. This is because there are certain unknown risks that the organization is not even aware of
It may be difficult to build an automatic system that collects the values and intimates the decision-makers at the correct time.
It is also possible that companies may focus too much on the symptoms of the key risk indicators instead of focusing on the actual root cause.
Lastly, many companies may not have action plans ready. There may be ambiguity about the actions that need to be taken once an action crosses a certain threshold.
The bottom line is that the key risk indicator approach is an integral part of the advanced measurement approach suggested in the Basel norms. This is the reason that this approach is followed widely in different parts of the world.
|❮❮ Previous||Next ❯❯|
Authorship/Referencing - About the Author(s)
The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Risk Management - Introduction
- Benefits of Risk Management
- Principles of Risk Management
- Risk Management Process
- Risk Identification and Assessment
- Aspects of Risk Management
- Steps in Risk Management Process
- Approaches to Risk Management
- Risk Management Policy
- Commonly Used Measures of Risk
- Risk Management Plan
- Evaluation of Risk Management Plan
- Risk Treatment
- Role of HRD in Risk Management
- Enterprise Risk Management
- Implementing ERM
- Risk Management and Stock Market
- Outsourcing Risk Management Program
- Risk Management as a Profession
- Anticipating and Mitigating Organizational Risks in the Digital Age
- Challenges Facing the Australian Economy
- The Economic Costs of MeToo
- Automated Claims Processing
- Challenges in Global Insurance And International Claims
- Conflicts of Interest in the Insurance Business
- The Cost Structure in the Insurance Industry
- How Drones Will Impact the Insurance Industry?
- How Is Health Insurance Funded?
- How Self Driving Cars Impact Insurance?
- How Stock Market Volatility Affects Insurance Companies?
- Insurance Agents vs. Insurance Brokers
- The ABCs of Insurance Fraud in India
- Technological Advances in the Insurance Industry
- The Basics of Unemployment Insurance
- The Pros and Cons of Unemployment Assistance and Why it Matters in the Present Times
- The Role of Insurance In #MeToo Movement
- Why the Flood Insurance Market should be Privatized?
- Basics of Pet Insurance
- Cannabis Insurance
- Challenges Facing Cryptocurrency Insurance
- Evolution of Insurance Regulation
- Food Delivery Apps and Insurance
- How Does Captive Insurance Work?
- On-Demand Insurance
- Reinsurance vs. Double Insurance
- Solvency Regulations in the Insurance Industry
- Terrorism and Insurance
- The Basics of Microinsurance
- The Basics of Reinsurance
- Types of Captive Insurance Companies
- What is P2P Insurance?
- How Risks Affect Companies Providing Financial Services
- Risk Management Information System
- Disadvantages of Risk Management Information Systems
- The Known-Unknown Classification of Risk
- Operational Risk: Definition and Drivers
- How Regulations Have Affected Operational Risk?
- Identification of Operational Risks
- How to Identify Operational Risks
- Using Internal Loss Data to Mitigate Operational Risks
- External Loss Data in Operational Risk Management
- Risk Control Self Assessment (RCSA)
- Scenario Analysis in Risk Management
- Key Risk Indicators
- Basel Approaches in Operational Risk Management
- The Basel Risk Categories
- Cause Categories in Operational Risk Management
- Loss Distribution Approach
- The COSO Framework for Internal Control
- Mistakes to be Avoided While Building a Risk Management System
- Credit Rating Terminology
- Types of Exposures to Determine Credit Limit
- Types of Credit Events
- Active Credit Portfolio Risk Management
- Metrics to Measure Credit Risk
- Credit Derivatives: An Introduction
- Credit Linked Note
- How do Credit Default Swaps Work?
- Why are Credit Default Swaps Dangerous?
- Total Returns Swap
- What are Collateralized Debt Obligations and How do they Work?
- Collateralized Debt Obligations: Advantages and Disadvantages
- Mark To Market Accounting
- What are Recovery Rates? - Different Types of Recovery Rates
- Netting, Close Out, and Acceleration
- Expected Default Frequency (EDF)
- Expected Default Frequency: Advantages and Disadvantages
- Altmans Z Score Model
- Unexpected Loss and Economic Capital Buffer
- Stress Testing in Credit Risk Management
- Provisioning in Credit Risk Management
- How Corporate Governance Impacts Credit Risk
- Exit Strategies In Credit Risk Management
- What is Market Risk? - How its Measured and Sources of Market Risk
- Why is Market Risk Management Important?
- Introduction to Value At Risk (VaR)
- The Three Types of Value at Risk (VaR)
- Marginal, Incremental and Component Value at Risk (VAR)
- How Value at Risk (VaR) is Implemented?
- Backtesting Value at Risk (VaR)
- Advantages of Using Value at Risk (VaR) Model
- Disadvantages of Using the Value at Risk (VaR) Model
- How Margins Are Calculated Using Value at Risk (VaR)
- Market Risk Limits
- Tail Risk
- The Upside of Market Volatility
- Relationship between Volatility and Risk
- Importance of Data Quality in Risk Management
- Impact of Using Poor Quality Data and Metrics to Measure Data Quality
- Enterprise Risk Management (ERM) vs Traditional Risk Management
- Benefits of Enterprise Risk Management
- Corporate Risk Governance
- International Risk Governance Committee (IRGC) Framework
- Failure of Market Risk Management
- Mistakes to Avoid in Risk Management