Risk identification and classification (Project risks (PNEFCPB)…
Risk identification and classification
Identifying risks associated with a project
to supplement brainstorming, which involves looking at similar projects underatken by the sponsor and others
Risk register or risk matrix
Setting out risks and their interdependencies
High-level preliminary analysis
Confirm that there are no big risks that mean it is not worth continuing
Use (consult) experts
who are familiar with the details of the project and the plans for financing it
with project experts and senior internal/ external people to:
identify likely/ unlikely, upside/ downside risks
discuss these risks and their interdependency
broadly evaluate the frequency and severity of each risk
generate and discuss initial mitigation options
opposition to project, war, terrorism, problems relating to approvals (e.g. planning permission if involves building construction)
interest rate or exchange rate movements
sponsor default, incorrect cashflow estimates
time delays, budget overruns, bad design, poor planning
competition/ lack of demand, operational problems, obsolescence
Wider risk identification techniques
risk classification, to ensure that all types of risk have been considered
risk checklists, as used for regulatory purposes (e.g. Solvency II standard formula components)
Utilising the experience of staff who have joined from similar organisations, and of consultants with broad experience of the industry concerned.
The organisation should gain input from everyone involved in the business, at all levels. Senior management may not be aware of a weakness in an operational process, which the more junior operators could readily identify.
The risk related to changes in investment market values or other features correlated with investment markets such as interest rates/ inflation.
The risk of failure of third parties to meet their obligations
The risk that an insurer, although solvent, does not have sufficient available resources to enable it to meet its obligations as they fall due (at least, without an adverse impact on the price of assets held). The risk for an insurer is usually low since investments usually include a large proportion of cash, bonds and stock market assets.
Risk specific to the business underaken
Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.
arises from external events.
Natural disasters such as storm, fire or flood
Regulatory, legislative and tax changes
Market risk subdivisions
The consequences of changes on asset values (due to changes in the market value of assets or changes in interest and inflation rates)
The consequences of a change in investment market values on liability values, where liabilities are directly related to investment market values, interest rates or inflation rates.
The consequences of not matching asset and liability cashflows.
constraints on perfect asset-liability matching
There may not be a wide enough range of assets available; in particular it may not be possible to find assets of sufficiently long duration.
Liabilities may be uncertain in amount and timing
Liabilities may include options and hence have uncertain cashlows after the option date
Liabilities may include discretionary benefits
The cost of maintaining a fully-matched portfolio is likely to be prohibitive.
The issuer of a corporate bond defaulting in the interest or capital payments
Any risk associated with credit-linked event, which could include changes to credit quality (e.g. downgrading of an investment) and variations in credit spreads
Counterparty risk - one party to a transaction failing to meet their side of the bargain (e.g. an individual who has sold a security fails to deliver it, although they have already received the purchase price)
General debtors- the purchase of goods and services failing to pay for them
The security of a debt and of the borrower
the nature of the debt (e.g. debebture, unsecured)
the covenant of the borrower (e.g. credit rating, income and asset cover, level of gearing, prior ranking debt, ability to raise more debt, future prospects of the borrower)
Market circumstances and the relative negotiating strength of the borrower and lender
What security is available and whether it can be realised if necessary (e.g. the existence of any charges against the borrower's assets - fixed or floating- and the assets to which a fixed charge is secured
A rating given to a company's debt by a credit-rating agency as an indication of the likelihood of default
Top rating is usually AAA (or similar, depending on the agency)
Credit ratings are much used
close to cash in nature, e.g. a term deposit, or
can be converted to cash quickly and the amount of cash it would become is almost certain, e.g. a government bond
A liquid market is likely to be a large market with lots of ready participants
Why banks are exposed to significant liquidity risk
Banks lend depositors' funds and funds raised from the money markets to other organisations for potentially long periods. Customers may want instant access to their deposits, creating a need for liquidity. There is a risk that more customers than expected demand cash.
Inadequate underwriting standards leading to the mis-pricing of risks (underwriting risk)
More claims than anticipated (insurance risks)
Investment in a business or project that fails to be successful (financing risk)
Greater exposure than planned to a particular risk event, e.g. due to higher volumes of business sold than expected or due to lack of diversification (exposure risk)
Inadequate or failed internal processes, people or systems
The dominance of a single individual over the running of a business (dominance risk)
Reliance on third parties to carry out various functions for which the organisation is responsible, e.g. outsourcing
The failure of recovery plans following an external event
Identifying an analysing operational risks
A model could be used but such models are only as good as the parameters input.
Identification and analysis of operational risks typically requires considerable input from the owners of a business, senior management and other individuals with a good working knowledge of the business.