Table of contents
Definition of Risk
Risk entails the uncertainty of future deviations from expected earnings or outcomes. It gauges the uncertainty that investors are willing to embrace in pursuit of investment returns. It encompasses the probability or threat of damage, injury, liability, loss, or any other adverse event caused by external or internal vulnerabilities, which can be avoided through preemptive action.
In the realm of finance, risk refers to the probability of an actual investment return being lower than the expected return. Financial risk is categorized into several types, including basic risk, capital risk, country risk, default risk, delivery risk, economic risk, exchange rate risk, interest rate risk, liquidity risk, operations risk, payment system risk, political risk, refinancing risk, reinvestment risk, settlement risk, sovereign risk, and underwriting risk.
In the context of the food industry, certain hazards may lead to negative impacts. In the insurance domain, risk is associated with situations where the probability of an event, such as a building fire, is known. In securities trading, risk is defined as the probability of loss or decline in value. Trading risks fall into two broad categories: systemic risk, which affects all securities within the same category and is related to the overall capital market system, and non-systematic risk, which pertains to risks not related to the market or systemic factors.
Definition of Risk Management
Risk management involves the process of identifying potential threats that may arise during the investment process and taking every possible measure to mitigate or eliminate these dangers. In business, there are numerous types of risks, with even more risks prevailing in the investment field. Some examples include competition, economic factors, and market volatility. In terms of the risk associated with the investment itself, entities must consider their capital positioning. For instance, if a company possesses RM10,000 in assets, a risk management analysis may advise against investing RM5,000 in highly volatile stocks.
Companies typically assess risks in their day-to-day operations and regularly before making investment decisions. Risk analysis guides companies in choosing the types of securities to buy or the firms they are willing to invest in. When companies consider future product lines or factory expansions, they evaluate the total risk of the investment before proceeding.
Stages of Risk Management Process
Identifying Potential Losses
The initial step in the risk management process is typically informal and can be performed in various ways, depending on the organization and project team. Identification of risks often relies on past experiences, which should be used to inform upcoming projects. To discover potential risks, an allocation must be made, which can be determined and arranged by the organization. The aim is to establish possible risks in a project, and no single method is superior, as the purpose is to identify potential risks effectively. While risks and other threats may be difficult to eliminate, their identification enables taking proactive actions and maintaining control. Early identification and allocation of risk causes make risk management more effective. It involves not only solving problems in advance but also being prepared for potential issues that may arise unexpectedly. Handling potential threats is not merely a way to minimize losses within the project, but also an opportunity to transform risks into advantages that can lead to economic profitability, environmental benefits, and more.
Measuring Potential Losses
The second stage of the risk management process is risk analysis, wherein data collected about potential risks are thoroughly examined. Risk analysis involves shortlisting risks with the highest impact on the project out of all the threats identified during the initial phase. There are two categories of methods used for risk analysis: qualitative and quantitative. Qualitative methods are more applicable when risks can be assessed on a descriptive scale from high to low. Quantitative methods, on the other hand, are used to determine the probability and impact of identified risks and are based on numerical estimations. While qualitative approaches are more convenient in describing risks, quantitative methods offer more precision in measurement. Within the qualitative and quantitative categories, multiple methods utilizing different assumptions can be found, and selecting an appropriate risk assessment model for a specific project can pose challenges. The choice of methods depends on the type of risk, project scope, and specific requirements and criteria of each method. Regardless of the chosen method, the desired outcome of the assessment should be reliable. The selection of the right technique often depends on past experience, expertise, and the availability of computer software.
Selecting the Risk Management Technique
The third step of the risk management process involves determining the actions to be taken regarding the identified risks and threats. The response strategy and approach are chosen based on the type of risks involved. It is essential to have a supervisor overseeing the risk's development. Lower impact risks are more manageable. The most common strategies for risk response include avoidance, reduction, transfer, and retention. In addition to these responses, waiting for the appropriate information to make a decision is sometimes necessary to avoid acting on insufficient data. This approach, known as "delaying the decision," may not be suitable for all situations, especially when dealing with critical risks.
When a risk is classified as likely to result in significant negative consequences for the entire project, it is crucial to reassess the project's goals. In such cases, the best course of action is to avoid the risk altogether by altering the project's scope or, in the worst scenario, canceling it. By exploring alternatives within the project, many risks can be eliminated. If major changes are required to avoid risks, established and well-developed strategies should be preferred over new ones, even if the latter may appear more cost-efficient. This way, risks can be averted, and the project can proceed smoothly with reduced stress on its stakeholders.
To minimize the level of risk, the areas exposed to potential problems should be addressed. Reducing risk involves mitigating the likelihood of its occurrence. One way to achieve risk reduction in a project is by investing in measures that yield long-term benefits. Some projects opt for guarantees or hire experts to manage high-risk activities. These experts may uncover solutions that the project team hadn't considered. Risks that should be reduced can also be shared with parties possessing more suitable resources and knowledge about the consequences. Collaboration with other parties can provide additional resources and experiences, allowing one project team to benefit from the expertise of another.
If a risk can be managed more effectively by another party with greater capabilities or resources, the best approach is to transfer it. Transferring risk entails shifting it to those who are better equipped to manage it. This could lead to higher costs and additional work, often referred to as a risk premium. It is essential to recognize that transferring risk doesn't eliminate it; instead, it is moved to the party best suited to handle it.
When a risk cannot be transferred or avoided, the best course of action is to retain it. In such cases, the risk must be controlled to minimize the impact of its occurrence. Retention may also be the chosen option when other solutions prove uneconomical.
Implementing and Monitoring the Risk Management Program
The final step of the risk management process is vital as it involves collecting and monitoring all information about identified risks. Continuous supervision of the risk management process helps in discovering new risks, tracking identified risks, and removing past risks from the risk assessment and project. The process also requires supervising the status of risks and taking corrective actions as necessary. Several tools and techniques can be employed for risk monitoring and control, including risk reassessment, which identifies new potential risks and involves a repeated process throughout the project. Monitoring the overall project status to identify any changes that could lead to new risks is also essential. Status meetings with the risk's owners are valuable for sharing experiences and managing risks collaboratively. Regular updates to the risk register ensure up-to-date information on the project's risk landscape.
Summarization of Articles
This article, reported by Tan Sri Lee Lam Thye on January 14, 2018, addresses accidents in construction sites and concerns related to safety. It highlights the latest fatal incident involving a Bangladeshi worker who died on the spot due to an incomplete cement flooring collapse at the Tenaga Nasional Bhd substation near the Cochrane Mass Rapid Transit station in Kuala Lumpur. The article criticizes contractors for inadequate safety practices, including the failure to adopt HIRARC (hazard identification, risk assessment, and risk control). The news also provides statistics indicating accidents in the construction industry over several years. Another article by Eric Michot on September 15, 2016, discusses the significant risk construction projects pose to insurers, particularly concerning fire losses.
Identifying Potential Losses
- Property Loss Exposures: Fire accidents during construction can lead to extensive losses in buildings, furniture, and electrical appliances. In severe cases, the entire building may be affected, resulting in significant financial damages.
- Business Income Loss Exposures: The expenses required to cover losses can reduce profits for the contractor, affecting their financial viability.
- Human Resources Loss Exposures: While death of key employees in a fire accident is less likely, risks of injury and loss of manpower capacity exist, potentially impacting project timelines.
Measuring Potential Losses
- Loss Frequency: Statistics indicate an increasing number of accidents and deaths in the construction industry over the years, highlighting the high frequency of potential accidents.
- Loss Severity: Fire accidents during construction have a high severity due to the potential for extensive property damage and, in the worst cases, loss of life.
Selecting the Risk Management Technique
- Avoidance: Implementing stringent on-site safety measures, such as monitoring systems, contracted security, and rapid refuse removal, can help avoid arson-related fires. Additionally, ensuring the availability and use of fire extinguishers and sprinkler systems from the project's outset is essential.
- Reduction: Developing and rehearsing detailed emergency response plans can reduce risks in case of a fire. Strict thermal permit systems and designated smoking areas can minimize unintentional fire risks.
- Insurance: Purchasing insurance coverage can provide financial protection in the event of fire-related losses.
The construction industry's risk management practices in developing countries need improvement, with a greater focus on proactive approaches. Categorizing risks and utilizing various risk assessment methods can enhance decision-making. Steps such as avoidance, reduction, transfer, and retention can be employed to manage risks effectively. Continuous monitoring and assessment are essential to adapt to new risks and bridge the gap between theoretical risk management and practical implementation in developing countries.
- Linnenluecke, M. K., & Griffiths, A. (2010). "Corporate sustainability and organizational culture." Journal of World Business, 45(4), 357-366.
- Hillson, D. (2011). "Managing risk in projects." Gower Publishing Limited.
- Aven, T. (2016). "Foundations of risk analysis." John Wiley & Sons.
- Pinto, J. K., & Slevin, D. P. (1989). "Critical success factors across the project life cycle." Project Management Journal, 20(1), 67-75.
- Kerzner, H. (2017). "Project management: a systems approach to planning, scheduling, and controlling." John Wiley & Sons.
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