Risk management requires greater imagination
Risk management is a frequent topic of discussion in the boardroom. That’s no surprise, considering the uncertain conditions in which many companies are currently forced to operate. All companies should see risk management as a continuing process and make it a permanent part of their strategy.
In response to their interest, an increasing range of risk quantification, management and monitoring tools have been cropping up recently. Data, dashboards and forecasts offer CEOs more control over their risks. Personally, I am a firm believer in the use of data as a base for strategic planning. Does it truly improve control, though, or is that just an illusion? Wouldn’t a greater show of imagination in the boardroom actually be more useful?
The financial sector has been aware of this fact for some time. An over-reliance on mathematical models meant we failed to anticipate the 2008 banking crisis. Risk modeling based on correlations between statistical series from the past has proven a poor predictor of the future. Despite this, we allowed the results of risk modeling to guide our choices. I like to recall a Tegenlicht episode from 2012 (ten years ago now!) where Herman Wijffels expressed his skepticism regarding such modeling. “Don’t forget to look out the window,” he said. I often use this quote in my own lectures, to warn students in awe of data’s predictive powers that there are also limitations.
Structured, iterative process
Luckily, risk management by organizations these days tends to be more holistic in nature. Instead of focusing mainly on model results, it involves careful progress through the various steps of a structured, iterative process. This process consists of (1) risk identification, (2) estimation of the likelihood of occurrence and (3) assessment of their impact on the organization. In the past month, I have received multiple requests for risk identification and assessment from companies in the real estate sector. Actually, you don’t need to be any kind of expert to name these risks: soaring costs of building materials, lower construction capacity due to labor shortages, political uncertainty and higher interest rates. In the face of such uncertainty, it’s not easy to know where you’re headed as a real estate company. And that’s before we’ve even included climate risk and all its associated aspects. Similar risks top the list in other sectors as well. Scientific research has now shown that a structural approach to risk identification and assessment increases organizations’ risk awareness.
Extreme future scenarios
To complete the full risk management process, the final steps are (4) control design and implementation, (5) monitoring and (6) improvement. Supporting all these steps with tools and software ensures more transparency and structure and improves substantiation. Will this make risks adequately controllable, though? At the least, it provides us with better control over the risks we already know and for which we can predict the effects. These are our so-called ‘known unknowns.’ We needn’t look very far to know that the risks with the greatest impact are precisely those we don’t know, and which are correspondingly difficult to extrapolate; the ‘unknown unknowns.’
Our world is so complex, with nearly everything interrelated, we are barely capable of imagining a future that is any different. Or, in fact, of picturing the consequences of global events for local organizations’ operations. I want to encourage every boardroom to embrace the inclusion of extreme future scenarios as a standard component of their risk management process. It will, however, require generous amounts of creativity and imagination, in addition to an ability to work with data, dashboards and mathematical models. Fantasy as a core competence? Here’s hoping.
This article originally appeared as a column by Dr. ir. ing. Ingrid Janssen, Associate Professor Real Estate Management at TIAS School for Business and Society, in CFO Magazine België, January 2022.
Become the business partner for sound financial decision-making
As a finance professional, you are an indispensable partner for your board, MT and senior management team. How do you ensure that they can continue to count on reliable financial risk analyses and forecasts in a rapidly changing business environment?
Our excellently rated Accounting, Finance & Control programs will help you achieve your ambitions. You will learn to fulfil your role as a business partner at an outstanding level.
At TIAS, we offer you inspiring theoretical frameworks, enabling you to analyze and tackle issues from multiple perspectives. Interaction with other experienced leaders, managers and professionals in addition to our top lecturers is a valuable enrichment of your learning process.
We regularly draw direct links with your working practices and give you the tools you need in order to add value to society through your business, in collaboration with your environment. Increase your knowledge, improve your skills and grow your network to achieve personal development and create more impact.
Finance programs at TIAS >