ACADEMIA Letters

Financial Risk Management

SERGE CLAUDE EBOA EDOUBE

Over a couple of years, major securities firms, money centres banks and other commercial
and savings banks nationwide have undertaken financial involvement engaging risks they did
not fully understand and master, later generating in major losses and unexpected write offs.
As a result, senior managers in these firms are looking for new ways to identify, evaluate and
predict changes in financial risks to reduce the likelihood of similar outcomes.
Thus, Financial risk management appears as a crucial tool to mitigating these major losses
and unexpected write offs. There is a tremendous value in qualitative, as well as a quantita-
tive approach to risk management. Risk management cannot be reduced to a simple checklist
or mechanistic process ( Karen A. Horcher, 2005). In risk management, the ability to ques-
tion and contemplate different outcomes is a distinct advantage that merit to be scrutinized.
Understanding Financial risk management as a whole implies to discuss what is all about,
identifying major financial risks appearances , measuring financial risks as well as examining
their related challenges are relevant points of the issue.
Furthermore, we will extend our reflection on the various relationships that financial risk
management could have with the financial industry ; financial markets; financial crisis. In
the view of mitigating financial risks, an insightful examination is required in the angle of
risk management framework: policy and hedging. A better contribution to strengthen the
efforts to mitigating financial risks in its various components is indispensable. In this extent,
related financial risks perspectives and recommendations will be discussed in this work before
providing an overall conclusion of our essay.

Academia Letters, August 2021 ©2021 by the author — Open Access — Distributed under CC BY 4.0

Corresponding Author: SERGE CLAUDE EBOA EDOUBE, eboaedoube@gmail.com

Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

1
1. FINANCIAL RISK MANAGEMENT: WHAT IS IT ALL ABOUT?
The risk management process involves both internal and external analysis. The first part of
the process involves identifying and prioritizing the financial risks facing an organization and
understanding their relevance. Examining the process of financial risk management entails
defining risk, financial risk, having insights of its various components and how movable is the
financial risk management process all about.

Defining Risk
Risk is the possibility of losing something of value. Values (such as physical health, social
status, emotional well-being, or financial wealth) can be gained or lost when taking risk re-
sulting from a given action or inaction, foreseen or unforeseen (planned or not planned). Risk
can also be defined as the intentional interaction with uncertainty. Uncertainty is a potential,
unpredictable, and uncomfortable outcome, risk is a consequence of action taken in spite of
uncertainty (Wikipedia, 2018).

Defining Financial Risk

Financial risk is any of various types of risk associated with financing, including financial
transactions that include company loans in risk of default often it is understood to include
only downside risk, meaning the potential for financial loss and uncertainty about its extent
(Wikipedia, 2018).
Financial risk management is a process to deal with the uncertainties resulting from finan-
cial markets. It involves assessing the financial risks facing an organization and developing
management strategies consistent with internal priorities and policies. Tackling financial risks
proactively may provide an organization with a competitive advantage. It also ensures that
management, operational staff, stakeholders, and the board of directors are in agreement on
key issues of risk. Managing financial risk necessitates making organizational decisions about
risks that are acceptable versus those that are not. The passive strategy of taking, no action is
the acceptance of all risks by default. Companies manage financial risk using a wide range of
strategies and products. It is important to understand how these products and strategies work
to reduce risk within the context of the organization’s risk tolerance and objectives (Karen A.
Horcher, 2005).

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Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

2
Various components of Financial Risks
Financial risk arises through countless transactions of a financial nature, including sales and
purchases, investments and loans, and various other business activities. It can also happen as
a result of legal transactions, new projects, mergers and acquisitions, debt financing, the en-
ergy component of costs, or through the activities of management, stakeholders, competitors,
foreign governments, or weather.
Financial risks are part of several components that merit to broken downs as follows.
A brief taxonomy of risks discloses the followings:

• Market risk

• Liquidity risk

• Operational risk

• Business risk

Financial risk Management Process

The process of financial risk management comprises strategies that enable an organization to
manage the risks associated with financial markets. Risk management is a dynamic process
that should evolve with an entity and its business activity. Its commits and impacts several
parts of an organization including treasury, sales, marketing, legal, tax, commodity, and cor-
porate finance.
In addition, the risk management process involves both internal and external analysis.
The first part of the process involves identifying and prioritizing the financial risks facing
an organization and understanding their relevance. It may be indispensible to examine the
organization and its products, management style, customers scheme, suppliers varieties, com-
petitors impact, pricing levels, industry tendencies, balance sheet structure, and position in
the industry. It is also critical to take into account stakeholders and their given objectives and
tolerance for risk (Karen A. Horcher, 2005). There are three wide alternatives for managing
risk known as:

• Do nothing and actively, or passively by default, accept all risks.

• Hedge a portion of exposures by determining which exposures can and should be hedged.

• Hedge all exposures possible.

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Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

3
Measuring and reporting of risks provides decision makers with information to execute deci-
sions and monitor outcomes, both before and after strategies are taken to mitigate them. Since
the risk management process is ongoing, reporting and feedback can be used to refine the sys-
tem by modifying or improving strategies. An active decision-making process is an important
component of risk management. Decisions about potential loss and risk reduction provide a
forum for discussion of important issues and the varying perspectives of stakeholders (idem).
Developing a risk management process is to take into accounts the following points.
• Make o board commitment to risk management and appoint one member responsible
for the process.

• Identify key people to be involved in the process (stakeholders, coaches, instructors,

treasurer staff, event coordinator, etc…).

• Establish a committee to undertake the risk management process and report to the board
regularly.

• Communicate your risk management strategies to everyone in your organization.

• Monitor and review your risk management plan on regular basis and at the board level.
Generally, risks management tends to focus on what can go wrong, but it is important
to remember that any event, circumstances or situation that takes place can also provide an
opportunity for improvement (the Australian Risk Management Standards, 2015).

2. FACTORS INFLUENCING FINANCIAL RISKS

There are several factors influencing major Financial Risks.

Factors related to market risks

Major market risks arise out of changes to financial market prices. Market risks are usually
the most obvious type of financial risk that an organization confronts. These major market
risks include foreign exchange risk, interest rate risk, commodity price risk and equity price
risk. Thus, market risk is the possibility of an investor experiencing losses due to factors that
affect the overall performance of the financial markets in which he or she is involved. Market
risk, also called “systemic risk” cannot be eliminated through diversification, though it can be
hedged against.
Market risk exists because of price changes. The standard deviation of changes in the
prices of stocks, currencies or commodities is referred to as price volatility.

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Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

4
Factors influencing liquidity risk
Liquidity risk refers to an inability to supply liquidity requirements by a banking corporation
from its profits and capital structure. Banks are exposed to liquidity risk because they trans-
form liquid deposits (liabilities) to illiquid loans (assets). These are the key operations of the
banks and the liquidity risk management’s role is to ensure their continuity in the liquidity
availability extent.
Furthermore, the liquidity position is related to stakeholders’ confidence. That is a bank
having no confidence can face liquidity shortfalls for instance withdrawal of the deposits.
There is no financial institution that is not prone to liquidity risk and it has been noticed of
recent that it is one of the greatest contributory factors to bank failure nowadays (Anye Paul
TSI, 2018).

Factors Influencing operational risk

The systematic approach to operational risk management requires a comprehensive control
structure that is designed to address the full spectrum of risks faced by firms. The increasing
level of interest in operational risk management has been stimulated by a variety of factors:

• The increasing complexity of financial products and trading mechanisms, particularly

with the development of derivative products;

• The introduction of further requirements by banking and securities regulators and su-
pervisors with the particular focus on the mechanisms for the “regulatory capital” cal-
culations;

• The acceptance of senior executives that the system supporting operational risk man-
agement have been and in many cases still are , inadequate , and that good quality risk
management requires significant improvements in processes and technologies that are
now available for effective operational risk management;

The increase in knowledge and expertise in the practical application of statistical tech-
niques to the operational risk management challenge.
Thus, operational risk stands as the risk of loss resulting from inadequate or failed in-
ternal processes, people, and technology or from external events. Operational risk implies
process risks, people risks, technology risks and external risks that need to be clarified (Pey-
man Mestchian, 2001).

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Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

5
Factors influencing Credit Risk
As for the prudential regulation of capital, it might also help to explain why banks take risks.
The ratio of capital and its regulation aim to reduce the level of bank risk-taking. When risk
is highly taken, we expect to find a negative relationship between these two variables.

• There is an inverse relationship between capital regulation and bank credit risk.

• The Bank size affects the levels of risk negatively.ng of the bank.

• Macroeconomic factors affect bank credit risk.

Factors influencing related Business risks

Business risks can arise due to the influence by two major risks: internal risks arising from the
events taking place within the organization and external risks arising from the events taking
place outside the organization.
Business risks are composed of 5 main types stated as follows: strategic risk, Financial
Risk, operational risk, Compliance risk, Other risks imply different risk like natural disaster
such as floods and other depend upon the nature and scale of the industry (Wikipedia, 2018).

3. FINANCIAL RISK MANAGEMENT CHALLENGES AND FI-

NANCIAL RISK MEASUREMENT
Financial risk management as described so far is facing serious challenges that need to be
overcome in order to ease its fight and enhance better financial risk mitigation. As far as
literature we went through, the following challenges have been found out and hereby raised
out. These challenges could be classified in internal and external extents to the corporate.
These challenges could be classified in internal and external extents to the corporate.

INTERNAL CHALLENGES OF FINANCIAL RISK MANAGEMENT

Internal challenges point out in line with the firm’s specificities is the system itself, human
errors, risk identification, challenges related to the process, metrics.

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Corresponding Author: SERGE CLAUDE EBOA EDOUBE, eboaedoube@gmail.com

Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

6
EXTERNAL CHALLENGES OF FINANCIAL RISK MANAGEMENT
It is all about the necessity to maintain a favourable macro- environment, the business model
transformation, response to macro- environmental changes, basel III reforms.
The challenge for financial risk management at the external extent for any given financial
institution is to put in place this recommended framework and applied its related recommenda-
tions. As a concrete response to the Basel III reforms, it is imperative for financial institutions
to create and implement a plan which closely follows the position of each individual jurisdic-
tion when fulfilling the capital requirements and the RWA calculations set out in the Basel III
over the next four years as implementation period is scheduled for 2022.

FINANCIAL RISK MEASUREMENT OR ASSESSMENT

The challenge for financial risk management at the external extent for any given financial in-
stitution is to put in place this recommended framework and applied its related recommenda-
tions. As a concrete response to the Basel III reforms, it is imperative for financial institutions
to create and implement a plan which closely follows the position of each individual jurisdic-
tion when fulfilling the capital requirements and the RWA calculations set out in the Basel III
over the next four years as implementation period is scheduled for 2022.

4. FINANCIAL RISK MANAGEMENT AND FINANCIAL CRI-

SIS
Financial crisis prevention and response is a critical issue as far as financial risk assessment
is concerned. It requires tougher ways and initiatives to be undertaken in the aim of ensuring
and promoting global financial stability and preventing financial systems distortions. To ex-
amine the links between financial risk management is relevant to raise and clarify the issues
related not only to its prevention but also laying emphasis on critical responses after a related
meltdown.
Undertaking Financial Risk Management and Financial crisis point out the followings:

• Financial crisis prevention

In the angle of preventing financial crisis from the global perspective, some relevant points
are to be taken into account and put in place within each country’s financial system. These
measures are clarified as follows from the light and contribution of financial risk assessment.

• Addressing systemic risk and procyclical risk-taking

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Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

7
 • transparency and disclosure

• considering credit rating role

• balancing comprehensiveness and diversity

5. FINANCIAL RISK MANAGEMENT PERSPECTIVES AND

RECOMMENDATIONS
Promoting effective organization that enables companies to manage control and compliance,
while still allowing risk professionals the time o devote to analysis, development and providing
counsel to the board( Price Waterhouse Coopers, 2005).

• Leveraging risk intelligence

• Reassessing risk

• Building an appropriate framework for policy and hedging

• Seeking for the new paradigm

• The central theme of disruptive technology in the form of artificial intelligence, robotics
and a general increase in automation are pathways to be explored in order to have a
mastery of data analysis in financial markets as well as data analysis and trends forecasts.

• The growth of digital technology also stands as a significant tool that shortens decision
making process and allow to have a rapid global view of risk management landscape.

• A multi-stakeholder response is required to tackle global risks since it cannot be tackled

in isolation.

• Strengthening Risk Management environment

• Enhancing Risk Measurement, Risk Mitigation, Risk Monitoring, Adequate Internal

Control

• Managing financial risk through diversity, Use of savings account, Investing sooner
than later, Learn about investments, Be savvy, not greedy, Monitoring and review.

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Corresponding Author: SERGE CLAUDE EBOA EDOUBE, eboaedoube@gmail.com

Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

8
Conclusion
Financial Risk Management brings its contribution in mitigating risk in money issues, fi-
nancial instruments, financial markets, central banking, government regulatory bodies and
financial institutions as well without forgetting to advocating a critical behaviour assigned to
effective Financial Risk Management for financial markets prospective investors. One may as-
sert that Financial Risk Management stands as the most prominent tool of enhancing financial
stability within a country’s overall financial system.

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Corresponding Author: SERGE CLAUDE EBOA EDOUBE, eboaedoube@gmail.com

Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

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Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

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Corresponding Author: SERGE CLAUDE EBOA EDOUBE, eboaedoube@gmail.com

Citation: Eboa Edoube, S.C. (2021). Financial Risk Management. Academia Letters, Article 2626.

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