CHAPTER 6

ENTERPRISE RISK MANAGEMENT

Teresa Freitas Belo, B.Bus, MM, PhD

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• Risk is everywhere.
• The law of conservation of energy says energy
cannot be created and cannot be
destroyed. Energy moves from one place /
living thing to another place / living thing.
• Risks like energy. Risk cannot be eliminated or
created. Risk can only be transferred from one
party to another.

Manajemen Risiko Mamduh

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M Hanafi
 ENTERPRISE RISK MANAGEMENT

• Living things naturally anticipate and 'manage' risks

• How about the organization?
• Organizations do not have the ability to manage risk as
humans or living things manage risk, because organizations
are not living things.
• The task of the manager of an organization is to make the
organization able to anticipate and manage risks as well as
living creatures manage the risks they face. In other words, the
manager's job is to make the organization aware of risk, so
that risk can be anticipated and managed properly.

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 EXAMPLES OF SOME CONSEQUENCY FAILURE IN
RISK MANAGEMENT

Year Descriptions
1997 Trader Bank Baring (Nick Leeson) buys Japanese stock derivative
instruments (Nikkei futures). Baring Bank is a bank from the UK. Japan's
economy dropped dramatically because of the Kobe earthquake. As a
result he suffered a great loss. Subsequent transactions (selling options)
do not reduce losses, but exacerbate losses. In the end, Baring Bank
suffered a loss of $ 1.3 billion. Baring Bank was forced to go bankrupt
because the losses had exceeded the capital.
1997 Long Term Capital (LTC), investment company in the United States, has
a position on the Russian Ruble which is quite large. They predict that
Russia will not go bankrupt. But Russia turned out to be bankrupt,
declaring it could not and would not pay off its debts. As a result, Long
Term Capital suffered huge losses, around $ 3.5 billion, and in the end
LTC was forced to go bankrupt.

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 EXAMPLES OF SOME CONSEQUENCY
FAILURE IN RISK MANAGEMENT
1980s The Saving Loan (S&L) Association (a bank that provides home loan
loans in the United States) has a balance sheet structure: providing home
loans with long-term fixed interest (for example 20 years), while
obtaining funds through short-term deposits (eg 1 year). Such structures
are vulnerable to the risk of changes in interest rates. When the interest
rate in the United States rose significantly in the 1980s, many S&L
experienced problems and dozens of S&L went bankrupt because of it.
1995 Bank Duta (Indonesia) suffered huge losses because they traded foreign
exchange and suffered large losses from the forex trade.

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• Can you give another
example?
• Well there must more
similar examples !!!!

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 The question is, can those
organizations above avoid big losses
because of these risks?
 Enterprises risk management aims to
create a system or mechanism
within the organization so these risks
that can harm the organization can
be anticipated and managed for the
purpose of increasing the value of
the company. 7
 OLD AND NEW PARADIGM ON RISK
Risk-
Return Adjusted
Return
Zone 1
Zone 2
Insufficient Optimal Risk
Risk Taking Taking

Zone 3
Higher Risk leads Excessive
Risk Taking
to higher return

Risk
Risk

OLD PARADIGM: NEW PARADIGM

HIGHER RISK, HIGHER RETURN RISK MUST BE MANAGED !!

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•Risk management can be illustrated through travel by using
a vehicle (car). Cars that run too slowly will be detrimental,
because for example too long, can be dangerous to other
vehicles.
•If the car is running too fast (for example, speeding), then
the risk of crash or losing control becomes even greater. Of
course this is unfavorable.
•The most optimal is the car runs at optimal speed, which is
fast enough but can be controlled.
•Risk management can be illustrated as a combination of
gas pressure (accelerating vehicles) and brake pressure
(slowing vehicles). The ideal combination can make the car
run fast but stay in control.

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 DEFINITION AND UNDERSTANDING
OF RISK MANAGEMENT
• Enterprise risk management is a system of
risk management faced by organizations
comprehensively for the purpose of
increasing the value of the company.
• THERE ARE MANY UNDERSTANDINGS
AND OTHER DEFINITIONS

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Chart 3. Some Definition Enterprise Risk Management

ENTERPRISE RISK MANAGEMENT (ERM)

ORGANIZATION RISK MANAGEMENT (ORM) RISK
INTEGRATED RISK MANAGEMENT
TOTAL RISK MANAGEMENT

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Chart 4. Organizational Risk
Management Framework
Risk Management Process
ORGANIXATION:
1. PLANNING:
SOFTWARE SYSTEM:
Setting the goal mission,
Setting the target, formulating policies,
Culture Risk procedure.
Management Support 2. IMPLEMENTATION:
Risk Identification and Measurement
Risk Management: insurance, diversification
HARDWARE SYSTEM : Hedging, avoidance, etc.
Information of Technology Enterprise Risk Management: structure
Other physical organization, staffing, incentives, etc.
3. CONTROLLING:
Evaluation, reporting, communication
Feed back
-

MAXIMIZE COMPANY VALUES

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ORGANIZATIONAL RISK MANAGEMENT
FRAMEWORK

• INFRASTRUCTURE: SOFTWARE AND

HARDWARE
• RISK MANAGEMENT PROCESS
• PURPOSE: MAXIMIZING CORPORATE VALUE /
ORGANIZATION

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 SOFTWARE SYSTEM

• DEVELOPING RISK CULTURE IN ORDER TO

CONSCIOUS ORGANIZATION WILL BE RISK, AND
WITH THIS ORGANIZATION BECOME A REALISM TO
RISK
• CREATE A COMPENSATION SYSTEM THAT SUPPORTS
RISK CULTURE
• SUPPORT FROM PEAK MANAGEMENT
• OTHERS ??

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 HARDWARE SYSTEM

• COMPUTER
• OFFICE ROOM
• COMPUTER ANALYSIS, SIMULATION, AND
OTHERS
• MORE ????

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 Chart 5 Explicitly Rising Aspects of Risk

Explicitly
K
E RIS Strategic
Management Rising
UR P

Of Risk
LT LO
CU VE
DE

Risk
Operation Management
Management

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For Example a manager will launch a new product. He must
think of the three aspects mentioned above, with questions
like the following.
Strategic Aspects: Will this product meet the needs of
consumers? Is this product can help achieve company
goals (achieve certain profit targets)?
Operating Aspects: How to produce this product? Does the
company have the ability to produce this product? How to
market and develop a distribution network for this product?
Risk Aspects: What risks can arise related to the launch of
this product? How can companies control these risks?

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For Example a manager will launch a promotional / advertising
program. He must think of the three aspects mentioned above,
through the following questions.
Strategic Aspect: What is an effective promotion strategy? How
does this promotion contribute to organizational goals?
Operating Aspects: How do you run this promotional program?
What is the most effective media? What are the timings for this
promotion? What about other detailed aspects of this
promotion? How to control the risks that might arise from the
launch of this promotional program?
Risk Aspect: What potential risks arise from this promotional
program? Can this promotion result in a lawsuit? Is this
promotion ethical? Which parties might object to this
promotion?

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 MANAGEMENT FUNCTION (RISK)

• RISK MANAGEMENT PLANNING

• IMPLEMENTATION OF RISK MANAGEMENT
PROGRAMS
• RISK MANAGEMENT CONTROL PROGRAM

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 RISK MANAGEMENT PLANNING

• Determination of vision, mission, and goals,

risk management
• Determination of targets, policies and
procedures related to risk management
• Compilation of more specific policies and
procedures

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 IMPLEMENTATION OF RISK
MANAGEMENT

• RISK MANAGEMENT PROCESS:

IDENTIFICATION, EVALUATION AND
MEASUREMENT, RISK MANAGEMENT
• RISK MANAGEMENT ORGANIZATIONS
• RISK MANAGEMENT STAFFING
• LEADING RISK MANAGEMENT STAFF

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Chart 6 Risk Management Organization Structure

Main
Director

Chief Risk Line

Officer Director

Risk Management
Management Line
Unit Unit

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Chat 7 Risk Management Bank Organization Structure

Commissioner

Board of Directors <--------------------

-- Risk
Management
Committee
|
|
Director Manager
Obedience Line Risk
Director
|
|
Obedience Business Unit -------------> Risk
Unit Management
Unit

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 RISK MANAGEMENT CONTROL

• PERIODIC EVALUATION
• GOOD REPORTING SYSTEM
• SYSTEM RUNNING FEEDBACK

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 Monthly Risk Report

Gross Losses Risk Incident Management Assessment

1.
Current YTD Incident Exposure Response
Operational Losses 1.
Credit Losses 2. 2.
Market Losses 3.
Other Losses 4. 3.
Sub-Total :
Loss/Revenue Ratio: 4.

Management
discussion of
major risk issues
(“what keeps me
Accounting for Report of risk up at night”)
Actual losses Incidents, exposure,
incurred and near misses

Losses

1997 1998 1999 2000 2001 2002

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Chart 10 . Example RISK FOR VAR dan Trading Error

VAR Analysis

VAR
Limit

Time

Trading Error
Limit

Time

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Tabel 2. Risk Profile for Invesment Ideas
Finance Social Politic
Project A 1) High 3) High 5) High
4) High
Project B 1) Medium 3) Medium 5) Low
2) Low 4) Low
Finance: (1) Accessing financial fund risk, (2) Exchange rate change risk
Social: (3) acceptance from local community, (4) Support from local government
Politic: (5) Political stability, (6) Changes to Regulations

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