What are the Types of Risk in Business & Investment?
‘Risk’ is rather a broad term to say the least! In business and investment there are a large number of different types of risk to consider. It’s quite a job for risk managers to pin everything down through intricate analysis.
Here’s a breakdown of a handful of the types of risk areas you may encounter (and potentially even specialise in) if you’re interested in a career in risk management:
This is to do with all risks posed to a company through failings or unsuitability of its internal procedures and processes. It includes everything from mitigating and, wherever possible preventing flaws in internal systems to identifying possible risks with company employees (are they well equipped to do their jobs or human error, for instance) and providing guidance on the best ways to manage these risks. Legal risk also sits under the operational risk umbrella.
There is a risk that regulatory standards throughout various procedures could be missed. Banks and financial services providers must meet specified standards set out by the Financial Conduct Authority (FCA), so there must be risk management in place to ensure that everything meets specified requirements
There’s also a cross over here with cyber security and the risk posed to a company through insiders leaking out confidential information to external bodies (something that analysts in a digital forensics team will specialise in).
Credit risk forms part of the fixed income market – the market on which debts are traded, such as bonds. It refers to the risk that a borrower will not be able to pay back the amount they owe, plus interest, and therefore creates a loss for the lender.
A straight forward way of looking at this is to think of a mortgage scenario. Mortgage lenders must assess the level of risk that a lender will be miss a mortgage repayment, or struggle to pay for months, or even altogether. The higher the likelihood, then bigger the risk for the lender company. Credit checks therefore form part of the risk management process relating to credit risk.
Credit risk also relates to the lending and borrowing of money between countries. A prime example of when things go wrong is Greece’s financial situation in recent years.
Risk management focusing on market risk revolves around mitigating the possible losses which derive from things that effect the state of the financial markets. It could be the likelihood and potential impact of external events which could cause a particular market to nosedive, for example.
Many things can be completely out of a company’s control – take a natural disaster for instance – so market risk management will help to ‘hedge’ and minimise losses in case of these external influences and drastic market fluctuations.
Market risk is also known as systematic risk.
After a trade has been made, the period and procedures that follow are known as clearing and settlement. This is when a third party ensures that all elements of the deal are fulfilled on time, and that the exchange of security (the asset bought) and the payment for it runs smoothly and to schedule.
It sounds pretty straight forward, however there is a risk that the sell side may not deliver the security they are selling after the money for it has been transferred – known as ‘settlement risk’.
There are times in trading and investment when an asset needs to be sold quickly in order to make a return on investment and/or avoid a loss. The easier it is to do this, the more ‘liquid’ the asset is.
Liquidity risk relates to the difficulties and losses that can arise if an investor cannot get rid of an asset quickly enough – a bit like a hot potato! It maybe that the demand for a particular asset is very low, so it’s very hard to sell on, or a company with a fallen credit rating may lose its appeal as an investment opportunity, making it tricky to sell shares in it.