Enterprise Risk Management (ERM)

Definition

Enterprise Risk Management (ERM) is a plan-based business strategy aimed at identifying, assessing, and preparing for any dangers, hazards, and other potentials for damage that may impact an organization. It involves predicting and managing risks that could hinder a company’s operations or objectives. It is a continuous process that should be embedded in strategy formulation and execution.

Phonetic

The phonetics of the phrase “Enterprise Risk Management (ERM)” is:Enterprise – /ˈɛntərˌpraɪz/Risk – /rɪsk/Management – /ˈmænɪdʒmənt/ERM – /ˌiːˌɑːrˈɛm/

Key Takeaways

1. Systematic Approach: ERM provides a framework for risk management, which facilitates identification, assessment, and management of risks across an organization. This systematic approach aids companies in aligning their risk-taking activities with their business strategies.
2. Holistic View: Instead of different departments managing risk in silos, Enterprise Risk Management proposes a company-wide, integrated approach. This allows for a more holistic understanding of the organization’s risk profile and leads to efficient resource allocation.
3. Improves Decision Making: ERM improves the organization’s risk response decisions, as it provides executives with a better understanding of the significant risks faced by the enterprise. This understanding supports strategic planning, enhances decision making and helps identify opportunities for gain and growth.

Importance

Enterprise Risk Management (ERM) is crucial as it provides a strategic approach to managing risks across an organization. By identifying, assessing, and preparing for dangers that could potentially interfere with a company’s operations and objectives, ERM supports decision-making, improves performance and safeguards the business against uncertainty. This holistic approach to risk management leads to resilience by ensuring the continuity of business operations under various adverse scenarios. ERM also contributes positively to the company’s reputation by demonstrating its commitment to risk management to stakeholders, thereby promoting trust and reliability. Thus, ERM is essential in promoting business sustainability and resilience.

Explanation

Enterprise Risk Management (ERM) is primarily used for identifying, assessing, and preparing for any risks that may directly or indirectly impact the operational efficiency, effectiveness, and economic value of an organization. Its purpose is to create, protect, and enhance shareholder or stakeholders value by managing the uncertainties that could influence the achievement of the organization’s objectives. ERM is an integral component of a firm’s business strategy, as it allows management to deal effectively with potential future events that could affect progress. ERM is also used to implement adequate measures to minimize or eliminate risks. It involves a coordinated and systemic approach to managing risks, ensuring that risk handling activities are aligned across the company and contributing to the enterprise’s overall risk profile. By having a definitive ERM plan, corporations can ensure that they’re capitalizing on their potential earnings, creating a safe working environment, and safeguarding their finances, reputation, and operational capabilities from potential threats.

Examples

1. British Petroleum Deepwater Horizon Disaster: One of the most fatal instances of poor ERM was the BP oil spill in 2010. A deep-sea oil drilling rig exploded, causing one of the largest marine oil spills. The underlying root cause was not only technical failure but also lapses in risk management strategies. BP failed to account for severe risks tied with deep-water drilling and did not have an adequate disaster response strategy in place. After the disaster, BP’s stock price plunged by 55%, and they paid approximately $65 billion in damages and clean-up efforts. 2. Credit Risk at JP Morgan: In 2012, JP Morgan’s “London Whale” incident happened, wherein traders made large, risky bets that led to over $6 billion in losses. This was a clear cut case of ERM failure as JP Morgan’s risk management department was unable to identify the magnitude of risk the traders were taking on their complex derivatives trades. This also resulted in the bank enhancing its ERM framework to prevent such happenings in the future. 3. Toyota’s Recall in 2009: Toyota Motor Corp, once known for its superior quality control, went through an ERM failure resulting in the recall of millions of vehicles in 2009-2010. The reason for the recall was unintended acceleration due to a flaw in the design of the accelerator pedal. This dramatically impacted their reputation and cost them billions in recall costs and lawsuits. It was a colossal oversight in risk management that led to a colossal financial loss. After the incident, Toyota took measures to strengthen its risk management processes to prevent such issues in the future.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Risk Assessment
• Risk Control
• Operational Risk
• Strategic Risk
• Financial Reporting

Sources for More Information

• Oracle
• Investopedia
• TechTarget
• Wikipedia