4 Tasks of a Financial Risk Manager - dummies

4 Tasks of a Financial Risk Manager

By Aaron Brown

Some jobs are named by what they do – a nurse nurses, an actor acts, a homebuilder builds homes. Financial risk managers belong to a different class of jobs, named for what they aspire to do – like a justice or a peacekeeper. A risk manager in a financial institution spends a lot of time listening, observing, measuring, analysing, reading and thinking; plus a little bit of time talking. To do the job of managing risk, a risk manager has four primary tasks:

  • Set limits: A financial risk manager designs a system of measures and limits that let line risk-takers know how far they can go. Of course, a system of limits is dynamic and includes mechanisms for approving increases with various levels of escalation. Risk managers are always looking for unused risk capacity that can be re-allocated to more attractive areas.

  • Set stop losses: Except in the most desperate of circumstances, any risk decision should have a maximum loss attached to it – the most you’re willing to lose if the decision is wrong. When that loss is hit, the risk must be removed. Even if you’re 100 per cent certain that the original risk decision is still correct, you know you were wrong about how bad things would get before the payoff. Having been wrong about that once, you’re foolish to assume that you can predict future losses. Better to get out now, wait for the turnaround, and then get back in if you wish. With any other plan, you’re betting the firm on a trade, and reaffirming the bet after you’ve been proved wrong once.

  • Control drawdowns: Drawdown control reduces risk smoothly, because drawdowns strain resources and reduce risk appetite, putting the risk back on smoothly either when performance improves or expectations recalibrate.

  • Hedge: A financial risk manager trades in financial markets in order to manage market exposures. This is a job she performs only reluctantly. Managing a risk at the source is better than to try to adjust it afterwards with a hedge, but that’s not always practical – at least in the short term.

Used properly, these four basic tools of the financial risk manager can keep a business under risk control, which in turn allows risk to be managed. Risk management is an intangible goal, hard to explain at a party. Limits-setter, loss-stopper, drawdown-controller and hedger are the tangible actions that make up financial risk management.