Risk Management

Mistakes in risk management often occur due to the constantly changing nature of risk, the grey area between risk and uncertainty and also the inability to act in a timely and decisive manner on the outcomes of risk management processes. Risk management cannot be conducted without assuming the interconnectedness of all the risks and hence upon considering the failures of these models due to the aggregation trap, these measurements of risk need to be well applied with stress testing and scenario analysis techniques to validate the results. An article by Ralph C. Kimball (2000) an economist at Federal Reserve Bank of Boston argues that it is difficult for financial institutions to guarantee their solvency by keeping enough equity capital; as possibility of huge loss events even though they are low probability events, always exists. Firms can only make reasonable estimates of these events and make efforts to reduce the probability of insolvency.

Risk management is often assumed to be in place to eliminate risk, which is a misconception instead it is argued to be a source of competitive advantage. An article in the Harvard Business Review by Taleb, Goldstein and Spitznagel (2009) describe and argue about the so-called Black Swan events that are low probability but high impact events and the illusion that is perceived about risk management as a tool, which can manage risk by predicting extreme events. These activities of transferring risks by banks enable them to have a comparative advantage over their competitors and are basically conducted as a part of risk management techniques to achieve some strategic benefits.