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This can lead to following regulation to the detriment of managerial principles.: the former aims at keeping averting the most dramatic impacts, whilst the latter helps towards optimizing the risk profile of the enterprise at all times. Such confusion inevitably leads to using soothing risk management patches rather than fully understood solutions, to complacency in risk management, and it prevents progress towards understanding risk appetite.
Financial institutions, having to focus on risk regulation, often end up being content with identifying risk and maybe engaging into some mitigation measures after a significant mishap has occurred or when regulatory authorities get nervous. Keeping potential impacts within risk capacity limits becomes the key. However, whilst it keeps everybody at their jobs most of the time, this does not lead towards risk optimization.
We detail a framework for handling identified risks, highlighting the measures that are apt to merely satisfy regulators and the measures that fully take into account tail risks as well as routine risks, and the costs and benefits of controls. We also highlight the measures that merely consist at blindly throwing resources at risks.
Using the whole set of risk management tools, financial institutions can aim at a better understanding of potential profits and risks, likelihoods and potential impact, and hence be able to take the right amount of the risks that need to be taken, within their own risk appetite.
Risk control and risk management: both terms are often taken interchangeably. Due to practical, managerial and brain-saving reasons, financial institutions have been accustomed to this simplification. This hasty assimilation of risk control and management is akin to, on the road, mixing up side barriers and the steering wheel. Neglecting the differences will have nasty consequences, especially in these unprecedented times. We highlight here the practical and financial benefits of digging into the difference, and the insights and benefits this could bring.