Current Risk Management Position In India

The risk management function is set to become increasingly important over the next decade where shareholders will look to add value to their business and protect customers

This article covers the current risk management

position in India and looks into the future from

an opportunities’ point of view in the area of risk

management. Key points discussed in the article

are drivers of risk management, current corporate

governance practices, challenges in the implementation of

risk management and emerging future opportunities. The

article looks into the present risk management position and

advocates that there are plenty of opportunities in this field

in time to come.

Corporate Governance Guidelines

Human existence is fraught with future uncertainties and

managing the same in your own way is not something

new, however, in recent times, with successive failure

of businesses across the globe, there is greater focus

on management of risk. The series of changes made to

corporate governance guidelines across the globe is a

testimony of the seriousness shown by different regulatory

authorities. Some of the recent changes brought up by

regulatory authorities across the globe are risk-based

capital provision in the banking and insurance sector. The

focus of different regulatory bodies has increased on setting

up of Risk Management Committees and strengthening the

role of these committees in providing risk oversight. It

has been realized that risks cannot be eliminated but can

only be managed, so their identification is a key step in

the process of risk management. The recent changes in

corporate governance guidelines made in Indian financial

institutions are as follows:

• IRDA (Insurance Regulatory and Development

  Authority) - 2016 Corporate Governance Guidelines

  are sharper and have described the objectives of risk

  management committee. The guidelines also state

  that certain positions cannot be helped by the same

  individual due to conflict of interest.

• Reserve Bank of India - governs the risk management

  activities for Indian Banks.

• SEBI (Security Exchange Board of India) - 2015

  Corporate Governance Guidelines for listing companies.

  In 2017, SEBI has issued a circular on Board evaluation.

• Company Laws - 2013 Company law requires having

  risk management assessment by the Board.

What is risk management?

Risk management is a proactive step of identification of

risks, assessing their impact, and preparing an action plan

should such risks occur in reality. Risk management is not

just about identifying the risks; management action is an

integral part of the process. Stressing the same point, the

Chinese President quoted while addressing the National

Financial Conference that “Failure to detect financial risk is

a breach of duty; spotting risks without addressing them, a

refusal to perform the duty”.

It is important to understand that risk management

through a silo approach is no longer sufficient where risk

management is performed by a few departments only. In

the Enterprise Risk Management (ERM) concept, risk

management is performed across the organization where

every employee is a risk manager. The silo approach to risk

management does not work as risks are highly correlated

and cannot be segmented and managed independently.

There is also a higher cost of management of risk if handled

independently as the benefit of diversification does not

come into force.

What does risk management do?

In business, risk identification not only helps in proactive

action but also helps in giving risk diversification, better risk

transfer to the third party, better allocation of capital, and

enhancing the value of the Company including stabilization

of flow of income.

• Diversification effect - Many risks are correlated, so,

  managing one risk also helps in reducing another risk. In

  the insurance sector, when the lapse risks (policyholder

  leaving the portfolio earlier than expected) are reduced,

  this helps in reducing the claim risks as well.

• Better risk transfer - Identification of risks helps in

  identifying those risks which the Company may not

  manage and need transfer to the third party. Example,

  derivative products.

• Better allocation of capital - Risk management helps

  in the better deployment of capital based on the riskreturn

  ratio.

• Impact on the valuation of the Company - For listed

  Companies, risk management helps in improving the

  share price and overall valuation of the Company.

• Reduce earnings’ volatility - Reducing earnings’

  volatility helps in stabilizing the steady flow of income.

It is imperative that risk management facilitates benefits to

organizations which practice it; however, it has been seen

that there are practical challenges in the Indian market in

its implementation.

Challenges in the Indian Market

The ERM in India is a relatively new concept where its

implementation in some sectors has been made to meet

minimum regulatory requirements. There are challenges in

fully implementing ERM across different financial sectors;

some of those challenges are discussed below:

• Risk culture is not mature in India to fully implement

  the ERM; the behavior towards acceptance of risk has

  an element of reluctance; this may be driven by the

  attitude of not accepting the existence of risk. Such

  attitude could further be the output of audit mindset

  where audit findings are considered as a gap in the

  process. More research is needed in this area to find

  out the real reasons. The point to understand is that

  risk identification is not a gap because identifying the

  risks only help in locating the pitfalls that may come in

  the way of achievement of the business objective. Risk

  management is not a deterrent but an enabler.

• The current business culture in India focuses on rewards

  based on year-on-year growth of the business; western

  markets, on the contrary, have elements of effectiveness

  of risk management as well as the growth factor in

  the reward structure. Such inclusion of controls will

  not only help in boosting the bottom line but also in

  creating the right risk culture within the organization.

• Very few business organizations in India are using

  statistical models to project future scenarios and apply

  stress testing to look into the anticipated future and

  preempt the risks. Scenario and Stress Testing (SST) is

  becoming a very strong tool to assess the resilience of

  the business against various economic and demographic

  variables.

• Currently, in many organizations, strategy and risk

  management are not integrated which results in strategy

  failing. Strategic risk management helps in keeping the

  strategy agile based on emerging market conditions.

• Apart from these technical gaps, there are also shortages

  of qualified risk professionals; this is further aggravated

  by lack of quality risk management institutions to

  deliver risk education. Many B-Schools in India are

  yet to include risk management courses in their core

  curriculum. This however, is prevalent globally.

• Most of the corporate governance guidelines issued in

  recent years have strengthened the role of the Board

  in providing risk management oversight. The 2008

  economic crisis highlighted many gaps in providing

  risk oversight at the Board level that may be used as a

  reference point.

Future Opportunities

The application of risk management in India is likely to

rise due to regulatory requirements by different financial

regulators and requirement under Company law, where the

Board is to report development and implementation of risk

management policies.

Risk management in India is new, but it is going to stay

because all financial regulators have recommended setting

up a Risk Management Committee as part of the corporate

governance process. This includes the establishment of

separate risk management function within the Company

headed by the Chief Risk Officer. The role of risk management

function is a part of the three lines of defense model, where

the first line of defense is the function which runs the

business and does the operational management within the

Company including owning the risk and its management.

The second line of defense is the risk management function

that provides the oversight and challenge on the risks

identified by the first line of defense. The third line of

defense is the Audit function that provides the assurance

on the effectiveness of the risk management process and

controls.

The SEBI has a listing requirement that top 100 listed

companies must have a risk management committee,

the 100 listed entities are determined on the basis of

market capitalization at the end of the immediate previous

financial year. On all the listed companies, the risk

management practice of oversight is likely to increase

because any adverse news about the Company may impact

share price.

The Reserve Bank of India issued guidelines on Basel-

III reforms on capital regulation in May 2012, to the

extent applicable to banks operating in India. The

Basel-III capital regulations have been implemented

from April 1, 2013 in India in phases and will be

fully implemented by March 2019. The Basel reform is

based on a capital calculation based on the risks that

banks undertake, so any bank taking undue risks will

have a higher capital requirement. If risks are managed

well, the bank will be benefited through optimal capital

requirement; and that is where risk management will

add value. It can be concluded that the application of risk

management in the banking sector is likely to increase

manifold.

Similarly, to make the insurance sector in India more

resilient to internal and external changes, the insurance

regulator, IRDA has set up a committee on risk-based

capital which has given its report. Further communication

from the insurance regulator in this regard is expected in

the future. Post implementation of the risk-based capital

regime in India, the application of risk management will rise

as this will directly impact the shareholders’ optimization

of capital.

Apart from these highly regulated financial industries

in India, the requirement of risk management under

Company law 2013 will further increase application of risk

management across different sectors.

It is evident that risk management in the next decade will

be a tool that shareholders will look into to add value to

their business and protection of customers.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.