Enterprise Risk Management for Financial Institutions

The ongoing process of managing all risks within a financial services firm

What is Enterprise Risk Management for Financial Institutions?

Enterprise risk management (ERM) for financial institutions refers to the systems in place to identify and manage all risks within a financial services firm. These include financial risks, operational risks, event risks, and strategic risks.


Enterprise Risk Management for Financial Institutions


Key Highlights

  • Enterprise risk management for financial institutions refers to the systems that are in place to identify and manage all risks, including financial, operational, event, and strategic risks.
  • Enterprise risk management is important for financial institutions due to the inherent risk-taking nature of these businesses, and their systemic importance to the overall economy.
  • Enterprise risk management benefits financial institutions by allowing these companies to remain in compliance, mitigate loss, support growth, and improve profitability.


Why is Enterprise Risk Management Important for Financial Institutions?

Financial institutions such as banks, insurers, and investment management companies are entrusted with managing the economy’s finances. Because financial institutions are so systemically important to the economy, they are very tightly regulated. The risks these firms face can impact the broader economy, and thus it is particularly important for them to have well-developed enterprise risk management systems and processes.

Since the 2008 Global Financial Crisis, which led to the collapse of large financial institutions such as Bear Sterns and Lehman Brothers, there has been increasing internal and external pressure for greater risk management within the financial services sector.


Benefits of Enterprise Risk Management for Financial Institutions

Enterprise risk management can help financial institutions in numerous ways, including:

  • Remaining in Compliance: As mentioned, financial institutions are very tightly regulated and face the potential of significant regulatory penalties if they are found to not comply. A strong enterprise risk management system can help financial institutions maintain regulatory compliance and avoid financial penalties and operational disruptions.
  • Mitigating Loss: Financial institutions face a broad set of risks that can result in monetary loss. A strong risk management system can help identify potential losses in advance and allow institutions to manage these risks proactively. 
  • Supporting Growth: Financial institutions rely on consumer trust to operate effectively. Strong enterprise risk management processes and systems can assist in building consumer trust over time which in turn may lead to increased business.
  • Improving Profitability: Financial institutions are able to improve profitability when they optimize their risk exposures. A strong enterprise risk management system can help prevent and mitigate losses which boosts the bottom line of these firms.

In addition to these four benefits, the implementation of an effective ERM program often creates a cultural shift within the organization. Strong ERM programs typically enable financial institutions to view risk with a much longer-term lens and react to risk much more proactively. 


Enterprise Risk Management Framework

Enterprise risk management for large and complex financial institutions is exceedingly difficult. It requires a significant amount of dedicated people and resources. Successful enterprise risk management systems are typically implemented with an ERM framework. An enterprise risk management framework encompasses four key factors:

  1. Risk Transparency: Risks such as threats, potential crises, legal issues, and financial risk exposures need to be identified, clearly defined, and communicated to appropriate decision-makers.
  2. Risk Strategy: Management needs to establish risk tolerance levels in which the firm will operate. These tolerance levels are benchmarked against currently observed risks in order to develop a strategy to manage these risks firm-wide.
  3. Risk Decisions: Once risks are understood and risk tolerance levels established, decisions are made on which risks to accept, hedge, transfer, and/or mitigate.
  4. Risk Organization: Financial services firms need to establish robust internal risk teams, systems, and processes to continuously monitor and manage the firm’s risk universe. This includes establishing key persons to oversee risk, setting goals and milestones, and monitoring risk over time.


Thank you for reading CFI’s guide to Enterprise Risk Management for Financial Institutions. To keep learning and developing your knowledge, we highly recommend the additional resources below:

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