Which ERM are you talking about?

If you ask managers, and if they give an honest answer, the large majority of them will say that they do not really know what Enterprise Risk Management really means.

One major reason for that confusion is that there really are three different and largely separable ideas of ERM that are being performed in organizations and discussed by experts.  Much confusion results because of these highly mixed messages.  The three types of ERM are:

Loss Controlling – practiced in most non-financial firms and also the traditional risk management of financial firms.  This type of ERM has the objective of minimizing losses.

Risk Trading – practiced in firms like banks and insurers who see their business as risk taking.  The ERM of risk trading focuses primarily on pricing of those risks.  Modern ERM grew up in banks out of the trading desks of banks.

Risk Steering – is an ideal that exists much more prevalently in books about ERM and in articles by consultants than in reality.  Risk steering concentrates on using risk and reward information for strategic decision making.

Some firms seek to do all three.  Most are looking to do just one of the three.  Writers on ERM usually do not clearly distinguish between the very different activities that are needed to support the three different types of ERM or they might exclude one of the three completely from their discussion.

So some of the confusion about ERM arises from this confusing discussion.  Most confusing to everyone else is the Bankers.  They are focused almost solely on risks that can be traded in a real time basis.  Their risk trading.  They are so in love with that idea, that people like Alan Greenspan have suggested that all risks would be better managed by turning them into traded risks.

Unfortunately, what we have seen is almost the opposite of that.  Many risks can only be managed by a Loss Controlling process and the way that banks have abandoned Loss Controlling in favor of Risk Trading has proven disastrous for all of us.

For a discussion of how this idea impacts on actuaries seeking to practice in ERM see this post.

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Explore posts in the same categories: Enterprise Risk Management, ERM, Financial Crisis, Risk

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