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1 INTRODUCTION
The maxim "necessity is the mother of invention" recognizes that a problem can often generate creativity. Risk management was born out of necessity. It started with the management of credit risk, a core requirement for financial institutions and for nonfinancial firms that sell on credit. Then came management of market risk, including liquidity risk, which arose from the highly volatile environment in which banks found themselves. Desktop-computing capabilities allowed banks to hire analysts with the technical skills needed to manage data and build models useful for evaluating market risk. Ultimately, a rash of control breakdowns led to development of ways to manage operational risk, which exists in every type of organization.
The development of these three risk disciplines-consistent with a firm's business model and complexity-is a prerequisite for effective enterprise risk management (ERM), which includes strategic risk management as a core component and the bridge between risk management and strategy.
2 PROBLEM STATEMENT
Today's interconnected world, with its 24-hour news cycle and increasingly rapid deployment of disruptive technologies, has increased the stakes for strategic risk management. Risk managers have built many quantitative models to measure risk, but risk can come from factors well outside of models, requiring a more qualitative analysis that can further support strategic planning.
Focusing only on that which we can model quantitatively can result in the "streetlight effect," which Wikipedia defines as follows: A police officer sees a man searching for something under a streetlight. When asked by the officer what he is looking for, the man responds, "My keys." After a fruitless search, the officer asks the man if he lost his keys there, to which the man replies no, he lost them at the park. But he is looking under the streetlight because that's where the light
The streetlight effect is an example of how cognitive biases can impact our ability to identify risks. We frequently look for things in the easiest place as opposed to the best place.
Setting the firm's strategic direction is arguably the most critical role for the board and executive management, and it involves taking risk. Strategic risk management is the means through which risk management can be deployed to support the firm on offense and defense.
3 KEY ELEMENTS:
STRATEGIC RISK...