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The path forward to a unified risk framework

Risk-taking is part of both social and corporate life. In order to understand what this phenomenon is, it is useful to imagine the goal we are aiming for and a situation which may, very likely, negatively affect the achievement of that goal. The probability combined with the impact of such a situation occurring is what is called risk. Risk management, on the other hand, is a complex process that relies on making decisions and implementing specific actions. The ultimate goal is to achieve an acceptable level of risk and thus stabilise financial performance and improve it further. There are many paths we can take when managing risk. The most important thing, however, will be to understand how different sectors affect each other – such as the manufacturing sector with the financial services sector.

The essence of supply chains.

In recent years, a number of events have demonstrated the importance of maintaining the interdependence between different sectors of the market. The closure of a terminal in one of the largest ports in China, the collapse of Greensill, or even the shortages of basic everyday materials in the face of the COVID-19 pandemic – all these situations oscillate around the issue of proper risk management related to the proper management of capital. We can see that in the above situations, when there was a sudden collapse in one sector, the others were “dragged down”. The reason why large businesses went down like a house of cards in the face of the crisis is simple – mismanagement of risk, and thus misallocation of forces, led to critical situations. Thus, in order not to replicate bad patterns, it is important to keep in mind the factors that help stabilize and manage risk effectively.

Economic risk capital – the complexity of modern supply chains

It is the capital that can be understood as a kind of security to cover the risk that has already been taken (then we are talking about absorbed capital) or the risk that is yet to be taken (so- called allocated capital)[1]. The capital that concerns the problem under discussion is Economic Supply Chain Risk Capital (ESCRC). To introduce this issue, let me refer to the definition provided by Dr. Kamil J. Mizgier, who presents ESCRC as “the amount of capital that a firm needs to cover losses associated with supply chain risks materializing at some future date with a specified probability. In other words, ESCRC converts supply chain risk into the amount of capital that is needed to cover it.”.[5]

It should be borne in mind that every business is to some extent exposed to losses, but modern risk capital management methods have developed over the years. They allow for a more accurate estimation of losses and how much capital will be needed to cover them. The amount sufficient to cover the economic risk already taken is called absorbed capital. The amount to cover a situation in which the risk is yet to be taken is called allocated capital. 

The digital revolution and the increased availability of data have also contributed to the development and improvement of risk management methods, helping to improve it. As a result, businesses have more options and a better view of both what losses to expect and how to manage them – by just being prepared to allocate the right amounts of absorbed and allocated capital, among other things.

Factors favouring the development of risk management methods

There are elements that are largely responsible for the development of risk management techniques. As Kamil J. Mizgier points out in his article “Risk management in financial services and manufacturing industries-the path forward to a unified framework“[2], the following factors should be specified:

  1. Increase data availability

Advancements in accessibility and analytics allow for more effective management of a company’s potential loss data. This enables better risk management models to be developed in real time.

  1. Investing in technology

The use of third-party vendors with the latest technology allows you to better exploit the potential offered by the digitization of your business today. This ties in with the first point – because greater digitization means greater accuracy in predicting potential losses and thus, better prevention.

  1. Technology-based management

Through the development of the latest technology, the form of relationships with customers and suppliers has changed, moving mainly to the virtual foot. This has its advantages, since the digitalization of the contact allows easier acquisition and comparison of data from different sources. Relationship models are thus created on the basis of data that enable analysis in various categories, such as transport, prices, and the time of a given service.

  1. Increasing transparency in the supply chain – ESG

The ESG (environment – society – corporate governance) strategy is based on aspects that have played an increasingly important role in the market assessment of companies in recent years. ESG factors are becoming more and more important and thus should be taken into account when managing a company in general and when managing risks, as companies operating in this vein have enjoyed better performance in recent years.

  1. Risk modelling – the interface between data and enterprise risk analysis

There is a constant flow of new information in this area. Value at Risk, hitherto unexplored to a wider extent, is slowly gaining more attention in connection with corporate risk programs. It is also worth noting the aforementioned economic capital, which can help in assessing return on investment and subsequent business decisions.

Next steps

When analyzing risk management methods and the path towards standardization, it is not difficult to see that the topic is extremely broad. With the development of technology and digitalization, new methods and increasingly effective tools are emerging to deal with risks more and more effectively. Focusing on the analysis of management strategies by observing the global situation and reacting to emerging changes has a positive impact on the results. As Dr. Mizgier notes, the essence of cross-sector collaboration – related to sharing, flowing and managing data – can allow for a better understanding of risk management tools and a fuller utilization of their potential.

Bibliography:

  1. Pawłowicz, L. – Optymalizacja alokacji kapitału w budowaniu wartości banku dla akcjonariuszy. Kwartalnik Nauk O Przedsiębiorstwie 18(1), 17-26.
  2. Mizgier, Kamil J. – Risk management in financial services and manufacturing industries–the path forward to a unified framework, The European Business Review, https://www.europeanbusinessreview.com/risk-management-in-financial-services-and-manufacturing-industries-the-path-forward-to-a-unified-framework/ ( 22.11.2022)
  3. Guziejewska B. – Decentralizacja fiskalna jako ograniczenie zjawiska Lewiatana, WUŁ, Łódź 2022
  4. Mizgier, Kamil J./Jüttner, Matthias/Wagner, Stephan M. (2013) –  Bottleneck Identification in Supply Chain Networks, International Journal of Production Research, Vol. 51, No. 5, March, pp. 1477-1490, doi: 1080/00207543.2012.695878
  5. Mizgier, Kamil J. – On Economic Supply Chain Risk Capital, The European Financial Review, August/September 2018.

dr Kamil Mizgier
Bio:

He is passionate about research in risk management in the manufacturing and financial services sectors. He is currently working as Global Supplier Relationship and Risk Management Leader at Dow Chemical Company in Switzerland. He gained practical experience at UBS and Credit Suisse, as well as managing the risk modeling department at BNY Mellon Bank. He received his Master’s Degree in Physics at Warsaw University of Technology, and his PhD in Management at Zurich Federal Institute of Technology.

Kinga Zarzecka
Redactor
Bio:

A fourth-year law student at Cardinal Stefan Wyszynski University in Warsaw and a second-year student of finance and accounting at the Warsaw School of Banking – she is pursuing her education in the two fields that interest her. She is primarily interested in topics in legal sciences, primarily financial and medical law. She fulfills herself by attending many scientific conferences – both as an audience member and as a speaker – and by being a member of the Scientific Circle of Medical and Pharmaceutical Law.

Written by:

dr Kamil Mizgier, Kinga Zarzycka

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