Risk Management in Financial Institution in Nigeria

Risk Management: Within the management literature a significance focus of theoretical and empirical attention has been the structure of organisation environment leakages.Gives specific task environment the management action is typically measure by factors that are both internal and external to the firm specific signals emanating from these sources can be interpreted either as crucial or simple tachal. In risk utility terms there signals or impulse have been associated with the positive (disutility terms these signals or impulse have been associated with positive utility generating) of negative (distillate inducing) potentials.

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Positive signals imply a specific opportunity necessitating management exploitation. Negative signals on the other hand represent a threat requiring some militating strategy on the part of responsive management.

Since the environment is both a source of opportunities and threats to a business concern, management action must be geared towards.

1. Maximizing the outcome potential of the positive signals and

2. Maximizing the outcome potential of the negative signals.

Therefore, it is the concern of this study to show that within financial institutions total management implies that attention is equally divested at the decision needs represented by both categories of organizational problems.

According to Ehiaghe T. Akhile (1991) consideration of these threat will lead to the separation between dynamic and static source of risks what is analogist to that between pure and superlative risks”. This distinction is made because within financial institutions, the tradition has been to separate management responsibility for dealing with each type of risk.

DEFINITION AND GENERAL CONCEPT OF RISK

Several definitions exist for risk; many eminent schools of thought defined risk and interpreted risk in different perspectives.

Pretter I. (1956) defined risk as “A combination of hazard measured by profitability”. In the chambers 2^nd century dictionary a risk is defined as a hazard or danger of a lose or injury. It can be the degree of probability of loss. It can as well be the agent person or factor that can constitute the danger or lead to loss (Odike J.C. 200)

According to Ude S.O. (200) risk in financial analysis is the variability associated with expected future returns from an investment. Therefore risk is to a product of uncertainty, which in turn is an outcome of changes in economic and political conditions of the time.

Risk is also acceptably defined as uncertainty as to loss, this stresses that if it is certain that cost or loss with occur it should be planned in advance and treated as a definite and know expenses. When there is uncertainty about the occurrent of a lost or cost, risk becomes an important problem.

Mathematicians who are interested in the behaviour of phenomena, defined risk as “the degree of dispersion of value in a distribution around the central position occurring in random chance pattern”. The larger the degree of dispersion the greater the risk.

Herald Cremier, I leading pioneer in risk theory, stated that the objective of the theory of risk is to give a mathematical analysis of the random fluctuations in an insurance business and to discuss the various means of protection against their inconvenient effects.

The fact remains hat risk or uncertain is universally present in every undertaking the future is unpredictable, organisation individuals, firms and society at large are all exposed to different kinds of risk.

There is risk or loss of a firm’s asset and earning power through distribution or loss of proportion arising from various events such as fire disastis, environmental pollution, credit risk, explosion, flood, erosion, risk of damages or loss of goods etc.

An individual is exposed to various risk such as motor accidents, theft, five to mention out a few. There is also social risk such as riots, civil strikes, civil commotion, laws hindering business operations, current inflation and political events.

The impact or consequences of risk is abhorred and therefore it is not surprising why most people try to avoid risk as much as possible reduce its negative consequence.

Looking at some notable examples of risks or uncertainty will enhance clear understanding of the concept of risk.

Some years ago the Nigerian external communication multi-million naira building was set ablaze.

On October 17^th 1990, the serious fire incident at the institute of management and technology (IMT), Enugu rendered the main Rectors office, Exams and records, estate and worker and the photographic studio of the department of mass communications of the institute in sorry state.

Beside, the Nigerian Airways Fourth 28 on Lagos/Enugu route crashed and 53 persons lost their lives

Nine employees of a commercial bank located along Akran Avenue Ikeja, were interrogated by the police over the loss of N 133,000 by their bank to an engineering company. The branch manager the accountant of standard trust bank Okpara Avenue Enugu was punished for paying a cheque for N40,000,000 without confirmation from the drawer as the bank lost the amount on the grounds of negligence.

The occurrence of risk real they happen everyday we live in a world full of hazard and we do not know when misfortune will strike, or where we cannot eliminate it but we can reduce it and can to some extent shift it to others.

In addition to physical dangers to which everybody is exposed in varying depress, financial institutions (Banks and insurance companies) are exposed to risk, which are inherent in the economy and in the environment.

CLASSIFICATION OF RISK

According to Ude S.O. (2000), risk can be classified into two broad categories:

Systematic and
Unsystematic risk

SYSTEMATIC RISK

There are risks that arise on account of the economy wide uncertainties and the tendency of individual financial securities to responds to changes in the market.

This type of risk cannot be reduced by investing in bundle or combination of individual assets or securities (diversification). Investors are exposed to systematic or market risk even when they hold well-diversified properties portfolios of securities because of:

A change in interest rate
An increase in corporate tax deficit.
Restrictive credit policy by the Central Bank of Nigeria.

UNSYSTEMATIC RISK.

These are types of risk that emanate from the uncertainty which are peculiar to individual securities and which can be reduced (diversified) if large number of securities are combined to form a well-diversified portfolio expected to conceal out each other. Unsystematic or unique risk can arise as a result of:

(i) Strike action by workers.

(ii) Strong competitors entering to market.

(iii) Increase in indirect taxes e.g. custom duties, on the materials used by the firm.

(iv) An expert in research and development leaving the firm for the purpose of analysis two broads divisions of risk are particularly useful to this study, these are:

1. Pure and speculative risk and

2. Fundamental and particular risks.

PURE AND SPECULATIVE RISKS

Pure risk are those risk where the occurrence of an event will result in no change in the situation of the organization or individuals exposed to the risk.

In other of words, there is likely to be neither gain nor loss. For instance, the destruction of an car or a building would only lead to loss, but if the building or car was not destroyed, there is no loss and equally no gain.

Pure risks involves only a chance of loss, thus it is uncertainty whether the destruction of an object would occur.

Pure risks arise from fraud and criminal violence. Adverse judgment at law court, death of disability of key employees or owners, damage to asset, and damage to property or others.

On the other hand speculative risks are exposures that may result in a possible gains or loss it arises mainly from unexpected changes in the economic activity of a given capital investment for example, in capital or stock exchange market prices normally fluctuate. They may go up or down. If the price goes up, it means gain to the invest. If it decrease, it means loss to him, unlike pure risk, speculative risk is as a result, its pollution nature, not normally handed by insurance and therefore not transferred to an insurer.

FUNDAMENTAL AND PARTICULAR RISKS

Fundamental risks arise from losses that are impersonal in origin the consequences of these losses are not caused by the individual and its impact fall on the society as a whole. Most of the fundamental risk arises from economic, political or social inter dependent of society or sometimes from pure physical occurrence.

For example, events such as unemployment inflation technological changes etc, normally take place due to social interdependency while the physical occurrence are in form of erosion, earthquake, wind storms, flood, volcanic eruption.

Particular risk on the other hand are losses whose origin could be traced to individuals and therefore the impact is localized. In other words, particular risk arises from losses that are not personal in origin that is they are losses caused by the individual.

BRIEF HISTORY OF RISK MANAGEMENT

The concept of risk management had its origin from the organization of insurance section of the American management association in 1931.

The association holds many conferences, symposia seminars and workshops every year, which are devoted to all aspect of risk management. The concept has its origin from the United State of America. It later developed and extended its ten fades to European countries where the concept was widely accepted by management practitioners as an indisputable management concept up till today there is an increasing acceptance of the concept in the developing countries of the world.

DEFINITION OF RISK MANAGEMENT

In the ordinary course of business, the bank manages a variety of risk with operational legal and liquidity and countries risk being the most significant. These risk are identified, measured and monitored through various control mechanisms across the bank in order to highlight risk concentrations requiring management attention.

To Akigemi O.E. (1986), Risk management is an accompanying management function in the care of which all-larger oriented activities in order to enable an enterprise to handle such disturbance potential.

This definition shows an unmistakable analogy to the term “marketing where the entrepreneurial activity is oriented to the market and sales”.

Risk management is also concerned with the application of professional management principles to the identification measurement and control of personal and or corporate losses exposure in a business setting emphasis on a process framework with the ultimate objectives being the protection of the assets, earnings, persons and liabilities of the enterprises are minimum cost with maximum potential benefits.

EFFECTIVE RISK MANAGEMENT

1. Provide against significant reduction on profit margins.

2. Leads to increase in profit and

3. Provide protection against the possibility of asset losses so operate as to cause severe dislocations.

OBJECTIVE OF RISK MANAGEMENT

Risk management has a unique objective, which differentiates it from other management devices. Therefore, risk management concept is adopted for the sole aim maximizing.

Productive efficiently by attaining on optimum balance between benefits and cost thus. The distinguishing objective of risk management is to make most efficient pre-loss balance between resources needed and resources available to preserve the effective operation of the business.

This refers to the control of the amount needed for post-loss resources by the use of systematic programmes of loss prevention and control devices, the techniques used in achieving the risk management are the following risk analysis:

1. Risk control

2. Risk finance

3. Risk administration

According to E.B. Azuka (1986); risk analysis is concerned with both the identification and measurement of loss exposures relative to the organizations special circumstances. Having identified potential exposures, the next stage in risk analysis is to measure the risk in terms of the frequency and possible severity.

1. Risk control covers all the measures aimed at avoiding eliminating or preventing losses from occurring. Avoiding of risk is often not feasible especially for a business enterprises therefore mean are bought to reduce the dimensions of the risk, either through pre-loss or post loss measures.

2. Risk financing is concerned with the manner in which the residual risks remaining after physical control measures have been implemented shall be financed. The two approaches to financing risk are risk transfer and risk retention. Risk transfer may be achieved by purchasing appropriate insurance cover or otherwise through contractual clauses. While risk retention in its purest form is achieved when a contingency fund is created expressly to finance risk costs. As an alternative to creating such a find the losses may be changed to current operating expenses or in extreme cases. The organisation might resort to borrowing that is contingency loans.

3. At the level of administrating risk management programmes the organisation needs to effectively implement, monitor and control the overall risk control (such as records keeping, investigation of events, job scheduling accounting) must be established. Responsibilities for achieving results must be defined and the resources to achieve this provided.

RISK MANAGEMENT PROCESS

The risk management identifies, analysis or evaluates and develops policies to ensure that risk, which threatens the community, firm or organisation, are eliminated or reduced.

Therefore, the risk management process is defined as Efforts taken to minimize the impact of uncertain events whose probability of occurrence is calculable Ehiaghe T. (1989).

There are three basic steps involved in the management of risks, these are:

1. RISK IDENTIFICATION: Discovering the various sources from which risk may arise

2. RISK EVALUATION: The impact of loss on individual or organisation should loss occur.

3. RISK HANDLING/TREATMENT: Selecting the most effective and efficient techniques to reduce risk.

RISK IDENTIFICATION

Risk identification is the first step in risk management process. It deals with the discovering and analyzing of risks to which an organisation is exposed. This is very necessary because if the risk are not discovered and identified, the organisation will remain ignorant of the possibility of a loss until it occurs.

Thus, it involves the ability to discover the likely peril to which the individual or organization is exposed.

The management therefore must be able to discover and identify and risk that threatens the organisation. This will enable them find effective ways of controlling and minimizing risks. Therefore, the management should identify risk confronting.

1. Its building, motor vehicles

2. Its customers

3. The organizations legal, political and economic environment in which it operates.

There are some common established ways of risk identification these includes: analysis of accounting statement:

This method involves taking a detail analysis of the organisation, balance sheet, profit and loss accounts. The use of these method help to establish the values and earnings exposed to risk of financial losses to the organisation.

SURVEY

This comprises a detailed plan, report photograph and recommendation for risk improvement.

THE USE OF FLOW CHART

Flow chart is used in most organisation, for instances manufacturing companies its use shows clearly the existing relationship in its operations from the supplies of raw materials, through the manufacturing, storage and distribution stages until the product reached the financial consumer.

RISK EVALUATION

This is the second step in risk management process it is the most important of all the risk management techniques and involves the measurement and impart of risk on individual or organisation. Risk evaluation involves proper planning organizing and effective management of all possible losses. It normally requires knowledge of several disciplinary techniques and experience of various other techniques etc. So as to achieve evaluation objective other time there might not be any laid down rules guiding the risk manger in his evaluation function for example in evaluating possible losses from the liability hazards of a new product, necessary aids must be obtained from both legal department and research and development. Thus.

One very important reason for carrying out careful evaluation is to ensure that the company does not spend too much money on controlling of risk that is not likely to cost a great dear should it occur. (Pius Okigbo 1990).

This therefore means that it is better for the organization to spend a small amount of money to prevent an event since they know that, it will cost a huge sum, if the risk occur.

Evaluation of the financial impact of losses in any organisation, involves analyzing the financial strength and loss structure of the firm as they form the brains of measurement.

Therefore the concept of loss frequency and loss severity, which involves the randomness, and gravity of financial loss must be evaluated.

Usually, the financial status of an organistion is analysed by top management and form the basic policy that is given to the risk manager. In most cases the financial position of the firm changes, this requires the risk managers to be versatile so as to be able to adapt to any necessary changes, therefore he has to continually evaluate the impart of risks on the organisation. This ability to do this will help the organisation to device an appropriate and efficient technique for evaluating risk at any time.

RISK HANDLING/TREATMENT

This is the last step in risk management process. It involves selecting the most appropriate and efficient techniques to economically control and deal with the obtained from evaluation process.

According to Allen W. (1951); there are five division of risk treatment and these are:

Risk avoidance
Risk prevention
Risk financing
Risk transfer
Risk retention.

1. RISK AVOIDANCE

Risk avoidance is the most effective way of controlling risk, most time it is very difficult to avoid or eliminate risk. Completely, but it might be possible only on a rare occasion.

Risk avoidance involves opportunity coat which requires avoiding any undertaking that will lead to risk with the consequences of loosing the gains that would have accrued from such undertaking. Hence it involves sacrificing the benefit that may be derived from the activity.

For instance, in locating an industry in a particular area risk or earthquake can be avoided by avoiding the establishment of such industry or any financial institution in earthquake prone area.

2. RISK PREVENTION

This is another method of controlling risk. It is designed to prevent the occurrence of loss. To reduce it seventy as it occurs. The firm must adapt to all preventive device, which should adequately reduce or prevent loss expectances. Thus “all preventive measures or method are geared towards reducing losses that may occur as well as dictating probable losses”.

The preventive measures are categories into two directives. Those directed towards detecting the adverse occurrence before it occurs (Pre-loss) and finding all possible means of eliminating it. On the other hand, some are directed towards minimizing the loss after the adverse occurrence has taken place (Post-lost_. The preventive items are fire extinguisher, theft alarm, water loss, fire alarm sprinkler etc.

Therefore, it is advisable for risk management of any organisation to use these items in order to prevent losses facing the firms (financial institutions inclusive).

3. RISK FINANCING

Risk financing involves the manner in which the residual risk remaining after the physical control measures have been implemented shall be financed. There are two approaches to risk financing these are:

Risk retention
Risk transfer

RISK RETENTION

The retention of risk may be simply refereed to failure to take positive action to prevent undesirable consequences of an existing risk. Thus, risk retention normally occurs when the risk situation is carefully considered and a divisions is deliberately made to take no action against the risk. Risk can be either planned or unplanned when risk is unplanned, no financial provision it is called self assurance, in this case financial provision is made to salvage the loss that may occur.

Thus risk retention in its purest firm is achieved when a contingency fund is created to finance risk cost. As an alternative to creating such as fund, the losses may be changed to current operating expanses or in extreme cases; the organistion might resort to borrowing.

In this regard, risk manager of an organistion such as financial institutions should be able to envisage and weight the impact of any probable loss contorting them. Hence such institution should be advised on self assurance technique to control the risk or simple and negligible financial consequences.

RISK TRANSFER

Another method of handling risk of loss is transferring risk from one organisation to another or from the organistion to customers. This can take two forms, that is transferring the activity that creates the risk or by means of insurance.

This can be divided into two form of risk transfer viz:

(a) Surety ship

(b) Insurance

There are some situations under which an organisation is required to transfer losses, such situation are:

1. Where losses are too long from the organisation to retain to enable it achieve its objective.

2. Where the organization has a legal obligation, which requires it to transfer.

3. Where loss transfer becomes the most efficient device for the disposition of loss even though loss transfer is not required by contract.

LOSS TRANSFER THROUGH CONTRACT

This method of transfer involves the transfer of the financial consequences of loss or damages from one part a contract to the other party by means of clauses in the contract.

One of the major ways of transfer is by surety ship.

SURETY SHIP

This is a transfer of legal liability form one organisation to another or from organisation to customers.

HENCE

Surety ship is a sort of bond where physical damage of loss coverage protects the insured against loss or damages toward property.

This type of contract usually involves the parties in which case one party agrees to take obligation of another party from principal debtor.

LOST TRANSFER BY INSURANCE

Insurance companies generally have the most sophisticated techniques of handling risks. This is why it is very advisable to transfer losses by insurance contract especially losses of high severity. This is because it provides effective means of controlling risk with low probability of ensuring a large loss which an organisation cannot afford to retain even on an internal funding basis.

There are a lot of factors that necessitate mangers to purchase insurance for their organisation. It could be due to potential size, frequency of losses, the size of the premium and the value of organisation financial size.

—-This article is not complete———–This article is not complete————

This article was extracted from a Project Research Work Topic

“RISK MANAGEMENT IN FINANCIAL INSTITUTION IN NIGERIA

A CASE STUDY OF UNION BANK OF NIGERIA PLC”

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