Risk Element Considerations for Management and Boards, Part 2

Understanding Inherent Risk, Residual Risk and Direction of Risk

The financial industry is currently experiencing a great amount of pressure from examiners and consultants to ensure risk assessments are in place for every regulation and business process. In the midst of this increasing focus on improving and expanding internal risk assessments, the value of the assessment process can be overlooked.

There are three risk concepts that management and boards should consider when discussing the preparation and use of risk assessments:

  1. Inherent risk views the risk in the absence of any actions management takes to alter either the risk’s likelihood or impact. 
  2. Residual risk views the risk remaining after management’s response, sometimes viewed as the control risk. This risk takes internal controls into consideration.
  3. Direction of risk provides better information for understanding risks over time and gives management a more holistic understanding of the risk environment. This can be one of the most critical elements in developing risk mitigation strategies. 

For more information about these risk concepts, read the entire Banker’s Digest article Risk Elements that Management Should Know and Boards Should be Asking, Part 2 by Weaver’s Bruce Zaret and Michael Winters. Or for information regarding risk culture, visit part 1 of this series.