Managing uncertainty

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(New Straits Times Via Thomson Dialog NewsEdge) WE have many outstanding statesman whom we revered. In my Form Six history lessons in the early 70s, one that fascinated me was Benjamin Disraeli, (British premier 1804-1881). One of his famous statements was: "What we anticipate seldom occurs; what we least expect generally happens". This quote has a lot of relevance to the art and soul of risk management because its fundamentals are not complete without the understanding of "uncertainty" or "unknown". Indeed, risk is all about the uncertainty of risk occurring. If we know the risk will occur, we will not do the deal or execute the operation.



The fact is that we do not know, and only hope that it does not occur.

For this reason, we diligently apply all the known ways of managing the uncertainty of risk occurring. Obviously, it is not easy to prevent the risk from occurring, especially if it is something beyond our control. But if it does occur, the negative impact would be minimised to that we could accept or live with. After all, we are not too concerned about the risk per se. Rather, our focus is on the impact of the risk that may be negative for us. If the impact is positive, or we gain from the risk, then of course that would be welcomed. WHAT CAUSES UNCERTAINTY? Uncertainty crops up because of few factors that haunt our mindset, attitude or opinion. They include: * Uncertainty due to poor overall decision and wrong opinion: The feeling that the option or decision we take would be the wrong one; * Uncertainty due to rationale or relationship: The rationale or relationship of the issue being studied might be seen from the wrong perspective where we may have inadequate parameters; * Uncertainty due to doubt in the analysis process: The model/guide-values for our evaluation of the issue may be irrelevant or wrong; * Uncertainty due to inadequate sampling: The statistics that we use for the assessment of the subject matter might be insufficient, unrealistic, incomplete or outdated; and * Uncertainty due to errors and biases: The analysis done for the samplings taken might be tainted with errors and poor human judgment.

The above five factors causing the doubt. The elements of unknown/uncertainty in us can turn haywire to our risk management programme. To minimise such unknown, it is vital to ensure that these issues are adequately addressed.

RISK OCCURS FROM THE UNKNOWN. It is not easy to manage unknown events, as some of the risks are beyond human controls, such as flood, earthquake, tornado and robbery. However, managing the negative financial or non-financial impact might be easy to strategise. For example, we can keep all our precious assets on higher floor, so that should a flood still occur after a heavy rain, the negative financial impact and damage by water would be minimised. Or we would install an alarm system in our premises so that should the robbers came unannounced, they might abort the raid because the alarm bell was triggered. Thus the risk of robbery is mitigated. Assuming we have taken the burglary insurance cover, should the robbers succeeded in carting away the valuables, we would have the financial loss minimised because we have insured the valuables and could claim back the amounts from the insurance company.

THE PAST AS GUIDES TO MOVE FORWARD. Machiavelli, an Italian philosopher and statesman who lived from 1446 to 1507, once said, "Wise men say, and not without reason, that whoever wished to foresee the future might consult the past." More often than not, risk managers rely a lot on past data and historical events to chart forecast and assess the various risks inherent in any organisation. A lot of truth prevailed in the quote by Machiavelli. In some instances, history tends to repeat itself because the same kind of risk could surface again at some later time, if such risk is then not effectively managed using the lessons learnt from the past risk occurrence. RISK MANAGEMENT IS A PROACTIVE ART. Of course, we must be mindful that risk management is not about history alone. It should have balanced proactive feature - using the previous risk occurrences to predict what would happen in both the short and long period in the future. It is not a fallacy to state that risk management is about moving forward. It is about preparing and predicting the future state of events and operations using past patterns or historical trends in supporting such predictions.

SIX WAYS TO TREAT THE UNKNOWN. How do we treat risk? There are many ways, but the more popular options are: i) Avoid. We can simply avoid the risk and do not do the deal. But this is not really risk management since there will be nothing to manage anyway, given that the transaction or operation is aborted. But not everything is as simple as that. There are risks that we have to face everyday, and as part of our way of doing the business and operations. ii) Share. We can share the negative risk impact by putting up a strategic alliance, joint-venture or merging our smaller outfits to bigger outfit that can withstand more risk or cushion the negative impacts. There is truth in the adage of "strength in unity" and the bigger the size, the stronger it should be. iii) Transfer. A good example of risk transfer is using insurance. An insurance policy taken to cover the damage and loss by fire would provide comfort to the property owner as he would be able to receive the financial compensation benefits from the insurance company. However, not all risks could be insured. We are still left at the mercy of the non-insurable risks. So, the need to ensure that we have a good risk management plan to address those non-insurable risks is very critical for the success of any organisation. iv) Reduce. We can reduce the likelihood of the risk to occur, and minimise the negative impact of the risk by either cutting down on our exposure or involvement in the operations.

v) Accept. Many risks that haunt us are common day-to-day events that cannot be avoided, which we address as the cost of doing that kind of business. We need to accept those risks as a normal way to do the business. An example of this kind of risk is a supermarket's cashier with a minor cash shortage at the end of the day's takings. vi) Prevent. Some forms of risk can be prevented from occurring. For example, theft of valuable asset from a strong room is a risk. One way to prevent this is to ensure that no one can enter the strong room alone, and a closed-circuit TV must be installed for monitoring purpose. There must be at least two people holding the keys and going in at any time. The writer is chief risk officer of a commercial bank and author of Enterprise-wide Risk Management Made Easy. He can be reached at e-mail: [email protected]. Part two of this article will appear next Saturday.

Copyright 2006 The New Straits Times Press (Malaysia) Berhad. Source: Financial Times Information Limited - Asia Intelligence Wire.
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