This lesson examines how financial institutions classify risks and the principles of Enterprise Risk Management (ERM).

2.1 Taxonomy of Financial Risks
Financial institutions face a wide range of risks that can be categorised into several types :

  • Credit Risk: The risk of loss from a borrower failing to meet its obligations .

  • Market Risk: The risk of losses from adverse movements in market prices (e.g., interest rates, exchange rates, equity prices, commodity prices) .

  • Liquidity Risk: The risk that the institution cannot meet its short-term financial obligations .

  • Operational Risk: The risk of loss from failed internal processes, people, systems, or external events .

  • Regulatory and Compliance Risk: The risk of legal or regulatory sanctions, financial loss, or reputational damage .

2.2 Enterprise Risk Management (ERM)
ERM is a holistic, integrated approach to managing the full spectrum of risks facing an organisation . The IRM syllabus frames ERM as a key concept for financial services, emphasising that it moves beyond “siloed” risk management to a comprehensive, firm-wide view . This integrated perspective ensures that risk is considered in strategic decision-making and that capital is allocated efficiently . Key features of ERM include risk appetite definition, risk aggregation, and performance evaluation .

2.3 The Risk Management Framework
A formal risk management framework provides the structure for identifying, assessing, and managing risk . Key components include:

  • Risk Identification: Using a range of techniques to identify potential sources of risk .

  • Risk Assessment: Analysing the likelihood and impact of risks .

  • Risk Measurement: Quantifying risks using tools such as Value at Risk (VaR) and stress testing .

  • Risk Response: Selecting appropriate strategies to address risks (tolerate, treat, transfer, or terminate) .

  • Risk Monitoring: Continuously monitoring the risk profile and the effectiveness of risk controls .

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