Risk Management - interview with Professor Rachev

Professor Svetlozar T. Rachev, Chair of the Department of Statistics, Econometrics, and Mathematical Finance in the School of Economics and Business Engineering, Karlsruhe University

Raw material prices are skyrocketing, environmental consciousness is on the rise, and financial markets are being shaken by crises. In such a situation, it's important to recognize and assess at an early stage the risks associated with these and other global developments, and then take measures to counteract them. Systematic risk management can help prepare companies for crises in advance, while also contributing to overall business success.

The global markets are currently marked by instability and uncertainty. What risks does this pose for globally operating financial service providers?

Today, companies are not threatened by risks specific to individual markets but instead by market interdependencies. It's becoming increasingly the case that a sharp downturn in one market leads to declines in others. A good example of this is the sub-prime lending crisis that originated in the United States but also had a negative effect on financial markets around the world, impacting everything from highly speculative hedge funds to standard securities. The important thing today is to recognize risks that threaten several different markets simultaneously - including the financial services market, for example.

Is there anything the automotive sector should be paying particular attention to at the moment?

For one thing, commodity and energy prices are skyrocketing, with the increases affecting not just oil, but also metals, plastics, and electric power. Because the auto industry has a global focus, exchange-rate risks must be taken into account as well. Also to be considered are fluctuations in vehicle residual values, which can impact the vehicle financing business. Risk management systems in the automotive sector need to look at environmental aspects as well and the traditional risks also have to be kept in mind. These include interest rate changes, credit defaults, and operating risks resulting from flawed budget planning or IT system failures, for example. Finally, the risk of damaging a company's good reputation shouldn't be underestimated either.

Sounds like a job for a clairvoyant. Short of being able to see into the future, how can a company prepare itself to address all of these potential risks?

By implementing an intelligent risk management system, which is admittedly a complicated thing to do – but it can be done nevertheless. The first thing you have to do is to recognize and monitor risks. Next, you need to take measures that will contain these risks to the greatest extent possible. For example, a company can counteract rising energy costs by utilizing energy more efficiently. The key here is to establish an integrated risk management system that takes a holistic view of risks and how they interact, rather than just addressing each risk individually.

Regulations and guidelines like Basel II or the Sarbanes-Oxley Act, have made companies more aware of the importance of risk management over the past few years. Isn't that enough?

The Basel II regulations play a major role in rating customers and thus in the loan approval process. Sarbanes-Oxley requires joint stock companies to provide complete and accurate financial information and to use transparent business processes. The legal requirements regarding security and transparency have thus become much more stringent as a result of such measures. But that's precisely why it's essential to have systematic risk management at every level of a company – and a lot of firms still need to improve in this regard.

Many companies believe that risk management offers additional benefits. The catch phrase here is "yield risk management." What exactly does this mean?

I understand it to mean achieving a balance between regulatory requirements and internal controlling procedures for managing risks and yields. In other words, this whole process is not just about obeying laws or protecting a company from nasty surprises, because risk management can also help companies develop innovative strategies, products, and services.

Are you saying that systematic risk management can generate a competitive edge?

Yes, because every risk also holds an opportunity. Companies that carefully compare their current risk profile with their strategic goals can plan more reliably, make more effective decisions, develop fresher ideas, present themselves more transparently, and significantly improve their attractiveness and image. Risk management is therefore an investment that pays off.