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Risk Perceptions and Risk Appetite: Role of the Risk Matrix

By Okechukwu Onwuka

Last week we started the series on business risk assessment and management. This week we continue by reviewing the values in the use of the Risk Matrix. Fundamentally, we all differ in terms of the way we view or perceive risk. In much the same way, our risk appetites differ. While some people are chronic risk-takers, others are extremely conservative.

For some, flying is an extremely risky venture. If a journey cannot be made by road or sea, forget it. They simply cannot afford to go through the trauma of flying, made much worse by the fact that when air accidents occur, it is almost always costly in terms of life and property damage. Some others consider military service extremely risky while another group consider running any kind of business as high risk. On closer examination, you’ll find that those who consider air travel as risky, only think of the consequences that result from an aircraft accident or failure.

Although the probability of death or multiple fatalities in an air crash is high, the likelihood of an air crash is quite low. When you compare the rate of vehicle road accidents per year with that for aircraft accidents, you’ll find that vehicle accidents and deaths occur at a much higher rate than air disasters.

This suggests that to have a balanced perspective on risk, we need to factor in the likelihood(probability) of the unwanted event occurring together with the likely impact (Consequence).

This is somewhat academic because the traditional mind tends to use experiential or  generic knowledge of consequence/impact only to categorize risk. Relative likelihood is not often given significant thought, especially if the decision is not to be taken in a corporate setting where formal risk assessment practices are entrenched. What tends to happen is that we make judgements based on our perception of specific risks in line with our risk appetite. In basic terms, risk appetite is the relative propensity to accept the risks on the path of venture or task.

People or companies who pride themselves as risk takers would often take on dangerous projects, partly to satisfy an idiosyncrasy, prove critics wrong or pursue the anticipated high gain rewards. Conservative risk takers will not take a chance on anything unless they a reassured that nothing will go wrong.

These group of people are more interested in preserving their value, capital or reputation than take an unacceptable level of risk for high gains. The former group tend to believe that the end justifies the means. Whatever group you belong to, it is important to have a method of determining or estimating risk levels.

Because business is all about risks and risk management, a proper estimate of risks becomes of prime importance in effective and efficient decision making process. Basically, all risks can be classified into three broad zones. Each of the zones would have different risk handling strategy. The zones are HIGH RISK, MEDIUM RISK and LOW RISK.

HIGH Risk: These are risks that you or the company MUST reduce to at least MEDIUM risk level by implementing additional controls or safeguards.
Otherwise, the task or project may best be discontinued.

MEDIUM Risk: These are risks that can be TOLERATED if the cost or effort required to reduce them further will not be worth the value in risk-reduction.

LOW Risk: This is the broadly acceptable  but uncommon risk level. There is no need to really apply further efforts to manage low risks unless the risk owner considers further risk reduction efforts as inexpensive.

Risk Matrix. The next step is to define your risk appetite in a Risk Matrix as a formal tool to manage your Risk Acceptance Criteria. A simple 3 x 3 Matrix is illustrated below. Every individual or company has unique risk perception and consequently, should have a customized Risk Matrix.

In the sample matrix below, an event or incident that could result in a loss in excess of N50m is considered of SEVERE consequence category. If the likelihood of the event occurring is FREQUENT, it means the event is a potential HIGH Risk one. Anyone in charge of managing the event or task will be required to identify and implement steps to reduce the risk to at least MEDIUM.

There are many ways of doing this and we shall address this in the near future. The key thing to observe now is uniqueness of the risk matrix and the value definitions.

For some multi- billionaires, a N50m loss potential will be considered MINOR. For an undergraduate, a N100,000 loss potential may be considered SEVERE. This is one reason why you should not use another person or company’s risk matrix definitions without calibrating against your own specific situation. If you take another look at the Consequence chart, you’ll notice 3 categories, FINANCIAL, HEALTH and REPUTATION. This implies that risk impacts go beyond just money.

While some people don’t care if their reputation is damaged in the pursuit of wealth, there are others who will not attempt any venture with a high risk of reputation damage. The potential to cause death (Fatality) in personnel is another area for evaluating consequence.

Although no one wants to die in the pursuit of money, some others do not care if other people’s lives are lost in the process, so long as they are connected or loaded enough to cover up the potential crisis or backlash. You can begin to see the importance of really taking the time to develop some form of risk matrix for your business or company as a functional decision-making tool. This becomes even more important in group ventures or companies where people from diverse backgrounds and orientation come together as members of management team or board.

A harmonized, reviewed and approved company risk matrix together with clear working definitions for PROBABILITY and CONSEQUENCE categories becomes a common basis for taking decisions on Corporate Governance and Strategy formulation. How do the uneducated and successful enterpreneurs without a formal documented risk matrix succeed? Find out next week.


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