Pros and Cons of Key Risk IndicatorsBanker Resource
July 19, 2013 — 2,473 views
The Organization for Economic Co-operation and Development defines a risk indicator as a barometer that uses mathematical models and formula to make an estimation of the potential of a resource to suffer some form of degradation. A key risk indicator is a similar tool used in management to indicate the risk involved in a decision or an activity. The prefix or key to the name ‘risk indicator’ is used typically when an important decision or activity is being analyzed. A key risk indicator is also used to define a risk indicator which does the job of indicating potential risks exceptionally well.
The Pros of Using Key Risk Indicators
The advantages of employing key risk indicators can be indexed in three simple terms:
- An anticipatory action – to reduce the exposure
- A warning intimation – that the risk appetite of the business has been reached
- A learning lesson – from previous risk events and their treatment
The timely communication of risk aptitude can help presidents, vice presidents, branch managers, accountants, controllers, loan and compliance officers, managers as well as attorneys to layout preventive measures and exit strategies. Day-to-day risk management becomes easier and more effective since key risk indicators provide a clearer foresight of the situation.
Accommodating risk management becomes easier as managers get an idea of the strings to pull to reduce exposure and get back on track. The element of surprise is also eliminated when using key risk indicators. The staff and management have an idea of what to expect of their action and in many cases, can take relevant measures to lessen the impact of damage.
The Cons of Using Key Risk Indicators
Forecasting losses using key risk indicators make Enterprise Risk Management more manageable. However, the use of KRIs comes with some disadvantages of its own. A majority of businesses have yet to crack the modus operandi of setting up an efficient key risk indicator due to its convoluted nature. Also, businesses usually get divided in the opinions of the staff and management on the use of key risk indicators. Having faith on the usefulness of risk assessment using KRIs becomes difficult for many, especially if the previous history of risk assessment if the organization was not particularly bright.
The Common Pitfalls Encountered in Implementing Key Risk Indicators
One of the challenges businesses face while implementing KRIs is the lack of consistency and standardization. The way businesses use key risk indicators can be highly inconsistent. Different businesses and often different units of the same business scout the same parameter or risk factor and name it differently. This worsens the already difficult task of accruing, interpreting, or comparing key risk indicators in an analytical way.
Additionally, proving that KRIs apprehend losses well has been quite challenging. Often times the specs defined for the key risk indicators are incomplete, inaccurate, or inconsistent. A sort of universal language across all organizations for KRI, standardized parameters, and methods is required before businesses can tap into its usefulness.