Risk management cannot be imagined simply as a totality of disconnected elements, as it is quite often done by some researchers.  It is insufficient to imagine risk management, as a totality of some universal control procedures: revelation, identification, analysis, and evaluation of risks, choice of methods and leverage on various factors and conditions of the existence of risks etc.  Though, the latest notion is surely more informative. However, this notion does not state it clearly what unites all elements of risk management into the whole, what general content is specific for various risk management processes in our time, what the boundaries are, and to what degree it is possible and necessary to manage risks.

It is obvious that not a unity of individual elements or functions of risk management process in managers’ heads notifies individual elements, parts and characteristics of risk management process on some common, systemic features. In order to imagine risk management theoretically and practically in systematic way, it is necessary to separate a key, strategic bond therein, which just makes specific, peculiar features, characteristics, functions of individual elements, change existence, characteristics and functions of these elements into a purposeful practical and historically specific process.

Such strategic bond is business arrangement, reproduction of value and capital. Risk management is a part of complex system of business arrangement and capital reproduction process. However, on the other hand, both the capital reproduction process, and complex system of business arrangement have some common, universal strategic bond, which is someway present in all private moments of business organization and capital reproduction. This bond is an interrelation of elements and processes of business organization, and reproduction of capital, directing and suppressing the cost formation during production for the sake of making a profit.

Financial resources cover all expenses in the course of reproduction not only for production and sales of goods, but also for normalization of negative or unpredictable effect on production and capital flow of external and internal factors of the organization (business). Risk management consists of impact arrangement of various factors on the reproduction process and capital flow, causing deviations with possible negative effects in them (losses and damages).

Risk management, owing to the specified strategic bond, that is to say the bias of various factors, is becoming an integral part of value begetting process, reproduction, and capital flow. In the first instance, risk management lies in the fact that economical, and, eventually, financial implications of bias of internal and external factors for specific reproduction and movement of specific capital are introduced in the certain boundaries of tolerable losses. Reproduction and business process can take place regularly and normally within the limits of tolerable losses, whereas capital flow quite regularly ends in getting normal profit, taking into account proper risk premium.

Secondly, risk management has a positive aspect. It lies in the fact that bias of uncontrolled factors is deeply reasoned, selected, creatively converted to new element combinations of organization reproduction and capital flow, which possibly provide a means for positive quantitative and qualitative changes in the organization, and the results of reproduction process and capital flow. The highest positive effect of risk management is expressed in the entrepreneurship as an activity, associated with the development of new combinations of production factor use, in innovations and their economic profit.

The essence of risk management, as a cost increase in relation to the strategic bond of reproduction process and capital flow, consists in system management of income and expenditures of reproduction process. This management is focused on the exposure arrangement of uncontrolled factors on the reproduction process, holding negative economic and financial consequences of this exposure in admissible limits for production and business, and transformation of the part of this exposure into the reproduction improvement, leading to the growth of capital, improvement of income and expense ratio.

In such a manner, risk management has two basic aspects, two levels of organization. Risk management represents the use of various bonds of reproduction process (technical, technological, organizational and administrative) on the first level of organization for the purpose of arrangement of uncontrollable effect of external and internal factors and systematic obtaining of acceptable reproduction results. The latest ones are expressed by the fact that negative consequences of uncontrolled factor exposure are kept in permissible margins, not affecting the normal reproduction course, besides, some uncontrolled impact of organization factors can be beneficially used or selected and transferred into positive changes of reproduction process.

Organization uses only own resources and possibilities for the regulation of impact of uncontrolled factors on the reproduction process at the first level. Thus, technological tools, changes in technology, sociopsychological factors, organizational management systems, personnel and scientific potential of organization and things are used.

Risk management is involved in the course of self-expansion of capital on the second level of organization. Finances become an organization form of capital self-expansion. New possibilities of organizations’ risk management and individuals on account of attraction of supplementary capital, which receive a part of risks and incomings respectively, arise thanks to financial markets, pecuniary institutions, and application of various financial instruments.   Thereupon, possibility of the company to control and retain unfavourable consequences from direct uncontrolled factor impact in some admissible and relative safe limits for finances of the company expand essentially at the expense of insurance, hedging, detachment, distribution, risk transfer of other organization or individual.

In such a manner, financial risk management represents the use of internal relations of the organization by self-expansion of capital (Marx) for income and expenditure management. This management is directed to the control provision over the economical and financial consequences of possible unfavourable events, limitation of possible economical and financial losses with permissible margins, which allow the company to receive normal profit. In addition, this management is focused on the detachment, selective use, and transformation of certain uncontrolled environmental exposure in positive changes of business arrangement, able to make additional income with a degree of probability or other benefits, which have financial measuring.

It is obvious that non-financial risk management appeared historically, primarily based on the direct enterprise management and its resources. Planning, projection of production effect allows recognizing and identifying various risk manifestations. In addition, potential of enterprise in the sphere of risk management is limited to own experience of administration, the volume of proper economic resources, which have arsenal of production management method in general.

Presence of developed financial system, financial market essentially changes the risk management of the company and individuals. Various aspects of positive financial influence on the primary risk management are eventually transformed into the financial mechanism of risk management. In order to understand the content, nature of influence, and additional features, which set a proper financial mechanism to risk management procedure, it is necessary to conceptualize the most important aspects of impact of developed financial system on the initially simple non-financial risk management process. Let us consider these aspects of impact.

1. Financial market, being an additional source of financial resources for enterprises, becomes a carrier and efficient distributor of economic information on the risks of the organization and their applied management methods, makes objectively generalized characteristics of risks, encourages (based on competition) to introduce new, more efficient instruments and mechanisms of risk controlling .

2. Rapid propagation of economic information, fast and flexible floating of financial resources on the basis of acting financial markets supposes the establishment of balance between all variants of investments as a necessary condition.

Traditional approaches to risk management are based on the specific subdivision of risks and extended set of risk management methods. Subdivision of risks on large kinds unites too broad classes of qualitatively heterogeneous unfavourable events, which should be prevented, or unfavourable consequences and/or possibility, which should be decreased. The selected methods of risk management comprise of too common, but simultaneously too identical, limited, homogeneous types of solved problems (diversification, detachment, distribution of risks etc.), too limited ways of impact on possible unfavourable events at present.

In order that the selected means of risk management are efficient, they should correspond to general and special content of unfavourable events, which they are destined to prevent, or unfavourable consequences, which they are destined to decrease. Meanwhile, a limited set of risk management methods does not fully reflect a special content of unfavourable events. Therefore, application of these methods without their further differentiation cannot be sufficiently successful and efficient.

Let us consider possible variants of unfavourable events, which may be associated with commercial risk. These possible variants of unfavourable events may be defined as risk factors.

COMMERCIAL RISK FACTORS

1. Price escalation on economic resources, acquired from outside parties;

2. Reduction of prices on the goods produced by the company;

3. Decrease in realization volume;

4. Worsening of market standing, deterioration of the competitivity (including the ability to affect prices and sell own goods);

5. Income reduction in customers;

6. Lowering of attractiveness estimation level of company goods by the customers;

7. Price reduction by business rivals, increase of attractiveness rate of their goods for the customers.

The split of specific risk types into further smaller subdivisions of undesired events, or risk factor, may be continued, if desired. «The most general, well used and efficient methods of risk prevention and reduction are the following: diversification, insurance, limitation, funds reservation, attainment of additional information on choice and effects» (A.S. Shapkin, Economic and Financial Risks. Evaluation, Management, Investment Portfolio // Шапкин А.С., Экон. и фин. риски. Оценка, управление, портфель инвестиций. 3-е изд. М.: «Дашков и К», 2005, с.286).

Enterprise risk management represents a system of principles and methods of development and realization of risk managerial decisions, securing an overall assessment of various risks and neutralisation of their possible negative effects. If we compare the selected risk factors with the most known risk management techniques, we will see that a limited set of general risk management techniques does not allow reacting efficiently against possible undesired events to the full extent.

As of today, risk management approaches have not much diversity. Thus, S.N. Vorobyov and K.V. Baldin provide two conceptions of risk management (S.N. Vorobyov, K.V. Baldin “Risk Management in Entrepreneurship” // С.Н. Воробьев, К.В. Балдин «Управление рисками в предпринимательстве», М.: Издательско-торговая корпорация «Дашков и К»): statistic conception of risk reduction, and dynamic conception. The majority of entrepreneurs prefer to rely on traditional risk management approaches, which are within the statistic conception. Its sense is in the following. All actions on prevention or reduction of risks, taken in accordance with this conception, stay unchanged in the course of realization of once accepted managerial decision. These are a sort of unchangeable single decisions, joined by one principle: to fulfill certain actions, and then wait for the outcome. In other words, the outcome of risk management actions is beyond the risk manager’s control. One may call such methods classical, as they are historically the first ones. However, companies were relatively small before their appearance, and their financial structure was simple. But these classical techniques are topical up to now. At the present time classical risk management techniques have application to financial transactions with the use of foreign exchange and capital structure.

The situation changed. Big business and stock markets more often began to encourage companies for the creation of new shareholder value. It often happens that the government takes innovation risks. New techniques are required for the provision and support of high-level capital expansion. These are techniques of alternative, dynamic conception of risk management. Market value index of the company possesses a wider spectrum of possible levers of risk management in comparison with target value of statistic conception. Apart from the growth of income and cost reduction, constituting the basis for maximization (minimization) of other basic target indicators of business operation, the increase of its market value may be associated with the growth of its image, organizational structure of company management, corporative culture, capital restructuring, synchronization of money flow of various kinds, use of synergism effect and others. And whereas the margins of profit or expenses economy have their limits in each particular company, the margins of increase of its market value have no such limits.

There are two principles within this conception. One refers to conformist, according to this principle one should adjust to risks or take corresponding actions with a view to predict risks in the future. The second principle is focused on development.

Generally, two method groups of financial risk management for the company are distinguished today: internal and external.

The internal ones are the following: avoidance of risk, limitation of risk concentration, hedging, diversification, self-insurance, transfer of risk. Measures on risk avoidance are such actions as, for example, refusal from the realization of highly hazardous financing transactions, termination of business relationships with unreliable partners, decrease of leverage ratio etc. Mechanism of limitation of financial risk concentration is used on such their kinds, which go beyond the accepted levels. Certain internal limits (standards, permissible margins) are established at the enterprise according to various indicators. It may be a maximum size (share) of borrowed funds, maximum amount of deposit in one bank or maximum volume on contracts with one counter party. Hedging is carrying out of corresponding transactions with derivative securities for the decrease of possible financial losses. For example, hedging using futures contracts annuls risks on transactions on commodity and stock exchange markets by means of carrying out of opposite transactions with various kinds of exchange-traded contracts. Diversification allows minimizing portfolio risks. Operating principle of mechanism is based on risk distribution, preventing theirs concentration. Let’s take, for example, diversification of credit portfolio. The mechanism of financial risk transfer is based on their frequent transfer to partners on separate financial transactions. The part of enterprise is transferred, on which partners have more opportunities for the neutralisation of their negative effects and have a more efficient ways of internal insurance coverage at their disposal. This may be risk distribution among the investment project parties. Mechanism of financial risk self insurance is based on the reservation of part of financial resources by enterprise, which allows overcoming negative financial consequences on those financial transactions, on which these risks are not connected with the actions of conterparties. Formation of insurance fund of enterprise refers to measures of this mechanism, as well as undistributed profit balance, received in the accounting period.

Other internal risk management techniques are also distinguished. They are risk prevention, by the affection of the risk source, risk aversion, reduction of the value of actual losses.

I.A. Blank mentions provision of demand with conterparty on financial transaction of additional level of premium for risk insurance, getting of certain warranties from the counterparty, reduction of the list of force-majeure circumstances in contracts with counterparties, provision of compensation from possible financial losses on account of specified system of penal sanctions.

Insurance of financial risks traditionally refers to external methods. At the same time, a lot of other methods refer to external methods. These are, for example, state control over the branch, price policy in the branch. Insurance is protection of property interests of enterprise by special companies (insurance companies) at the expense of money funds, formed by means of getting of insurance contribution (premiums) from enterprises (insurants) in the event of insurance event. (I.A. Blakc «Financial Risk Management» // И.А. Бланк «Управление финансовыми рисками», Киев: «Ника-Центр», 2005).  Insurance is a complex technique. It includes a large variety of techniques. Tis is direct insurance, and additional insurance, and coinsurance, and reinsurance (secondary distribution of risks), and tertiary risk profile. The enterprise may choose not only one of them, but also insurance methods in complex. Nevertheless, the inquiries of authors, who study risk management, is finished at that. But we are inclined to believe that variety of external methods is more diverse. For example, governmental regulation of risks refers external method, affecting the enterprise from the outside. This may be a regulation in the branch, for example, the establishment of certain norms of environmental allowability or output factors in the branch.

Generally, classification of risk management methods in all types of work is typical; division into internal and external, separation of certain subgroups in these method groups. We may distinguish methods, which are most often used by entrepreneurs. However, it is usually forgotten that methods are not used separately from each other. Risk management is a complex business, complex risk management system. All methods should be used interdependently in such a system. Moreover, defined risks demand the use of certain strategies. We should repeat that risks should be estimated in complex, and all methods on their management should work in complex.

Talking of investments, financial risk management requires the use of various methods of their management, which is to say, a parallel combination of insurance methods, self-insurance, hedging, and diversification on the basis of portfolio strategies. Integrated use and/or combination of methods, mechanisms and set of tools allow the enterprise to efficiently manage the investment activity. However, a part of risk may remain in the enterprise up to the supportable level for its self-insurance; another part is distributed between conterparties within business groups by way of captive or mutual insurance, moved into insurance company or a group of insurance companies for double insurance, coinsurance, and reinsurance. The most dangerous risks should be financed in reinsurance via the market at the insurance commitment securitization of insurance carriers and reinsurers. Enterprise can apply for self insurance and any other form of finite risk insurance at the low level of losses. Insurance can serve a purpose in case of severe losses. As for securitization, it may offset the losses of maximum degree; this is, for example, important for the protection of investments from heavy social and/or political risks.

Indeed, the structure of main methods of risk management can be expanded a little bit. For example, there are such risk management methods, like securitization or alternative risk transfer (ART), which are not mentioned by Shapkin.   The above mentioned are ART of the enterprise and insurers in western countries. Finite risk insurance and financial reinsurance, insured derivatives and securitization of insured risks with their direct transfer to capital markets are included here. Furthermore, they now speak about securitization of not only insured risks, but also securitization of credit risks, for example, when the whole credit portfolios are transferred to capital markets, as well as securitization of housing and public utility portfolios. In other words, alternative methods gradually receive greater diversity.

The most known methods of risk management are as follows: diversification, transfer, detachment, avoidance, redistribution, insurance, hedging, reservation (self-insurance), and limitation.

The systematized extended method list of risk impact can be shown in the following way.

Impact on risk

Decrease

Preservation

Transfer

Risk avoidance

Without financing

Insurance

Decrease of risk probability

Self-insurance

Receipt of financial assurance

Decrease of possible damage

Attraction of external financing

Other methods – contractual legal etc.

 

Classification of risk management methods (N.B. Yermasova, «Company Risk Management //»Н.Б. Ермасова, «Риск-менеджмент организации», М, Альфа-пресс, 2005, с.131):

Assumption of risk (self-insurance)

Risk avoidance (risk aversion)

Assignment of risk (distribution of risk)

Self insurance with risk fund formation

Self insurance without risk fund formation

Risk reduction by means of preventive localization and minimization

Denial of risk operations

Insurance

Use of limitation

Diversification (dissipation on the combination of kinds)

Programme of preventive measures

Transition to the conservative type investment policy

Primary distribution of risk (direct insurance)

Self-insurance in business group

Hedging

 

 

Complicated primary distribution of risk

Complicated self insurance forms

— reciprocal insurance

— captive insurance

 

 

 

Concurrent insurance

 

 

 

 

Coinsurance

 

 

 

 

Secondary distribution of risks (reinsurance)

 

 

 

 

Tertiary distribution of risks

 

Risk transfer is the interrelation of economical system, which allows involving other conterparties in the risk management process, transferring the risk to them since before the occurrence of an event. This is the most infallible method of risk management, as it allows neutralizing the loss of assets via the risk transfer to partners on individual business processes by means of contracting.

Risk aversion consists of timely study for every concrete risk form and adoption of measures in order not to allow the development of events, which lead to threat and losses. For example, risk prevention in the loan granting process (credit scoring system) acquires special topicality now. 

Risk aversion is not to be engaged in the kinds of activity where risk acts in such a way, that the company cannot handle it on its own. This method consists in the elaboration of measures, which fully excludes the risk kind. Refusal from certain expectations, prognoses, risky processes are implied. In practice the given method is most often realized in the form of refusal of the subject from transactions, connected with high risk, and preferences in favor of less risky or riskfree projects. For example, it is refusal from the use of borrowed funds in high volumes.

Impact on the risk source consists in attempts to changes the risk source behavior in order to decrease the threat from it. For example, it is possible to establish certain restrictions, access control to various investment transactions, which have high volume and importance.

Risk taking is understanding and evaluation of risk with ensuing consequences in case of measure rejection on its protection with simultaneous failure of risk management. Various regular small company’s risks are consciously taken, periodically writing down the losses, allowed by local legislation. This metod can be applied only in relation of these risks, defense against which costs more than predictable losses.  Normal reserves on losses are budgeted for such risks.

Reduction of unsafe behavior consists in protection of hazardous areas, establishment of cross check for the employee behavior, enhanced training and coaching of staff, adjudgment of fine and penalty rates of insurance for individuals and subdivisions, which repeatedly admit overexpenditures and other losses. In its turn, value decrease of potential losses consists in the establishment of absolute limits for investment resources – for example, investments in extremely dangerous industry sectors.

All named methods are essentially connected with the fact that, risks objectively exist in economics and society. Business entities undertake various actions in order to objectively and independently decrease negative consequences from substantial risks: to scuttle, delegate (for money) to others, redistribute responsibility, share it with others etc. Besides, various financial instruments are predominantly used for risk management; contracts, focused on price adjustment, interest rates, financial budgeting and forecasting, creation of financial reserves (self-insurance), insurance, hedging, pooling of financial resources for loss covering etc.  Such risk management can be called management on the ground of responsibility redistribution (for the consequences of objective risks).

In addition to the named methods of risk management, one may distinguish risk management on the ground of modification of risk origin conditions in production and economic activities. In this case integrated risks can be decreased for the whole society.

For example, one of commercial risk factors is price escalation on goods of suppliers of the given enterprise. Financial defense instruments against the given risk factor are as follows: long-term delivery contracts with price fixation, material stock gain, acquired at old prices, hedging of real bargains by contracts purchase.

Safety methods from price appreciation on goods by suppliers by means of changes in business conditions may be as follows:

— formation of consortium (association) of manufacturers for mutual purchases of materials or other recourses directly from their manufacturers;

— technological development, leading to relative lessening of the need in the advanced resource;

— transition to full or partial utilization of alternative resources;

— relative decline in production, using more expensive resources, redistribution of economic resources in enterprises in favor of other types of production or business;

— development of own material resource production, replacing more expensive supply from outside suppliers;

— state stimulation of competition in the sphere of relative appreciation of product manufacture;

— activation of state antimonopoly management;

— liberalization of export markets.

Formation of optimal protection tools from various risks associated with the division of fundamental risk types, combining varieties of unfavourable events, to individual risk factors, within which more qualified and more homogeneous sets of possible unfavourable events are grouped. Such division must provide the selection of special-purpose risk management tools, which may be selected according to the principle of the most effective targeted action on the specific risk factor.

Systematic division of various risk kinds into dozens of smaller and more homogeneous ones according to their risk factor content, which take place in the company, will allow to find common management tools for the same or similar diverse risk factors. Thus, one can select tools, which are the most suitable not only for the management of individual risk kinds of the company, but for the whole system as well. Comparison of miscellaneous factors of various risk kinds on the ground of separation of alternatively possible tools for their management will allow to find more rational tool combinations for the management of all set of risks. Consideration and assessment of alternatives will allow to exclude combinations of incompatible or badly compatible tools of risk factor management, or, at least, find the best combination from partially compatible tools of risk factor management.

Tools of simultaneous efficient management of several factors of various risk kinds acquire special importance for the systemic risk management. On the other hand, systemic risk management, contrary to separate, isolated management of selected risk kinds in the company supposes the selection of the most relevant risk factors for business functioning. Large risk kinds cannot be neglected: they all should be controlled. But how can resources be rationally redistributed in order to avoid or reduce losses from the most dangerous possible negative events?

A reasonable answer to this question is to accumulate resources for the opposition to systemic (comprising several risk kinds) most essential risk factors. But the most essential risk factors are individual for specific enterprises and for their situations. Consequently, for the reasonable selection of risk factors, it is necessary to learn how to objectively and uniformly estimate their application in relation to heterogeneous classes of unfavourable events, which should be equally efficient, self-consistent and useful.

Consequently, in order to raise effectiveness of risk management, it is necessary to find more differential means of risk management compared to general methods, in order to secure their targeted compliance to subspecific diversity of possible unfavourable events, available in practice.