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Risk identification

Category: Corporate Governance

Proper risk identification focuses on recognizing and understanding existing risks or risks that may arise from new business initiatives. Risk identification should be a continuous process, and should occur at both the transaction and portfolio level.

The focus is the view of whether the risk causes a negative deviation from desired or planned outcome or whether the negative effects are the risk itself. Sometimes a mixture of cause and effect (or so called Risk Identification Matrix) is used by banks for identification of risk.

For example:

In 1995, Nick Leeson, a 28 year old derivatives trader in the Barings Singapore office lost over $1.4b betting on Nikkei futures, wiping out the bank’s equity capital and making it technically bankrupt.

The conventional view that Barings’ derivatives losses were actually not market risks but operational risks, because no oversight was placed on transactions performed by the dealer.

It is not a matter of «either-or» but «cause and effect». The causes were doubtless operational: the grossly negligent breach of recognized internal control principles. But it is just as clear that the effect was an unexpected loss of market value, that is, market risk.

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