What is Risk Anyway?

There is so much confusion about what is risk and risk management even among professional risk managers that one has to wonder how much of this confusion contributes to the recurring risk management crises such as the current subprime mess.

I have often heard that risk management is everybody’s business, which means that it is in effect nobody’s business. Or I hear the risk of this and the risk of that and so on and so on which makes it sound as if everything is a risk, which effectively means that nothing is a risk. Science has achieved results, where other approaches have not, mainly because it took undifferentiated blobs (things or concepts) and separated out its components and developed an understanding of the properties of each of its components and their interrelationships. I think this approach could help remove much of the misunderstandings current running rampant within the risk management profession.

I recently read an article in which the CRO of one the world's largest financial intuitions was quoted as saying that business is about taking risk. Now that’s a fine example of muddle thinking, if there ever was one. Does that CRO really believe that everyday business managers wake up and say, “Which risk will I take on today?”

Business is about making money, period. Unfortunately, in this world, most of the time when we set out to make money so many things can go wrong that instead of making money we end up losing money. And risk is simply the potential to lose money. And so hopefully for the shareholders of that financial institution, what the CRO meant is that in taking actions to make money, business managers have to take on risk. So far so good, but not very insightful. Hopefully that CRO also meant to say that just as there are so many ways of making money there are so many levels of risk for any one of those ways. Put more simply, by taking action A you expect to make X, but you have the potential to lose Y. However, if you restructure action A you can still expect to make X and only potentially lose much less than Y. And that is what risk management is all about.
The current subprime mess and all its collateral losses runs in the trillions, once the share value losses suffered by the shareholders of financial institutions are added to CDO investor losses. Perhaps if CROs were more clear in their thinking the losses would have been much much smaller.