Risk Management Framework (RMF): Definition and Components

What Is a Risk Management Framework (RMF)?

All companies face risks. Without taking some degree of risk, they may have little chance of staying competitive. On the flip side, taking too much risk can lead to business failure. An effective risk management framework aims to strike the proper balance, protecting the organization’s capital and earnings without hindering its growth. In addition, investors are more willing to invest in companies with good risk management practices. This generally results in lower borrowing costs, easier access to capital, and improved long-term performance.

Key Takeaways

• Risk is a reality for business owners and managers regardless of the industry sector or size of the company.
• Well-run companies have a comprehensive risk management framework in place to identify existing and potential risks and assess how to deal with them if they arise.
• Risk identification, measurement, mitigation, reporting and monitoring, and governance are the five key pieces of an effective framework.

Understanding Risk Management Framework (RMF)

Effective risk management plays a crucial role in any well-run company’s pursuit of stability and growth. The adoption of a risk management framework that embeds best practices into the company’s risk culture can ensure its ability to withstand both the predictable and unpredictable perils it may face in the future.

For example, companies in the investment industry rely heavily on risk management as the foundation that allows them to ride out serious market downturns.

The 5 Components of Risk Management Framework

There are at least five crucial components that companies must consider in creating a risk management framework. They are risk identification, risk measurement and assessment, risk mitigation, risk reporting and monitoring, and risk governance. Here is a brief explanation of each:

1. Risk Identification

The first step in analyzing the risks a company faces is to define the risk universe. The risk universe is simply a list of all possible risks. They may fall into such categories as operational risk, regulatory risk, legal risk, political risk, strategic risk, information technology (IT) risk, and credit risk.

After listing all its possible risks, the company can then select the risks to which it is most exposed and divide them into core and non-core risks. Core risks are those that the company must take in order to drive performance and long-term growth. Non-core risks are often not essential and can be minimized or eliminated completely.

2. Risk Measurement

Risk measurement provides information on the amount of either a specific risk exposure or an aggregate risk exposure and the probability of a loss occurring due to those exposures. When measuring a specific risk exposure, it’s important to consider the effect of that risk on the overall risk profile of the organization. For example, some risks may provide diversification benefits, while others may not.

Another important consideration is the ability to measure exposure. Some risks are easier to measure than others. For example, market risk can be measured using observed market prices, but measuring operational risk is considered both an art and a science.

Specific risk measures often give the profit and loss (P&L) impact that can be expected if there is even a small change in that risk. Common aggregate risk measures include value at risk (VaR), earnings at risk (EaR), and economic capital. Techniques such as scenario analysis and stress testing can be used to supplement these measures.

Note

ISO 31000 is a set of international standards associated with risk management and mitigation.

3. Risk Mitigation

Having categorized and measured its risks, a company can then decide on which risks to try to eliminate or minimize, and how many of its core risks to retain. Risk mitigation can be achieved through such means as an outright sale of assets or liabilities, buying insurance, hedging with derivatives, or diversification.

Companies have more direct control over certain kinds of risks than others, but they need to attempt to mitigate against all of the significant ones.

4. Risk Reporting and Monitoring

It is important to report regularly on specific and aggregate risk measures in order to ensure that risk remains at an acceptable level. Financial institutions that trade daily will produce daily risk reports. Other kinds of enterprises may require less frequent reporting. Risk reports must be sent to risk personnel who have the authority to adjust (or instruct others to adjust) risk exposures.

5. Risk Governance

Risk governance is the process that ensures all company employees perform their duties in accordance with the risk management framework. Risk governance involves defining the roles of all employees, segregating duties, and assigning authority to individuals, committees, and the board for approval of core risks, risk limits, exceptions to limits, and oversight in general.

What Is the NIST Risk Management Framework?

The NIST Risk Management Framework is a federal guideline for organizations to assess and manage risks to their computers and information systems. This framework was established by the National Institute of Science and Technology to ensure the security of defense and intelligence networks. Federal agencies are required to comply with the risk management framework, but private companies and other organizations may also benefit from following its guidelines.

What Is the COBIT Risk Management Framework?

COBIT, or Control Objectives for Information and Related Technology, is a framework for the management and governance of enterprise IT. It was developed by the Information Systems Audit and Control Association (ISACA) to set reliable auditing standards as computer networks became more important in financial systems.

What Is the COSO Enterprise Risk Management Framework?

The Enterprise Risk Management—Integrated Framework is a set of guiding principles established by the Committee of Sponsoring Organizations (COSO) to help companies manage their business risks. It was originally published in 2004, although COSO has issued several updates to the framework as risk management practices have evolved.

The Bottom Line

Risk management is an essential part of running a business. As the market landscape changes, companies must constantly evaluate and reassess their own risk profiles. Having a strong risk management framework can help organizations identify and prepare for the different threats and dangers that they might face.