Financial Risk Management: Everything You Need to Know

By: Kaplan Schweser
January 14, 2021
A conceptual graphic depicting Everything You Need to Know about Financial Risk Management

Where there is a finance enterprise, there is financial risk. Therefore, financial risk management is an essential aspect of running a successful financial firm. It is a skill set that’s in high demand, but what exactly is financial risk management? What does it entail? What kind of careers does it offer? This article tells you everything you need to know, including what it is, the techniques used, what is required, and careers in the field.

What is Financial Risk Management?

To paraphrase Wikipedia, financial risk management is a finance practice that uses financial instruments and data analysis to manage exposure to operational, credit, market, foreign exchange, shape, volatility, liquidity, inflation, business, legal, reputational, sector, and other types of risk. The purpose of this practice is to identify the sources of risk, measure it, and develop plans to address it.

Most major retail, commercial, and investment banks have financial risk management practices or departments. However, as you can imagine, it is not limited to banking. You can find financial risk management at nearly every major asset management firm, hedge fund, consulting firm, and regulator in the world.

The long laundry list of risks from the Wikipedia definition aside, in the world of finance, financial risk management is usually applied to four types of risk:

  • Market risk: This is the possibility of incurring large losses from adverse changes in financial asset prices, such as stock prices or interest rates.
  • Credit risk: This is the risk that borrowers will not repay their debt obligations in full when they are due.
  • Funding (or liquidity) risk: This is the risk that a firm cannot obtain the funds necessary to meet its financial obligations, such as short-term loan commitments.
  • Operational risk: This is the risk of monetary loss resulting from inadequate or failed internal processes, people, and systems or from external events.

Financial Risk Management Techniques

The techniques used in financial risk management differ based on the kind of risk involved. For market risk management, statistical models are used to forecast the probability and extent of significant change in market prices. Called “value-at-risk” models, they are used to set capital against potential losses. Firms also use stress tests that examine the impact of large hypothetical market movements on their portfolio values.

Managing credit risk starts by setting different levels of individual borrower, industry sector, and geographic area credit limits, all of which are usually based on internal credit ratings. Firms also use quantitative models to measure and manage credit risk.

To manage funding risk, banks and firms diversify their funding sources, hold liquid assets, and make contingency plans, such as a backup line of credit. They set funding goals as benchmarks to measure their current funding levels and take action when they are below certain thresholds.

Operational risk management requires studying how the bank, firm, or company is run, creating a comprehensive view of the business, and addressing anything that it appears might do the bank, firm, or company damage in the future. The steps involved are risk assessment, measurement and mitigation, and monitoring and reporting.

Considering Financial Risk Management as a career? Download the free Before You Sit for the FRM® Exam ebook for advice from successful FRM professionals.

What Are the Requirements for Financial Risk Management?

Here are the requirements for financial risk management, including education, skills, and qualities:

  • College and graduate degrees: A career in this risk field requires a bachelor’s degree, but a graduate degree is preferred, especially an MBA or a doctorate in finance or economics. A PhD in statistics or physics is a viable alternative. Many of those in the field also earn the FRM® designation, a certification offered by the Global Association of Risk Professionals (GARP).
  • Financial acumen: Strong financial knowledge is required. Also critical is actual experience working with numbers in a variety of situations, from contract for difference (CFD) trading to translating objective concepts into measurable items.
  • An analytical and strategic mind: Because of all the data involved, anyone who works in the field should be analytical by gathering information, interpreting it, spotting risk and opportunities, and identifying appropriate strategies for managing financial risk.
  • Technology capabilities: Anyone in this field should be able to use software and other technological solutions, such as Risk (VaR) to Risk Scenario tools. In addition, it is important to keep up with the latest technological advancements in financial risk management.
  • Excellent communication skills: Those who work in financial risk management must be able to translate complex financial risk, products, and processes into a language the front office, management, and the board can understand. For this to work well, excellent interpersonal and general communication skills are a necessity.

Our article on the qualities needed in financial risk management offers an even more detailed breakdown of these requirements.

Financial Risk Management Careers

Financial risk management careers are most often found in financial institutions such as banks, financial services companies, brokerages, and asset management firms. However, there are opportunities in other types of business, as well, such as insurance, software, oil and gas, and publishing companies. The following job roles are the most common:

  • Risk analyst or risk manager: These financial risk professionals use analytical skills and knowledge of international business and currency markets to examine investment portfolios and analyze the risk involved. They project potential losses and recommend ways to limit risk through diversification, currency exchanges, and other investment strategies.
  • Credit risk analyst: These analysts review and assess the financial history of individuals or companies to determine if they are a good candidate for a loan. They evaluate financial data, such as balance sheets and income statements, to determine the level of default risk and calculate financial ratios to help lenders make comparisons.
  • Market risk analyst: These financial risk management practitioners use knowledge of an industry or sector to research market trends and provide companies or investors with a comprehensive market assessment. The company or investor then uses this information to make decisions about investments and future ventures.
  • Operational risk manager: These risk managers investigate how an organization or business is run and identify potential sources of financial, legal, and reputational damage. The goal is to mitigate as much risk as possible and offset financial losses.

These positions are just the tip of the financial risk management iceberg. You can get more details on them and explore other careers in financial risk management here.

Why Consider a Future in Financial Risk Management?

The future is bright in financial risk management. It is a respected profession because financial risk management professionals are critical to the functioning of a business. As a result, the salaries for these positions are promising. According to PayScale, they can range from $55,000 to $150,000 annually. Its popularity as a career is also on the rise. Positions in the field are expected to increase at a rate of 7% over the next decade.

How to Get Started in a Financial Risk Management Career

As noted in the section about the requirements for a financial risk management career, you should be focused on finance or a related field for your bachelor’s degree and have your eye on master’s or PhD. Earning the FRM designation can also help you secure a position in this field because it demonstrates to potential employers that you have a mastery of the important concepts in risk management. If this career move appeals to you, our FRM Exam prep study packages can certainly help you on your journey.

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