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Class 7 ‘Soft’ risks From counting risk to making risk count

Class 7 ‘Soft’ risks From counting risk to making risk count. How to deal with ‘soft’ risks that are hard to quantify?. Environmental risk Legal risk Political risk Social risk Reputational risk …. Ignore Focus on measurable risks

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Class 7 ‘Soft’ risks From counting risk to making risk count

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  1. Class 7‘Soft’ risks From counting risk to making risk count

  2. How to deal with ‘soft’ risks that are hard to quantify? • Environmental risk • Legal risk • Political risk • Social risk • Reputationalrisk • … • Ignore • Focus on measurable risks • Quantify and aggregate together with market and credit risk • Use special tools for framing and visualizing • E.g., provide top management with alternative future scenarios and expert opinions on emerging risk issues

  3. “Quantifying operational risk is basically a flawed thing because it is like measuring road safety risk in terms of traffic and the death toll. But the death toll is a function of whether the road was safe, whether the drivers drove too fast, and so on. So counting the death toll misses the point, and similarly, you cannot control operational risk with capital. That is just kind of a fine. It doesn’t trickle down to the businesses, it does not create incentives to operate without flaws. In order to really address this, you need to have a Six Sigma or a quality management initiative.”

  4. Political risk is becoming more subtle • Stems from the exercise of power by the government and related groups • Government action… or inaction • E.g. failure to issue permits as required • Country-wide or firm-specific • Raising taxes • Company’s expropriation / selective enforcement • Political instability / war • Change of power at elections

  5. Example of political risk in Russia: YukosHow to quantify this risk?

  6. Goriaev and Sonin (2007): Market reaction to Yukos events in 2003 Which YUKOS events had the strongest impact? • Employee-related events involving law enforcement agencies Which companies were more sensitive to YUKOS events? • Private firms: RISKS • Non-transparent – tax review • Oil industry – review of oil export tariffs • Privatized via loans-for-shares auctions – privatization review • State-controlled firms: • Transparent – larger involvement of bureaucrats

  7. How can foreign investors manage political risk? • How to measure political risk? • Country ratings • E.g.: Indonesia vs. Chile in 1997 • Surveys of customers • News smart search • Experts / consultants • War room: analyzing incentives and responses of political actors • How to manage it? • Legal contracts? • Insurance? • Financial instruments? • New tools • Maintaining goodwill • Framing investment • …as fair, equitable,… • Finding political pressure points

  8. In-class discussion. How to deal with regulatory risk? • Describe a possible (worst-case) scenario realizing regulatory risk for a large Russian bank. • How can the bank manage this kind of risk? • Suggest at least two alternative methods of risk management for your scenario.

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