Mitigating non-financial risks helps sustain organisation’s growth

LAHORE: Businesses usually take appropriate measures to reduce financial risks on their product and services; however, they mostly fail to take into account the non-financial risks they might incur due to non-compliance of regulations and inferior internal monitoring.

Producing a product or delivering a service efficiently is not enough for sustained growth of an organisation, until it is accompanied with a strategy to mitigate non-financial risks as well. A bank might be excelling in credit card business, but if proper controls are not in place, it might become a victim of credit card fraud.

Similarly, a medicine launched without properly taking into account its adverse side effects may cost the manufacturer a fortune if it has to be withdrawn when side effects start impacting the patient. The company might have to pay compensations to the affected patients.

The most recent and expensive non-financial risk was taken by Volkswagen that developed a software showing the company’s vehicles complied with the best emission standards; which in fact was not true. Volkswagen was polluting atmosphere much above the allowed limit.

When the trick used by the company was exposed, it had to withdraw all its vehicles and was subjected to billions of dollars of penalties in the United States.

Globally, as well as in Pakistan, banks are very careful while taking financial risks. They cover their loans by demanding collateral that has higher value than the loan amount.

This is the reason that the banks generally do not lose much in financial deals. The bankers however lower their guard while violating compliance standards, misconduct, technology or operational challenges.

Violation of prudential regulation of State Bank of Pakistan should be avoided at all cost. These violations invite heavy penalties. These penalties eat in to the profits of the banks as non-compliance or technology oversight could result in defaults and frauds.

Realising the substantial downside of non-financial risks, prudent companies establish risk and control management wings that evaluate all types of risks the organisation is likely to face, and suggest ways to mitigate them.

The risk managers also evaluate whether the cost that will be incurred on a particular risk, is worth taking. In case the risk is low and the cost is very high they prefer to take that risk. This means that assessing, managing, and mitigating risk must be justifiable on business grounds.

Non-financial losses fall in five categories. Some losses are minor but tend to occur frequently like credit card frauds. Wrong doing by the management results in heavy losses; the regulatory fines for non-compliance are another category.

It is not restricted to banks but also to food outlets and telecommunication service providers. Banks suffer losses on failure to comply with greater capital requirements. The most severe non-financial damage is that of reputation of the company, as suffered by Volkswagen.

If the risk management wing succeeds in identifying the risks, it reduces the burden of insurance charges on the organisation. The insurers differentiate between companies that have identified all risks and taken appropriate measures to address them and the companies that tend to ignore many risks.

Preventing or reducing the impact of risk also reduces remediation costs. It spares the companies of the cost of reviewing thousands of files. Internal audit can play an important role in mitigating both financial and non-financial risks.