Key risk indicators (KRIs) can measure the level of risk a business is exposed to. They can quantify the impact and the likelihood a risk could have and how it would affect the company. They are an important part of risk management as they alert managers if the business is surpassing the acceptable level of risk exposure. Key risk indicators are useful tools when it comes to monitoring risk and assisting the business in taking action to mitigate and control threats. Indicators will change as risk changes so they need to be observed carefully so risks can be predicted with better accuracy.
How useful are key risk indicators?
Key risk indicators are metrics that can detect flaws within an organisation’s risk management and help a business use its resources efficiently to control risks. If used effectively, key risk indicators can be beneficial in fortifying the business against threats. To develop effective key risk indicators, managers need to have a clear understanding of the company’s objectives and know how to use technology to improve their risk management.
The purpose of key risk indicators is to help in decision-making as the warnings it provides assist in the prioritisation of urgent matters. They can identify the obstacles that could hamper goal achievement and growth as they can detect the risks that apply to each objective.
Effective key risk indicators can be very useful in risk treatment and improving risk reporting. This is because they establish the risk appetite and exposure the company can handle so they enable leaders to adopt a proactive approach. When a company thinks ahead and is prepared, its response to risk will be better organised and more appropriate to the issue it is facing.
How to design effective key risk indicators
To develop useful risk indicators the company needs to understand the root cause of the threat. To do this, they will need to examine the internal and external environment to obtain high-quality information. The organisation should try to include data on the processes and technologies that the business uses as well as the employees and any weaknesses the business has.
The characteristics of effective key risk indicators are:
Key risk indicators need to be quantifiable. They should be able to be expressed in numbers, ratios and percentages and they should have a limit or a range that they reach before warning the management of an issue. They should be accurately measured and meaningful. For example, a business may use a percentage to measure employee satisfaction with the current work culture or leadership changes. Another example could be the use of ratios such as the value at risk or quick ratio in the finance industry. The value at risk (VaR) focuses on the risk an investment carries while the quick ratio determines an entity’s ability to pay short-term liabilities, more specifically, it looks at its solvency.
It is important to remember that risks are dynamic. They are constantly changing and so do the areas that are impacted and the likelihood of risks materialising. Key risk indicators should be able to predict the likelihood of a risk and the impact it could have on the organisation. The metrics used must be able to recognise how much a business can handle and alert the management as quickly as possible.
Key risk indicators should be comparable over time and easily compared to industry standards. The numbers and percentages used must be simple to use for comparison among competitors. The business can also use them to analyse performance based on previous years’ numbers.
The KRIs must directly associate with the risk they were created for. It should be clear how the information it provides was sourced and should not include data that is irrelevant to objectives. The information obtained should be used so decisions can be made accordingly. The risk tolerance levels must be assessed carefully to ensure that the key risk indicators provide a clear picture of the risk status.
Once these four characteristics have been established the KRIs can be designed. To create effective KRIs a business must:
To identify the risks, the probability and the impact the entity may undertake a risk assessment that will prioritise the achievement of the main business objectives. This will assist with the relevancy of the KRIs as they will be created to identify what could prevent these goals from being achieved.
There is not a specified number of KRIs an entity needs. It varies by organisation and industry and the number of risks a company is dealing with. However, the more key risk indicators a business chooses, the harder it is to track, monitor and review them. The company has to decide how many it can select based on the resources the business has available. Employers need to ensure that the KRIs chosen have all the characteristics that are necessary to be effective. They also need to ensure that the indicator chosen can detect the root cause of the threat.
Employers may choose to have key risk indicators for the whole organisation and then departments can choose to select their own for their area of operations. Employees undertaking the selection process need to be well-trained and knowledgeable to set acceptable risk tolerance thresholds and risk triggers. Once reached, these will warn the company of potential vulnerabilities and threats.
As highlighted, risks are dynamic. They can change over time due to external and internal factors. This means that the risk exposure of the business is also changing. It could decrease or increase which is why it is crucial to remember that risk management is an ongoing process. It is not enough to identify and select KRIs, employers have to monitor them frequently and review them. Observations should be reported to management as they will help with mitigation and strategic decisions. The business may decide to monitor some areas more closely or they may decide to take action based on thresholds being exceeded.
Once the selection process has been finalised and the KRIs are being monitored, the company has to develop a response plan in case risks materialise or reach the KRI limits. Timely action will ensure that there is little business disruption and the business continues to operate normally. For example, the percentage of customers who do not pay their debts to the organisation may increase which leaves the business vulnerable to credit risk. The company should decide the best way to mitigate this risk and implement strategies so it does not happen again in the future.
A key part of an appropriate response involves the delegation of responsibilities. Deciding who is responsible for monitoring and reporting KRIs, who is developing an action plan and who is reviewing the KRIs is important as it prevents confusion. Good communication is essential for everyone to understand the severity of the situation and make effective use of the resources available. By assigning tasks to each employee, it is easier to mitigate the risk.
Challenges of key risk indicators
KRIs can be very useful for the business but they carry challenges. It may be difficult to establish key risk indicators for every risk the company is facing. Management may also struggle to understand the risks fully and the source of the issues. This is because credible and meaningful information may be hard to obtain. There may be more qualitative than quantitative data available which, in some cases, can lead to poorly structured KRIs as the right information is not provided.
To have successful key risk indicators the business needs to have a well-organised enterprise risk management in place. This will prevent key risk indicators from being developed based on assumptions or poor data. They may be created to monitor risks but their development also carries a lot of risks and requires a lot of resources.
Key risk indicators may sound easy to identify and implement but they need a lot of accuracy to ensure effectiveness. As they are complex, it may be difficult to determine the right thresholds and response plans. Thresholds may be created that are not easy to analyse, measured and compared which makes them ineffective. Some organisations may neglect to track key risk indicators because they may have chosen a greater amount than what their resources can handle.
KRIs and KPIs
Key risk indicators are sometimes confused with key performance indicators. There are some differences between the two as well as some interconnection. It is always advisable that KRIs are used together with KPIs as in a scenario where a KPI is not addressed, a KRI may be triggered.
KPIs look at past performance data and if the business is achieving the objectives that have been set. They monitor the performance of the organisation and shape decisions based on improving that. So they look at past and current information but they are not looking at the full picture. Company performance may be increasing because of some high-risk behaviour that results in higher returns in the short term but in the long term, it could have severe consequences.
KRIs try to predict the future by detecting potential risks. They take into consideration the objectives the business wants to achieve and assess what risks could prevent the company from meeting these objectives. They can warn the entity about current and future threats and as a result, help the company improve its KPIs.
Are key risk indicators needed in your business?
Key risk indicators are not suitable for every company. Managers need to evaluate whether they have the necessary resources available to create and implement them. However, there are many more aspects to enterprise risk management. Managers can choose to use different tools to assess uncertainty and protect their businesses.
Polonious helps its clients by providing them with a space where they can fill out risk assessments easily, with built-in calculations for risk ratings and colour coding to indicate risk priority. Companies can automate reminders for reassessment based on their chosen intervals and everything is managed through a central hierarchy so risks and treatments can be cross-referenced. If you want to learn more, request a demo!
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