Financial risk management is the process of evaluating and managing current and possible financial risk to reduce an organization's exposure to risk. Financial risks must be continuously monitored, as new risks may arise and current risks may change. As a specialization of risk management, financial risk management focuses on when and how to protect yourself using financial instruments to manage costly risk exposures. Reputational risk is also known as reputational risk and is the loss of share capital, market share or financial capital resulting from damage to the reputation of an organization.
Banks and other wholesale institutions face a variety of financial risks when conducting their businesses, and how these risks are managed and understood is a key factor in profitability, as well as the amount of capital they must hold. However, in terms of financial risk management, operational risks can be managed within acceptable levels of risk tolerance. Once a list of potential financial risks has been compiled, it is important to evaluate and quantify the risks so that they can be properly prioritized. For small businesses, it's not practical to have a formal risk management function, but they tend to apply the above practices, at least the first set, informally, as part of the financial management function; see Financial Analyst § Corporate and others.
One aspect of exchange rate risk is economic risk or forecasting risk; the degree to which an organization's product or market value is affected by unexpected exchange rate fluctuations. Operational risk, as defined in the Basel II framework, is the risk of indirect or direct losses caused by failed or inadequate people, systems, processes, or internal external events. Financial risk management is the process of identifying risks, analyzing them and making investment decisions based on accepting or mitigating them. However, there is a wide distinction between financial institutions and non-financial firms and, as a result, the application of risk management will be different.
These potential risks can be described in a list and are generally classified according to the types of financial risk. Large banks are also exposed to systematic macroeconomic risk, that is, risks related to the aggregate economy in which the bank operates (see Too Big to Fail). This is important, as risks of greater urgency must be addressed much faster than risks of less severity. In the case of non-financial companies, priorities are reversed, since they focus on the risks associated with the company (that is, the production and marketing of the services and products in which one has experience) and their impact on revenues, costs and cash flow, while market and credit risks are usually of secondary importance, since they are a by-product of the main business agenda.
When applied to financial risk management, this implies that company managers should not cover risks that investors can cover on their own at the same cost.
