Dynamisms of risk and its risk management implications

The purpose of classifying risks is to develop a process to assist risk managers to think about the characteristics of a risk in a systematic manner. Diebold classified risks into three categories: the known, the unknown and the unknowable. The Diebold approach classifies risks according to the knowledge we have about their frequency and severity and is a quantitatively based system, while specifically recognising the lack of reliability of the modelling for some risks.

However, there is an underlying assumption behind the Diebold system of stability and an ability to distinguish classifications. Such an assumption leads to a misunderstanding of the nature of risks (particularly in a financial institution) and it consequently leads to a risk of insufficient and inappropriate risk management processes.

This paper discusses the dynamism of risks and its implications for risk management in financial institutions, and an alternative approach to operational risk management.