Treasury risk has been established as managing the risks posed to the treasury of an organization by any risk factor. The risks could only be managed if one is aware of the categories of risks and how to address the same.
This blog covers the aspect of different categories of treasury risks possessed by an organization and its treasury department. Although we have already clarified that enterprise treasury is not only the finance or accounts department, but also other departments such as enterprise resource planning, financial markets, trading platforms, market data, and banks.
Before devising a strategy to manage the treasury’s risk, understanding the types of risk is necessary.
An enterprise possesses the following types of risks:
- Business Risk
- Product risk
- Market risk
- Credit risk
- Operating risk
2. Hazard Risk
- Insurable risk
- Property insurance
- Liability insurance
- Shipping insurance
3. Financial Risk
- Liquidity risk
- Price risk
- Credit risk
- Operating risk
Among these categories of risks, the financial risks are mainly taken care of by the enterprise treasury. A brief of what these individual financial risks consists of is discussed as follows:
- Liquidity Risk
This is the most important responsibility of an organization’s treasury; it ensures the availability of adequate resources in an organization to maintain operations throughout the financial year and funds for strategic development. Capital structure and cash management are the two most important strategies to deal with liquidity risk.
- Price Risk
Another important treasury function is financial market price risk, which is the risk posed to the business by changes in market pricing for FX (Foreign exchange) and interest rates. Treasury manages commodity risk in many areas where it is relevant. Since any firm with overseas sales or procurement might have FX exposures, FX is the major price risk for most businesses. Interest rate price adjustments will concern businesses with huge volumes of long-term debt. This can be covered in a similar way to FX risk, but because the tenors are longer and the markets are less liquid, the risks associated with the underwriting process are higher.
- Credit Risk
Most treasuries are concerned about credit risk. Treasury departments are often in charge of controlling the credit risk of financial institutions such as banks. Several treasuries are also in charge of managing the credit risk of commercial entities like clients and stakeholders. Credit risk can be managed and controlled (or treated) through credit insurance and credit default swaps, as well as robust credit rules and procedures.
- Operating Risk
Operational risk encompasses all processes, therefore addressing it necessitates comprehensive knowledge, people, policies, and procedures. To identify the most cost-effective solutions for the organization, the treasury must once again weigh risk and cost. It appears that treasuries are frequently under-resourced, which could indicate that firms underestimate the risks associated with treasury and, as a result, focus narrowly on expenses.
The above-mentioned categories of risks are mainly dealt with by the treasury department and coping with these risks requires a robust plan. The risk management process is generally a four-stage process- IATM (Identify, Analyze, Treat, Monitor). A detailed discussion about this process will be covered in the upcoming blog.