Prevention and Reaction in Risk Management
Why stress testing and scenario analyses can help your business survive – and how we can learn from a worst-case scenario
It is one of the fundamental premises of risk management: When you’re aware that something might be coming your way, you can prepare for it. This is the very reason why businesses go to the effort of planning for different scenarios, calculating probabilities, and running stress tests. There’s just one catch: Being prepared for an event does not prevent it from actually happening.
The Covid-19 pandemic has taught us all a valuable, yet painful lesson: Even risk management is no silver bullet against a severe slump in demand and broken supply chains. As a treasurer, maybe this realization has you wondering if you should have bothered with all your plans and preparations in the first place. Is risk management even worth the effort? What additional steps could you have taken? And what could you do differently next time to be better prepared?
Risk management as a preventative measure
Why stress testing and scenario analyses benefit the entire company
Calculating the probability of a certain scenario occurring provides you with valuable clues. However, probabilities are always based on assumptions. But do these assumptions really consider all eventualities? For businesses, it is important to have a concept of what the financial worst case could look like and what the consequences would be. As a treasurer, you need to be responsive! You can only draw useful and actionable conclusions and react to changing market conditions by making timely adjustments to or rerunning scenarios and their consequences for cash flows, hedging etc.
Indeed, scenario analyses and stress tests provide you with valuable insights and point you towards possible courses of action:
- What would the impact on your liquidity reserves be?
- How long would your business be able to sustain a certain situation?
- Which organizational changes might become necessary?
- Where does it make sense to put in place additional safeguards, e.g. an extra credit line?
- Which adjustments to your hedging portfolio might be required?
These insights are not just important for treasury. If you communicate them clearly and early, they will benefit the entire company, for example by adjusting your supply chain.
Risk management as a responsive measure
What companies can learn from a stressful situation
From a purely mathematical point of view, one of the reasons why risk management is so complex is that there are so many unknown factors and correlations that need to be taken into consideration. If your company ran various scenarios, yet still couldn’t fully anticipate the unprecedented scale of the Covid-19 crisis, then you’re not alone! But what do you do with this realization? Are such analyses worth your time, and what impact do they have on your company’s future?
One thing is clear: any preparation is better than no preparation. This is why scenario analyses and stress tests are valuable even when they couldn’t accommodate all eventualities. By running them, you’ve almost certainly prevented or softened some negative consequences.
But what’s even more important: Any worst-case scenario that does become reality will in turn provide you with new data for future analyses. As a matter of fact, risk management should always take past data and experiences into consideration. So, if you feel like you weren’t fully prepared for the current crisis, then you now have the ability to catch up and do your homework for next time. Because unfortunately, there will always be a next time.
Risk management as a form of insurance
Ultimately, risk management is like an insurance. You may be paying contributions for years without ever needing to make use of your insurance cover. But it could also happen that you decide to save the money and do without insurance altogether – sometimes with disastrous consequences. Because if the worst case does hit you, you will be left with nothing. No one wants to have to go through that. But how do businesses and treasurers best decide what insurance they do need? There’s only one answer to this: data, data, data.
Only a risk management approach that takes into consideration complete data (historical, current and future) really enables you to make sound plans and decisions. If you do not have this complete overview, there’s little point in attempting to run a comprehensive analysis. And we’ve just experienced that sometimes a crisis can arise very quickly. When this happens, you don’t have the luxury of taking days or even weeks to collate data to run the analyses you should’ve run before. You will need to be quick. That’s why you need digital support!
Risk management in the digital age
How a treasury management unlocks completely new opportunities
How good your data is will determine how good your analyses and responses are. This is why there is no greater horror scenario for effective risk management than incomplete or outdated data. A treasury management system such as BELLIN’s tm5 gives you access to complete data, group-wide and in real time. This is data you can rely on, and these are figures you can use to make sound plans.
We can only hope that a once-in-a-century event such as the Covid-19 pandemic will remain the exception. But it may well happen again. We’ve learned from the past that disruptive scenarios which completely change market conditions happen regularly. It is your responsibility – as a treasurer – to learn from what is happening right now and to find answers to such disruptive events. By closely analyzing worst-case scenarios, you can draw valuable conclusions for all eventualities. There are always risks that cannot be fully controlled. But there are also always ways to ensure best-case conditions.
What could you have done differently? Maybe many things. Maybe some things. Maybe nothing at all. Is risk management worth the effort either way? You bet!