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Strategic Risks and Risk-Management Strategies of Securities Companies

Strategic risk management refers to the effective management of the risks facing a securities company in a comprehensive and systematic way. It involves risk control in work plans and work measures, as well as effective management of risks at a strategic level. Not only localized risks, but also risks with systematic implications should be managed effectively. Not only should risks be identified and controlled, but the balance between risks and profits should also be analyzed. A securities company's ability to withstand various risks is analyzed to ensure comprehensive and efficient development in an environment in which risks are controllable.

The Meaning of Strategic Risk Management

Management of Risks in Strategic Planning The survival and development of a securities company is affected by multiple internal and external factors, which fall into the following three categories:

1. The characteristics of the securities company itself

2. The characteristics of the securities industry

3. The overall external environment

Strategic risk management systematically identifies potential risks residing in the external environment, internal resources, strategic goals, development planning, and implementation plans for a certain period in the future. It avoids or reduces risks associated with strategic decisions through scientific decision making and risk-management measures. Risk-oriented strategic planning and implementation plans are the most effective strategic risk-management methods.

Strategic Planning for Risk Management Risk management and system construction should be properly planned from a long-term and strategic perspective. Economic capital allocation should be utilized to enhance competitive advantages, thus ensuring the fulfillment of the strategic planning goals. The risk-management strategy of securities companies is now to implement comprehensive risk management over the next three years.

Strategic Risk-Management Tactics

Risk-management tactics are the specific ways to implement the risk-management strategy. They should have well-defined risk appetite and risk tolerance; they should determine risk costs, such as economic capital costs; and they should establish basic principles and methods for the identification, appraisal, and quantification of various risks. They should also specify the methods and application principles for economic capital allocation.

An important part of risk-management tactics is economic capital allocation and assessment. This is an important method of strategic risk management for capital, a major resource of the company. In order to allocate capital reasonably, growth opportunities facing each business line, as well as risks associated with such opportunities, must be analyzed. Potential losses that could be brought about by these risks should be analyzed next. Then, the balance between the growth opportunity and the cost of risk should be analyzed. Finally, reasonable allocation is made among various lines of business, in view of the risk cost, opportunity cost, and operational cost. A certain business line may undergo rapid growth in a short period. However, the growth opportunity might be largely limited in a long-term perspective. Therefore, the idea of reasonable capital allocation must be represented in the guideline for strategic planning so that it can be implemented in specific work plans.

Economic capital is the capital prepared to make up for unexpected losses that are possible at a certain confidence level. Its quantity should equal the value at risk in a securities company's overall loss distribution at a given level of confidence. The allocation of economic capital should be adjusted and assessed according to risk-adjusted return on capital (RAROC). RAROC refers to the ratio of the expected return from certain investment to the amount of economic capital it takes. The basis of the RAROC criteria is the return on investment the shareholder asks for in order to take the risk. When it comes to economic capital allocation, the maximum profit cannot be generated by allocating all the capital to the asset with the highest RAROC. Requirements related to extreme risks, systematic risk prevention, and risk distribution dictate that changes in marginal profits and marginal risks should also be considered, in addition to the value of RAROC, while assessing the effect of economic capital allocation. The capital allocation with the smallest risk is identified for a fixed expected rate of return, while the capital allocation with the highest expected rate of return is identified for a fixed risk tolerance.

Assessing the various business divisions based on RAROC tends to make the business divisions unwilling to develop business or products with great strategic importance in favor of a relatively low return in the short term. Therefore, a revision is needed, with the main basis being the cost of the economic capital taken up by each individual business line.

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