Risk is the probability of incurring a loss or damage because of actual outcome being different from the expected outcome. This means that, broader the range of possible outcomes, the greater the risk. Risk is the major constraint on investment whilst return on investment is the major opportunity or benefit generated by it.
Risks are inherent in any kind of business. Risks and uncertainties form an integral part of banking industry which by nature entails taking risks. Therefore, risk management assumes more importance in banking industry as this industry exists for the purpose of taking risk.
Risk Heat Map
Risk heat map, is a commonly used concept in operational risk management. It is a graphical representation of risk related data where we represent the individual values contained in a matrix as colors based on risk scores. It is a tool used to present the in 2-dimensional displays of the values arrived at risk assessment process in a meaningful way. The heat map shows the management which risk to manage more importantly.
Operational risks are generally assessed and measured based on its likelihood and significance. Likelihood and significance of each risk is rated in 1 – 5 scale as follows:
- Likely, and
- Major, and
We can compute the overall risk score risk using the following formula:
Risk Score = Likelihood Score x Significance Score
Colors Used in Heat Map
In a risk heat map, red color signifies danger signal. So, we show extreme risk in red color. Also, when iron is too much heated it turns out to be red. Red zone in the heat map attracts attention of the management to take immediate action.
The color green is a relaxing color that is pleasing to the eye and people regarded it as healthy color. Therefore, management should not worry about the green zone in the heat map. Yellow zone represents moderate risk and attracts moderate attention of the management while light red zone attracts high attention after dark red zone.