The different types of non-financial risk
There are 7 common categories of non-financial risk, including:
- Model Risk
- Operational Risk (fraud, natural disasters, misconduct)
- Settlement Risk
- Accounting Risk (changes in GAAP)
- Regulatory Risk
- Legal Risk (Non-honouring of a contract)
- Political Risk
Non-financial risks can be described as events aside from financial transactions that have a negative effect on company operations. For example, South African parastatal Eskom has been found to have had fraudulent activities linked to rampant corruption and state capture. Not only has this had a negative effect on the organisation’s reputation locally, but it has also affected its ability to be entrusted with funds, so international investors are less likely to want to invest.
Business Risk, for example, is related to the market in which the company operates. If there are innovations in terms of technology and it affects the ways in which a company operates, then this is a risk. When the compact disc became a popular method of storing music, it replaced vinyl record in terms of popularity. Fast forward to 2018 and the former is almost regarded as a fossil of the music storage sector, with the digital revolution having transformed the entire music industry. For companies that relied heavily on CDs the prevalence of digital downloads presented a business risk. A prudent management team would have kept up to date with industry trends and put preventative measures in place to mitigate this risk.
With Strategic Risk, if there is a fundamental economic or political shift, then this will affect business functioning. Companies always need to be prepared to deal with such risks and to adapt the business strategies accordingly.
Misconduct (Operational Risk) occurs if a company’s employees flout regulations. This presents a non-financial risk because it affects the reputation of the company.
Organisations need to have risk-management policies in place in order to deal with the potential effects on the business.
