Managing risk is about raising society's resilience

FOLLOWING the Global Financial Crisis and the failure of many institutions to grasp the risks they were taking, the concept of risk and its consequences in terms of management have become central with regulators and more generally within society. Even though risk is an old concept, its perception has changed over the ages.

As early as in the 18th century, philosophers realised that risk contains two aspects as summarised by French thinker Etienne Bonnot de Condillac (1714-1780) who qualified risk as "the chance of incurring a bad outcome, coupled with the hope, if we escape it, to achieve a good one". This notion of risk would become prevalent in finance and economics during the 20th century. Taking risks is the defining trait of entrepreneurs or investors. They do so in search of a future good outcome. Their motivation for risk taking is the hope to produce a surplus either industrial or financial. The stochastic nature of future outcomes had been noticed earlier, with the creation of the first mortality table in the 17th century. However, a proper treatment of risk was not generalised before the second half of the 20th century with the advances of mathematics and economic theory.

The notion of risk is often confused with uncertainty. In economics, Frank Knight (1921) laid the foundation for distinguishing risk from uncertainty. "Risk" is defined as the randomness with knowable probabilities (measurable uncertainty), while "uncertainty" is the randomness with unknowable probabilities (unmeasurable uncertainty). In this sense, risk is measurable and thus manageable, while uncertainty is part of life and has to be accepted as such and managed only for its consequences. The realisation that taking risk can produce a return and that it is measurable has given birth to the insurance industry, starting with the first insurance contracts of the Babylonians.