In highly-regulated industries such as banking, the terms “compliance” and “risk management” tend to come up in the same breath—or even get used interchangeably. But there are subtle differences between them that can be valuable for organization leaders to know, particularly when figuring out how to fit the two processes into an overall business strategy.
So what is the difference between compliance and risk management? How do the two terms relate to each other? And how can executives use this information effectively when creating an action plan for their organization? We’ll be answering those questions here.
We’ll start by discussing what regulatory compliance and risk management are, as well as how they differ, at a general level.
Risk management is a broad term that encompasses strategies, policies, and procedures an organization uses to identify, predict, monitor, and minimize threats to its assets and income.
Compliance is a narrower term that can be considered a component of risk management in the banking industry. It refers specifically to an organization reducing its legal (and operational) risks by tailoring its systems and activities to meet standards prescribed by governments and other regulatory agencies.
It should also be noted that there is such a thing as compliance risk management. This is a risk management process explicitly about an organization knowing what can go wrong if it doesn’t comply with relevant laws and regulations, and thus optimizing its compliance operations to mitigate the chance of being non-compliant. But it’s beyond the scope of this article.
For now, we’ll discuss the difference between compliance and risk management.
What is Compliance?
Compliance refers to an organization meeting the legal and regulatory requirements for operating in a given industry. Sometimes, these requirements are specific things an organization must do or have in place to meet industry standards according to government bodies and regulatory agencies.
What is Risk Management?
Risk management is the process through which an organization identifies, predicts, monitors, and controls its risks of incurring losses. A key difference of risk management vs. compliance is risk management has no concrete rules; every organization must adapt the process to its unique situation.
As discussed in the introduction, a critical difference between risk management and compliance is that compliance is a part of risk management. Compliance is concerned with tuning an organization’s operations to fit within guidelines from governments and regulators. This helps the organization not only run safely but also avoid breaking the law and being penalized for it.
There are additional distinctions between the two that can be made, though. We’ll cover a few of them now.
Prescriptive vs. Predictive
For the most part, compliance is a prescriptive exercise. Governments and regulators lay out laws and rules—with some applying solely to particular industries—that organizations are legally obligated to follow. An organization simply has to ensure that it’s meeting the minimum benchmarks—as well as avoiding breaking the prohibitions—relevant to it.
Risk management is a more in-depth, predictive process. It involves considering not only all the risks an organization currently faces—including potential failures and penalties due to non-compliance—but also what risks the organization might face in the future. These include financial crime trends, cybersecurity risks, adverse market conditions (especially if planning to launch a new type of product or service), or even changes to compliance regulations.
Risk management is about being prepared for both current and future problems by not only having the proper control systems in place but also adapting them to cope with emerging threats.
Tactical vs. Strategic
Addressing compliance needs tends to be tactical in nature. That is, every organization in an industry has to, by-and-large, follow the same rules and regulations. So each organization may have different methods of achieving compliance, but they are all working towards what are more-or-less the same goals.
Risk management, on the other hand, tends to be more strategic. Its goals are more open-ended because every organization is in a somewhat different situation. An organization may face risks in common with other organizations overall, in common with its industry competitors, or unique to the way it operates.
So while there are some best practices for building a risk management program, there aren’t any one-size-fits-all checklists like there sometimes are with compliance. Each organization has to pick the systems, policies, and processes that work best for what it’s trying to achieve. This goes both for where the organization is now and where it envisions itself being in the near future in terms of its operations, risks, and compliance obligations.
Siloed vs. Integrated
Compliance is a function that often gets siloed at organizations—especially larger ones. An organization will hire a specialized team of people familiar with applicable laws and regulations, and then they become responsible for ensuring standards are met, and rules aren’t broken. However, they tend to have minimal contact with other employees and departments.
This can be a problem because risk management works better when it’s integrated into the organization’s operations as a whole. All departments and employees should know why compliance is essential from a risk management perspective and what they can do to minimize compliance-related risks. That goes for all other types of risk the company faces, too.
While it’s okay to partially silo teams based on their specializations, the goal should be to create a collaborative risk culture. This is where every part of the organization works together to manage risks, and all processes have risk management in mind right from the beginning. That puts less pressure on risk and compliance teams because it gives them fewer (and more negligible) risk and compliance issues to fix.
Risk Aversion vs. Value Creation
As compliance is a part of risk management, it’s a risk aversion process at heart. Governments and regulators create compliance laws and rules because they‘ve determined certain behaviors cause undue risk for organizations—and potentially entire industries.
So organizations being legally obligated to follow these regulations keeps them running safely and also limits the chance they’ll threaten the integrity of the rest of the industry if something goes wrong. Adhering to these rules also reduces risk for an organization in terms of avoiding legal penalties for being non-compliant.
Though it may seem counterintuitive, risk management as a whole is actually more about value creation. Risks are threats of an organization losing assets or sources of income. So an organization that wants to remain profitable must identify and control areas where losses are probable and/or could be catastrophic. It also needs to continually improve its risk management processes to be able to predict and adapt to future risks.
In this manner, reducing risk doesn’t just help make an organization profitable by safeguarding against losses. It also makes the organization more attractive to investors (who will appreciate having stable returns) and clients (who will build loyalty towards the organization because of its good reputation).
Bolster Your Compliance Operations and Smooth Out Your Risk Management with Tools from Unit21
While regulatory compliance and risk management are both important to organizations in highly-regulated industries, they are so for different reasons.
Compliance is mainly about meeting criteria and avoiding breaking rules from governments and regulatory agencies. Its purpose is primarily to keep an organization out of legal trouble. However, it often also improves the organization’s operational integrity (because of what the regulations are meant to protect against). So it should definitely be part of any organization’s risk management program.
The concept of risk management, however, is more significant than just compliance. It’s a collaborative, organization-wide commitment to thinking about what threats the organization may face in any area and developing policies and procedures to minimize the chance a threat will become an actual problem. That includes not only risks an organization is currently vulnerable to but also ones that may be obstacles to the organization’s business strategies down the line.
Ideally, an organization will want to improve its compliance operations as part of making its risk management processes more accessible and more effective. And it will want to improve its risk management strategies to both avoid unexpected losses and build a good reputation with investors, partners, and clients—both current and prospective.
An excellent way to start is by having the right tools. Unit21’s Transaction Monitoring and Case Management solutions bolster your compliance program with multi-channel information feeds, visual organization, and analysis capabilities, and automated alert scoring and report filing. To see them in action, contact us for a demo.
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