How to Calculate Residual Risk Effectively?
Every business decision has some degree of risk, whether it be strategic, operational, or financial. Some risks still exist even with the most successful risk-reducing techniques in use. This is where the residual risk comes into play. But how can you determine what remains after all mitigating steps have been made?
Understanding and estimating residual risk is critical for companies to make informed decisions and keep remaining risks below acceptable limits. Addressing the apparent risks is just one aspect; you also have to evaluate the residual ones to completely know your possible influence and exposure.
In this blog, we'll look at what residual risk is, how to calculate it, and why it's important to your risk management strategy.
What is Residual Risk?
Residual risk refers to the risk that persists after an organization has applied mitigation methods. Simply said, it is the residual risk left over after rules, procedures, and activities meant to lower the possible influence of a threat. While businesses strive to decrease risks to an acceptable level, certain risks are unavoidable and will persist, regardless of how thorough risk mitigation measures are.
Difference between inherent risk and residual risk
It's important to distinguish between inherent risk and residual risk.
Inherent risk is the degree of risk that exists prior to any controls or mitigation measures being implemented. The inherent degree of risk connected to a process, system, or decision to take action.
Conversely, residual risk is the remaining risk after the use of mitigating strategies meant to lower the inherent risk. Stated differently, it is the risk that remains even after implemented measures meant to either avoid or lessen the possible influence.
For example, a business may suffer a high inherent risk from cyberattacks, but by deploying robust cybersecurity measures (firewalls, encryption, etc.), the residual risk will be significantly reduced, although it is unlikely to be totally eliminated.
Importance of residual risk in risk management
Businesses must understand and calculate residual risk if they are to make wise choices. Understanding the remaining risk after reduction enables businesses to evaluate if they are prepared with the degree of vulnerability. It also facilitates the prioritization of resources and activities aimed at controlling the more influential risks. Effective resource allocation and guaranteed management of all important hazards depend on a correct awareness of residual risk.
How to Calculate Residual Risk?
Understanding the remaining risks to your business after risk-reducing strategies depends on knowing residual risk. Here is how to calculate it:
Formula for residual risk calculation
The basic formula for calculating residual risk is:
Residual risk = inherent risk - mitigation controls
Where:
Inherent risk is the level of risk before any mitigation measures are applied.
Mitigation controls refer to the actions, processes, and strategies implemented to reduce the risk.
Steps to calculate residual risk
Step 1: assess inherent risk
Inherent risk refers to the original degree of risk that exists prior to any controls being implemented. You must analyze the probability and influence of potential risks in order to assess this.
For example, an inherent risk in cybersecurity may be the possibility of a data breach and the resulting financial effect if no security measures are implemented.
Step 2: identify and apply mitigation measures
After recognizing the inherent risks, implement mitigation measures such as controls, rules, or risk-reduction techniques.
For example, establishing firewalls, encryption, and staff training would be part of a data breach mitigation strategy.
Step 3: calculate residual risk
To get the residual risk, reduce the effect of the mitigating measures from the natural risk.
For example, residual risk will show the remaining vulnerability after applied measures even if the natural risk of a data breach is large and the controls greatly lower the risk.
Risk rating scales
To quantify residual risk, you can use risk rating scales such as:
High: major risk still present even after controls.
Medium: some risk remains, but manageable with current controls.
Low: minimal risk remains after all mitigation efforts.
These ratings enable one to see and explain the degree of risk still present upon reduction.
Effective Strategies for Managing Residual Risk
When considering residual risk factors, you have a few different options on how to proceed. Below are the key strategies for managing and reducing residual risk:
Acceptance
One choice is to go ahead and accept the risk that lies ahead. This implies you run the possibility of either (a) the risk won't materialize or (b) the repercussions won't be strong enough to inflict major damage.
For instance, an organization could let a little risk in a non-critical sector knowing the possible impact is minimal.
Reduction
Another alternative is to lower the risk, making it more manageable. This involves putting policies or solutions in place to lower the impact of the risk.
For instance, installing a security system that reduces the effect score of a cybersecurity risk from three to one would be more acceptable without major worry.
Avoidance
Look for strategies to completely avoid the risk if it is too great to manage or to lower it. To reduce the risk, this might include altering procedures, avoiding certain activities, or adjusting strategies.
For example, a business may forgo a high-risk venture or relocate operations to a safer location to reduce exposure to political instability.
Sharing
Finally, you may be able to distribute the risk—usually by assigning it to a third-party vendor. Usually, this is accomplished by means of contracts or insurance wherein part or all of the financial repercussions are transferred to another company.
For instance, buying cybersecurity insurance coverage can help to lessen the financial effects of a data breach by distributing part of the risk to the insurance company.
These techniques enable companies to actively control residual risks, therefore enabling either reduction, acceptance, avoidance, or sharing of the residual risks to guarantee better operations and business continuity.
Conclusion
Building a complete risk strategy depends on an awareness of the computation and management of residual risk. Although attempts at risk reduction help to lower inherent risks, evaluating and controlling the residual risk that still exists guarantees a more informed strategy to decision-making. Properly calculating residual risk helps companies to balance risk and reward, hence increasing operational resilience and long-term performance.
Using the right tools can help streamline residual risk management. Auditive provides automated solutions that help you effectively evaluate, monitor, and reduce residual risks like Vendor Risk Management and Trust Center. Businesses may reduce possible risks and improve their whole risk management initiatives by using a proactive strategy and using best practices.
Want to optimize your residual risk management strategy? Schedule a free demo today to explore how Auditive’s solutions can help you assess and mitigate residual risks effectively.
