ALL ABOUT RISK SHIFTING

ALL ABOUT RISK SHIFTING 

MEANING

Risk shifting can be defined as transferring the risk by one party to another and is usually done in the financial sector, wherein risk ownership is transferred by the organisation to another in exchange of some fees. It also happens in those companies which are overly burdened with the debt wherein the equity shareholder stake declines and the debtholders stake increases. 

TYPES OF RISK SHIFTING

1. Standard type of risk shifting. Here, a party shifts the risk to another party in return of fees. 
2. Second is undertaken by financially stressed companies that are burdened with debt and equity shareholders are reducing. 

FORMS OF RISK SHIFTING

1. Derivative:

As we all are aware, derivatives refers to a financial instrument that derives its value from an asset underlying. It is also a form of risk sharing where one party shaft the risk of the underlying asset to another party. There are different kinds of derivatives such as forwards, futures and options. 

2. Outsourcing:

By outsourcing, one party can transfer the risk in a specific project to some other party. Companies tend to outsource a lot of their functions in which they lack expertise and instead concentrate on the functions that are their strengths. Such aspects and functions are outsourced to some third party vendor capable of performing the same and along with that risk is also getting shifted. 

MERITS

1. The companies can focus fully on their key area and expertise and strengths by shifting the risk relating to functions of different parties. 
2. The burden of bearing significant possible loss by the company is minimised as the company transfers the same to another part.

When positive risks are shared by contribution by other parties, it brings the merit of synergies with all parties making their best contribution towards making the things happen and minimising the extent of risk. 

DOWNSIDES

1. When the risk associated with any function is transferred, the parent entity may lose control over it. 
2. There is a lot of cost associated with the risk shifting which the company needs to bear in terms of expenses. 
3. When risks are being shared, the company will also be compelled to share its resources, confidential information and expertise with other parties.

RISK SHARING VS RISK SHIFTING 

Risk sharing refers to a strategy in which positive risks which are referred to as an opportunity are shared upon with a third party to increase the chances of gaining the benefit occurring to the parties when the risk will materialise. Risk sharing is not concerned with adverse risk and only positive risk can be shared upon. 

On the other hand, risk shifting means a process wherein risk is being transferred by one party in favour of some third party. The responsibility related to the risk may either be fully transferred or maybe partial. It is done to make sure that the 3rd party vendor will take care of the consequences in case when risk materialises. 

THE CRUX

Risk shifting process helps an entity to transfer the burden of risk to other parties, either in part or as a whole. The organisation incur expenses in the form of fees to shift the risks. It helps the company to focus on significant vital areas and relax about possible risk that might occur or happen in the future.