Risk management is an important aspect of every business as it minimizes the effects of the volatility of the market. Without proper and calculated risk management, no business can survive and most likely lose its assets to that risk. Thus, the banks need to make sure of profitability. The regulators need to ensure the financial system is safe and sound.
Over the years banking business has developed and introduced advanced trading technologies and sophisticated financial products. While these developments and technologies make trade and investment easier, it has their drawbacks. Similarly, these advances have enhanced banks’ role, promote profitability, and better expand risk, but they have significant risk factors as well. The risk management of banks is weak compared to the rapid changes in the financial markets. However, it is a matter of great concern to minimize risk challenges by proper methods to enhance the profitability and soundness of the business. However, if you need assistance with your online Ph.D. dissertation in banking and finance then you can ask us for PhD dissertation Help and say goodbye to the stress.
Risk & Risk Management in Banking Sector
Considering the financial crises of modern times, risk management has become an important concern for banking regulators and policymakers. The bank risk is the loss that a bank face when it invests its money somewhere. Bank risk is the potential loss to a bank due to a particular event. The key risks in banking include credit risk, interest rate risk, market risk, liquidity risk, and operational risk.
Why Risk Management is Important
Risk management is essential for banks to ensure their profitability and their security. As per the economic theory, the core management aims to maximize the wealth of shareholders thus it should maximize the expected profit of the business. However, if there are any losses from the investment then it harms the core principles, and if in case of poor management of those risks, it could directly impact the bank’s profitability and soundness.
Types of Risks
The risk is either the loss in financial terms or the loss of reputation. Banks are prudent to avoid losing so they make sure they have enough capital to negate any unforeseen event. Similarly, they manage, identify, measure and price the risk that is essential to take care of any mishap in the future. There are mainly 5 kinds of risks. These include:
- Liquidity Risk
- Market Risk
- Credit or Default Risk
- Operational Risk
When the bank lends credit to its customers, it takes the credit risk to incase the person will fail to meet its obligations following agreed terms. It is certainly one of the major risks for banks. The credit risk is not only related to loans but can drive from other activities on the banking book and trading book as well as on and off balance sheets.
Interest rate risk
The interest rate risk is linked to the changing interest rates of bank assets, liabilities, or balance sheet products. A change in the interest rate impacts the interest rate of the bank. It affects the bank’s probable interest income and expenses. It also affects future marginal profits.
There are three main types of interest rate risk such as gap risk, basic risk, and option risk. Gap risk is referred to the term structure of the interest rates. Basic risk is the relative changes in interest rates for financial instruments with similar periods but valued using different interest rate indices. While Option risk comes from option derivatives or options fixed in a bank’s assets, liabilities, and/or off-balance sheet items. Also, this is the indirect interest rate risk because it depends on the decisions of the bank or the customers.
It is the risk of losses in on and off-balance-sheet positions that occurs because of the movements in market prices. The market risk is both the interest rate risk related to instruments and equity to market, the foreign exchange risk of positions in foreign currencies, and the price risk of commodities that can be traded on a secondary market. Risk management identifies and measures risk while ensuring that the risks are consistent with the desired risks. Effective risk management is more than applying financial models. It needs good judgment and experience not only to know how to use the models suitably but also to appreciate the strengths and limitations of the models.
Liquidity risk is linked to the bank’s inability to fund the growth in assets and meet responsibilities at a reasonable cost. The liquidity risk includes funding liquidity risk and market liquidity risk. Funding liquidity refers to when a bank cannot meet efficiently current and future cash flow without affecting its daily operations or financial condition. On the other hand, market liquidity refers to when a bank is unable to easily eliminate a position at the market price due to inadequate market depth or market disruption.
It is the risk of loss that is incurred due to inadequate or failed internal processes, people, or external events. It generates from any banking products, activities, processes, and systems. Operational risk management focuses on the risks that have the most impact on the organization and it holds employees accountable who manage operational risk. Some examples of operational risk management include.
- Employee behavior and employee error
- Cybersecurity attacks
- Business processes and controls
- Natural catastrophes
- Internal and external fraud
Efficient risk management is essential for banks to ensure profitability and capitalize on the shareholder’s value. However, the risk management practice has changed dramatically in the last few years due to changes in the business environment and technology development. Regulation remains an important factor that contributes to the way banks manage their risk. However, if you’re currently working on your dissertation related to risk management then you may need professional assistance in producing a well-articulated dissertation. Thus, feel free to get in touch with us on My Dissertations and ask for PhD dissertation writing service. Our highly educated tutors will ensure that you produce a comprehensive dissertation.