Major Risks faced by the Banks
The financial sector has undergone significant changes over the decades due to internal and external factors. The modern banking sector is extremely complex and involves stakeholders with different backgrounds. In this increasingly dynamic environment, new challenges arise, requiring an adjustment to the structures and procedures of risk management. If history was an indicator, it was because of unwise risks that banks incurred billions of losses. The various types of risks that each bank faces are therefore crucial to understand.
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Major risks faced by the banks include credit risk, market risk, liquidity risk, reputational risk, operational risk, and business risks. To manage these risks bank have their own risk management measures, teams, and policies to evaluate and manage these risks.
What are the various types of Risks?
- Credit Risk: It is the biggest risk for a bank. It happens when borrowers or counterparty fail to meet their commitments. It can happen on the principal amount or EMI also. Banks cannot eliminate this risk but can lower their impact in several ways. Like giving loans to people/firms with good credit histories.
- Market Risk: Market risks generally occur from a bank’s exercises in the capital markets. It is due to the highly volatile equity markets, loans, credit, interest rates. Banks’ investment also depends on the commodity price as if a bank is investing in a company that produces that commodity, and if the price of the commodity falls, so the value of the investment will also fall. So to reduce this risk banks can invest their money in known/reputed companies.
- Liquidity Risk: This risk alludes to the capacity of a bank to meet its funding obligations. Like clients to withdraw their deposits, etc. If the bank delays in this process of withdrawal the clients may lose faith in the bank and may take out their deposits. This, therefore, lowers a bank’s ability to provide funds and running a bank.
- Reputational Risk: It refers to negative exposure, the public observation that adversely affects an organizations’ reputation that affects the income of the organization. It is highly unpredictable. The opinion of the customers, stakeholders, partners, and the public can a large impact on the companies revenue.
- Operational Risk: It is the risk due the errors, interruptions, any damages caused by people i.e human error or damage caused by the system. It is generally low in retail banking. Example: the cashier gives an extra $50 to a customer. Another threat is a breach of cybersecurity of a bank which gives the hackers info about the people’s accounts and money in the bank. This info can be misused. In such a situation, the bank’s reputation is compromised. Which makes it difficult to run in the near future.
- Business Risk: It is a risk that a company may have lower than the speculated profits or even may have a misfortune. It is impacted by various elements such as sales, financial condition. It can happen due to natural, human, economic causes. The business has many risks but it can be avoided by using certain measures that will minimize the loss. Avoid risky transactions, insurance for fire, etc.
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Hence we can conclude that risks cannot be avoided therefore every bank should adopt risk management strategies to help improve their financial and operational status. Thus this article concludes that risk management is very important for every bank and its customers.
Author – Priyanshu Ahuja
About the author – I’m a first-year student from City Premier College, Nagpur, pursuing BBA. My interest includes financial markets and investment domain.