Question

Analyse the importance of adjusting for risk in bank regulation and bank performance measurement.

Answer 1

Banking industry is the highest risk facing business in the world because of assymetric information that banks have about the customer which further causes moral hazard and adverse selection problem. Initially bank did not use to recognise the risks associated with its assets on the pretext that it would lead to a bad balance sheet .

But lately it was realised that the banks need to account for various risks including credit risk , market risk , interest rate risk , earning risk to name a few. But the credit risk is the highest . So now banks of all countries are required to follow Basel norms as set by Basel committee from time to time . All the measures are risk adjusted.

The importance of adjusting risk for measuring and regulating performance of banks is that it ensures that enough capital is available with the banks everytime so that there is no risk of any crisis as it has a direct impact on the economy of any country. It will also help the Central banks to regulate the banks so that they give the loans with due care and diligence. The performance meausred after accounting for risk will be a true one and will fair picture of the functioning of banks which are a major pillar of our economy.