Question

Discuss the common risks encountered by banks and suggest some ways of appropriately managing the identified risks

Answer 1

Risk is anything which may end up causing a loss to the person or firm with which it is associated. Since Banks deals in money by taking deposits and lending loans, so there are many types of risks associated with the bank. Some of the common risks are described below-

1. Credit risk - It is the most common or obvious of the risks associated with the banking. This occurs when the persons who have taken loans refuses to pay back the loans or are unable to pay back loans. This causes loss to the banks.

This type of risks can be managed by determining how much of a credit risk the bank is willing to take on a particular consumer. This is a question that the bank will have to answer for the individual situation. Every person has different potentials for credit which must be determined by the bank.

2. Operational Risk - These are the risks due to the mistakes in the day to day decisions taken by the bank and its employees. This means the risk is due to the incorrect operations measures.

This types of risks can be managed by adding more internal rules and accountability. This means the employees must be accountable to the loss caused by them so that they will be careful while making transactions. There must also be strict rules and regulations.

3. Market risks - Banks not only accepts deposits and advances loans but they also invest their money in the market in different forms and the risk of loss to the bank due to market conditions is the market risk.

The best strategy, for managing market risk, is one of diversification. Ensuring that assets are held in a wide range of investment options will help limit this type of risk. They also can invest in less riskier investments.

4. Liquidity risk - This type of risk may occurs due to sudden changes in the market. Banks keep a proportion of the deposits in liquid which may be cash or some other forms, but due to sudden changes in market there is liquidity shock.

The key to managing liquidity risk is to create mismatches between asset and liability maturity, and then to ensure that those mismatches keep enough funds flowing in the bank to both increase assets and meet obligations when customers ask for their money.