Question

Should financial institution’s try to avoid all sources of financial risk? Why or why not?

Answer 1

I think, Financial institutions cannot avoid all sources of financial risk, they can avoid to certain extent because they have to operate in this world and do their business, if they avoid all sources, how can they be in the market? They will be out of the market so they have to deal with the financial risk.

Types of financial risk:

1. Credit risk
2. Market risk
3. Default risk
4. Operational risk
5. Liquidity risk

These risks can be reduced by the following means:

1. Taking proper collateral on loan so that if customer is not repaying loan, his property can be sold to recover the loan.
2. By diversifying the business portfolio in different units and areas so that risk can be diversified.
3. By taking limited loan, loan increases the liquidity and credit risk for financial institutions.
4. By tightening the credit policy, provide less credit to customers and if so, charge higher interest over it.
5. By reducing Non performing assets (NPAs).
6. Financial institutions can take help from financial derivatives in which, with the help of hedging techniques, they can reduce risk.