The
banking industry has been tremendously changing the lives of ordinary people.
The banks have become much more advanced, and the security aspect has been
improved to a large extent.
However,
with the increase in growth of the banks, banking operations have become much
more complicated. The risks involved with the adoption of disruptive
technologies called for the change in regulatory environments and business
procedures.
In
banking, various risks can impact the financial stability and operations of
financial institutions. These risks can be broadly categorized into core risk
types. Here are some of the core risks in banking:
Risks Involved in the Banking
Industry:
1.
Credit Risk: One of the most
significant threats faced by banks is credit risk. In simpler words, credit
risk is defined as the inability of a borrower or a counterparty to meet contractual
obligations. In other words, when a borrower fails to pay the appropriate amount
to the lender due to any financial crisis. The banks have suffered huge losses
in the past from credit risks, and are still prone to such losses.
Although
credit losses are primarily defined by the inability of the borrower to repay
loans to the lenders, it also includes the delay in payments of the borrower.
That means if any borrower does not make timely payments, then such types of
cases also come under credit risks.
·
Ways
of managing credit Risk: Such types of losses commonly
occur due to borrower insolvency. Hence, banks should conduct proper investigations
before granting the loans and should only sanction loans to individuals and
businesses that are not likely to run out of their income during the payment
period.
2.
Market Risk: Market risks are
defined as the risks involved in the fall of a company's share or decrease in
the value of the stock of third-party companies where the bank has invested. We
all know that apart from sanctioning loans, the banks also hold a certain
amount of shares in the market. In that case, if by any means, the share price
of the banks decreases, then they will suffer huge losses, and these types of
losses generally come under market risk.
The
market risks can vary depending on the type of commodity a bank holds. in the
case of gold, silver, or real estate, they are exposed to commodity risks, etc.
similar is the case with equity risk.
•
Ways
of managing Market Risk: To mitigate market risks, banks
usually leverage hedging contracts. They use contracts like forwards, options, swaps,
and many more, to eliminate the various market risks.
3. Business
Risk: Business risks are a significant result of credit risk. To put it
simply, when a bank fails to generate profits during a specific period, then it
is called business risk. Many times, a business takes a loan from a bank and
then fails to repay it. In such a scenario, the banks lace losses due to
business risk.
The
result of business loss is either being acquired by some other banks or
collapse in big banks. Examples of such banks that suffered huge losses due to
the wrong business strategy are Washington Mutual and Lehman Brothers.
•
Ways
of managing Business Risk: Although there are no sure-shot
methods of eliminating business risk, the adoption of the right strategy might
do the work.
4.
Security Risk: Now that's a
considerable risk that has been on the top of the list for the global market,
irrespective of their domains. Cybersecurity has been impacting the financial
industry for quite a few years, and the problem is still prevalent in the
banking sector. We witnessed many cases where hackers penetrated the security
layers of some big banks and stole a large sum out of it.
Banking
institutions are still making considerable investments in the security aspect
to make their customer's data and their systems more secure than ever. The
industry is leveraging the latest technological advancements of Al, ML, Blockchain,
big data, etc. to yield positive results in terms of security.
•
Ways
of managing security Risk: The banks need to invest in
top-notch fintech software and mobile apps that are way more secure and impenetrable.
They should keep their private information safe using a technologically
advanced electronic medium.
5.
Compliance Risk: When a bank does
not follow proper regulatory standards put down by the financial institutions,
then such type of risk is known as Compliance risk. These are usually a not much
greater risk but surely have some significant outcomes. When a bank does not
comply with proper regulations formed by the banking institutions in their
certain branch, then they face financial and legal losses.
The
banks get severely affected by these losses and suffer losses in their daily
banking targets. They had to bear legal penalties and might face significant
challenges from the regulatory committee.
•
Ways
of managing compliance Risk: To mitigate such types of risks,
the banks should formulate, regulate, and manage all the regulations and
compliance policies across all their branches.
6.
Operational Risk: When there is a failure
in the internal processes of the bank due to inefficient systems, then it is
termed as operational risk. We all know that banks have to perform a wide array
of banking operations like daily transactions, cross-border transfers, cash
deposits, and much more. However, there are times when the internal systems or
the central system slows down. In such a scenario, the bank faces losses due to
operational risk. Not only that, when there are some other mistakes like
payment transfer in the wrong account, or execution of an incorrect order, etc.
also falls under operational risk. It is noteworthy here that banks do not
directly get affected because of the operational risks.
•
Ways of managing operational Risk: The
operational risks can be minimized by automating the workflows so that the
human interventions reduce. Also, the banks should use software from a
trustworthy development company to ensure smooth operations.
7.
Reputational Risk: Reputational risk
is a significant result of the operational risk and, to some extent, the
security risk. In other words, when a company fails to provide security to
their customers, or when they perform inefficiently in processing their
requests, then they suffer loss in users. People began spreading rumors about
the bank, and the bank's image gets spoiled The news channels interrogate the
people and make false perspectives about the banks. In such a scenario, the
daily revenue of the bank drastically reduces, and hence they suffer huge
losses. They lose their stellar reputation in the global market, and their
profits decrease.
•
Ways of managing reputational Risk: The
banks should ensure smooth functioning and should provide safety and security
to all of its customers. They should never participate in any unfair practices
and should ensure customer satisfaction in every possible way.
8.
Liquidity Risk: Liquidity risks
arise because of the increase in the non-profitable assets in the bank. That
is, if there is an increase in the credit losses and losses due to business
risk, then liquidity risk arises. Due to the rise in the liquidity risk, the
bank becomes insufficient to meet the obligations if any depositor comes to
withdraw its money. Looking back in history, the losses due to liquidity risk
was a significant concern of all the banks at that time. However, the
present-day scenario has been completely changed. Now the banks have new
regulations of keeping a minimum amount of reserved cash to mitigate liquidity
risk. That implies that the depositors can be paid even during the time of credit
for business loss.
•
Ways of managing liquidity Risk: The
banks should follow proper regulations of the central banks and should keep a
minimum requisite amount in the banks to eliminate the chances of losses due to
liquidity risk.
9.
Systematic Risk: Whenever there are
some external issues involved with the bank like employee's strike, market
fluctuation, non-stability of the government, and so on, then it is termed as
Systematic risk. The systematic uncertainty is beyond the control of management
since it entirely depends on the various external factors. The losses due to
systematic risks are unpredictable and cannot be wholly avoided. Banks suffer
huge losses due to systematic risk and may have to write off certain assets to
compensate for their losses.
•
Ways of managing Systematic Risk: The
systematic risks are entirely unpredictable, and so they cannot be eliminated.
However, with smart skills, they can be minimized up to a certain extent.
10.
Moral Hazard: Moral hazard is an
entirely new type of risk when compared to the other mentioned risks. It came
to light recently in the global market. The moral hazard occurs when a bank
takes some risk, even when they know that someone else has to bear the losses.
In other words, when a bank invests in a risky business, and it backfires, then
it is the taxpayers who have to bear all the losses.
Although
the central bank has been tracking the banks and their operations very
carefully, some of them still take dreadful risks when not under the regulatory
oversight. They get to indulge in the illegal practices and create an imbalance
on the taxpayers when their planning fails
•
Ways of managing moral hazard: The
central bank should pay more attention to the activities of the banks to
eliminate the losses caused by moral hazards. The banks should also not indulge
in risky businesses and should follow the proper path.