A bank faces many types of risks and these must be managed carefully. If the bank is not able to take its money back from a company or from a person then gradually the stake of the bank will go down and the bank will be in a financially weak position, as a result depositors will withdraw money from the bank.
There are eight types of risks. These eight risks are divided into 3 categories.
- Credit Risk
- Market Risk
- Operation Risk
Other Significant Risk
- Liquidity Risk
- Business Risk
- Reputational Risk
- Systemic risk
- Moral hazard
If a borrower does not repay a loan, the lender may lose the principle of the loan or the interest associated with it. It arises because the borrower expects to use future cash flows to pay current debts.
A credit risk is the danger of default on an obligation that may emerge from a borrower neglecting to make required installments.
Credit risk is most likely caused by loans, acceptances, interbank transactions, trade financing etc.
Market risk arises due to the factors affecting the overall performance of the financial market, it is also known as the systematic risk.
Operational risk is the risk not arising from financial, systematic or market-wide risk. It is the risk remaining after determining systematic and financing risk and includes risk resulting from breakdowns in internal procedures.
As per BIS (Bank of International Settlements) operational risk is the risk of loss, resulting from failed internal process, people and systems or from external events.
Operational managements are of following types
Human risk: loss because of a human error, done unconsciously or willingly.
IT/System risk: Losses due to failure of systems, failure of software, etc.
Processes risk: Loss caused due to improper information, leaking of information.
Risk due to the lack of marketability of an investment that cannot be bought or sold quickly. The inability of a bank to provide cash.
Business hazard is the likelihood of an organization to have lower than foreseen benefits or experience a misfortune instead of taking a benefit. Business hazard is impacted by various components, including deals volume, per-unit value, input costs, rivalry, the general monetary atmosphere and government controls
Reputational risk is a threat or danger to the good name of a business. It occurs through a number of ways, directly as the result of the actions of the company itself, due to the actions of an employee.
To avoid reputational risk a company also needs to be socially responsible and environmentally conscious.
Reputational risk is the major hidden risk than can pose a threat to the survival of the large companies. The reputational risk arises from the actions of errant employees.
Systematic Risk is the ups and downs of returns caused by macroeconomic factors that affect all risky assets.
Systematic risk consists of day to day fluctuations in a stock’s price
Moral hazard is a circumstance in which one party gets included in a dangerous situation realizing that it is secured against the hazard and the other party will acquire the cost. It emerges when both the parties have inadequate data about each other.
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