Risk Management in Banking

Old proverb “No risk no gain” is very much applicable for banking business. In the course of their operations, banks are consistently faced with different types of risks that may have a potentially negative effect on their business.  Risk management in bank operations includes risk identification, measurement and assessment, and its objective is to minimize negative effects risks can have on the financial result and capital of a bank. Banks are therefore required to form a special organizational unit in charge of risk management. Also, they are required to prescribe procedures for risk identification, measurement and assessment, as well as procedures for risk management. Risk management guidelines for banks, issued by Bangladesh Bank, the central bank of Bangladesh, defined risk management as “the deliberate acceptance of risk for profit making. 

The risks to which a bank is particularly exposed in its operations are: liquidity risk, credit risk, market risks (interest rate risk, foreign exchange risk and risk from change in market price of securities, financial derivatives and commodities), exposure risks, investment risks, risks relating to the country of origin of the entity to which a bank is exposed, operational risk, legal risk, reputation risk and strategic risk.

 

1. Liquidity risk  

Liquidity risk is the risk of negative effects on the financial result and capital of the bank caused by the bank’s inability to meet all its due obligations.

 

2. Credit risk  

Credit risk is the risk of negative effects on the financial result and capital of the bank caused by borrower’s default on its obligations to the bank.

 

3. Market risk  

Market risk includes interest rate and foreign exchange risk.

Interest rate risk is the risk of negative effects on the financial result and capital of the bank caused by changes in interest rates.

Foreign exchange risk is the risk of negative effects on the financial result and capital of the bank caused by changes in exchange rates.

A special type of market risk is the risk of change in the market price of securities, financial derivatives or commodities traded or tradable in the market.

 

4. Exposure risks 

Exposure risks include risks of bank’s exposure to a single entity or a group of related entities, and risks of banks’ exposure to a single entity related with the bank.

 

5. Investment risks  

Investment risks include risks of bank’s investments in entities that are not entities in the financial sector and in fixed assets.

 

6. Operational risk  

Operational risk is the risk of negative effects on the financial result and capital of the bank caused by omissions in the work of employees, inadequate internal procedures and processes, inadequate management of information and other systems, and unforeseeable external events.

 

7. Legal risk  

Legal risk is the risk of loss caused by penalties or sanctions originating from court disputes due to breach of contractual and legal obligations, and penalties and sanctions pronounced by a regulatory body.

 

8. Reputation risk 

Reputation risk is the risk of loss caused by a negative impact on the market positioning of the bank.

 

9. Strategic risk  

Strategic risk is the risk of loss caused by a lack of a long-term development component in the bank’s managing team. 

 

10. Money Laundering 

Money laundering risk is also a risk for banks.

Risk Management System: 

Board of directors of the bank outline policies and the senior management implements the same. Central bank of the country regulates and supervises the issue. Risk management manuals, guidelines, rules, procedures etc. have been developed for the purpose of properly identifying, measuring, monitoring and controlling the risk.