Every business enterprise is exposed to a number of risks. Therefore it needs to have a good risk management system to ensure the successful running of the business.
A banking risk is defined as a future uncertainty of earning and outcome in case of failure. In India, the major problem that every bank is facing is a lack of proper risk management system which may result in reduced profits ,lack of value investors ultimately leading to failure of the bank.
TYPES OF BANKING RISKS
The major risks faced by banks include credit risk, market risk & operational risk, which are discussed as below –
- CREDIT RISK – One of the major risks for the banks, a credit risk refers to a risk of default on a debt that may arise from a borrower failing to make required payments. This type of risk arises when one fails to fulfill their obligations towards their counterparties. It can be of three types, namely, credit default risk, concentration risk and country risk.
For Example: A default made by a borrower on repayment of principal or interest amount on the loan , is known as a Credit risk.
- MARKET RISK – Market risk mostly occurs from a bank’s activities in capital markets. It usually occurs due to reduction in company’s share prices, fluctuations in interest rates or due to loss in equity investments. This risk arises from both on-balance sheet as well as off-balance sheet items.
Banks can reduce their market risk by diversifying their investments or by hedging their investments with other, inversely related investments.
- OPERATIONAL RISK – As per the “The Basel Committee on Banking Supervision” loss resulting from inadequate or failed internal processes, people, and systems or external events is defined as Operational risk .
It includes Fraud risks, bankruptcy risks, risks arising from cyber hacks etc but exclude strategy and reputation risks.
This type of risk is low for simple business operations such as retail banking and asset management, and higher for operations such as sales and trading.
Like other risks, operational risks are nor occurred willingly therefore they cannot be diversified. This means that as long as people, systems, and processes remain imperfect, operational risk cannot be fully eliminated.
However, Banking risks can be controlled by having rules, systems, and processes in place that enable efficient banking and reduce the possibility of loss or mitigate the size of a potential loss.
These rules, systems, and processes can be at the branch level, the regional or zone level, and the top management level.