Commercial Banks are typically known to face some risks in the course of their business operations. Some of these risks are internal, while others are externally-induced. Do you agree? If yes, clearly analyze these risks and what banks should do to minimize the adverse effects of these risks.
Senior Lecturer, Economics, UNN
Dr Anthony Orji is a Ph.D holder in Economics and a lecturer at the Department of Economics, University of Nigeria Nsukka.
He obtained his B.Sc, Msc and Ph.D Degrees from the University of Nigeria, Nsukka and a Post Graduate Diploma in Sustainable Local Economic Development (SLED) from Erasmus University, Rotterdam Netherlands.
1.Credit Risk Credit risk – the risk that the promised cash flows from loans and securities held by FIs may not be paid in full Firm-specific credit risk – the risk of default by the borrowing firm associated with the specific types of project risk taken by that firm Systematic credit risk – the risk of widespread defaults associated with general economy-wide or macroeconomic conditions affecting all borrowers (e.g., an economic recession) Credit risk – the risk that the promised cash flows from loans and securities held by FIs may not be paid in full Firm-specific credit risk – the risk of default by the borrowing firm associated with the specific types of project risk taken by that firm Systematic credit risk – the risk of widespread defaults associated with general economy-wide or macroeconomic conditions affecting all borrowers (e.g., an economic recession)
2.Liquidity Risk Liquidity risk – the risk that a sudden surge in liability withdrawals may require an FI to liquidate assets in a very short period of time and at low prices Liquidity risk arises when an FIs liability holders demand immediate cash for their financial claim Serious liquidity problems may result in a “run” in which all liability claimholders seek to withdraw their funds and can lead to a solvency problem Liquidity risk – the risk that a sudden surge in liability withdrawals may require an FI to liquidate assets in a very short period of time and at low prices Liquidity risk arises when an FIs liability holders demand immediate cash for their financial claim Serious liquidity problems may result in a “run” in which all liability claimholders seek to withdraw their funds and can lead to a solvency problem
3.Interest Rate Risk Interest rate risk – the risk incurred by an FI when the maturities of its assets and liabilities are mismatched Federal Reserve tries to have an influence on interest rate volatility through its daily open-market operations Increased globalization of financial market flows has made the measurement and management of interest rate risk a prominent concern Interest rate risk – the risk incurred by an FI when the maturities of its assets and liabilities are mismatched Federal Reserve tries to have an influence on interest rate volatility through its daily open-market operations Increased globalization of financial market flows has made the measurement and management of interest rate risk a prominent concern
4.Maturity Mismatching and Interest Rate Risk Asset transformation involves an FI buying primary securities or assets and issuing secondary securities or liabilities to fund the assets, can often have differing maturities Economic or present-value uncertainty arises when interest rates change FIs can seek to hedge by matching the maturity of their assets and liabilities Asset transformation involves an FI buying primary securities or assets and issuing secondary securities or liabilities to fund the assets, can often have differing maturities Economic or present-value uncertainty arises when interest rates change FIs can seek to hedge by matching the maturity of their assets and liabilities
5.Market Risk Market risk – the risk incurred in trading assets and liabilities due to changes in interest rates, exchange rates, and other asset prices Closely related to interest rate and foreign exchange risk Decline in income from deposit taking and lending has been matched by increased reliance on income from trading FI management required to establish controls or limits on day-to-day exposure to risk Market risk – the risk incurred in trading assets and liabilities due to changes in interest rates, exchange rates, and other asset prices Closely related to interest rate and foreign exchange risk Decline in income from deposit taking and lending has been matched by increased reliance on income from trading FI management required to establish controls or limits on day-to-day exposure to risk
6. Foreign Exchange Risk Foreign exchange risk – the risk that exchange rate changes can affect the value of an FI’s assets and liabilities denominated in foreign currencies Returns on domestic and foreign direct investments not perfectly correlated –underlying technologies of various economies differ –exchange rate changes are not perfectly correlated across countries Foreign exchange risk – the risk that exchange rate changes can affect the value of an FI’s assets and liabilities denominated in foreign currencies Returns on domestic and foreign direct investments not perfectly correlated –underlying technologies of various economies differ –exchange rate changes are not perfectly correlated across countries
7. Insolvency Risk Insolvency risk – the risk that an FI may not have enough capital to offset a sudden decline in the value of its assets relative to its liabilities A consequence or an outcome of one or more of these risks: interest rate, market, credit, OBS, technological, foreign exchange, sovereign, and liquidity Occurs when the capital or equity resources of an FI’s owners are driven to, or near to, zero The lower an FI’s leverage, the better able it is to withstand losses due to risk exposures Insolvency risk – the risk that an FI may not have enough capital to offset a sudden decline in the value of its assets relative to its liabilities A consequence or an outcome of one or more of these risks: interest rate, market, credit, OBS, technological, foreign exchange, sovereign, and liquidity Occurs when the capital or equity resources of an FI’s owners are driven to, or near to, zero The lower an FI’s leverage, the better able it is to withstand losses due to risk exposures
Name:Eze Udoka Chidiebube
Reg no:2017/242428
Dept:Economics
Today, 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 proceduresHence, it’s vital to discuss the significant risks involved in the finance industry that are majorly faced by all the banks.Risks Involved in 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 the 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.What Can Be Done?
Such types of losses commonly occur due to borrower insolvency. Hence, banks should conduct proper research 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
.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. What Can Be Done?
To mitigate market risks, banks usually leverage hedging contracts. They use contracts like forwards, options and swaps, and many more, to completely 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.What Can Be Done?
Although there are no sure-shot methods of eliminating the 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. What Can Be Done?
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. What Can Be Done?
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.What Can Be Done?
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.What Can Be Done?
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.What Can Be Done?
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.What Can Be Done?
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.What Can Be Done?
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.
Reg no: 2017/249521
Dept: Economics
What are the Major Risks for Banks?
Major risks for banks include credit, operational, market, and liquidity risk. Since banks are exposed to a variety of risks, they have well-constructed risk management infrastructures and are required to follow government regulations. Government agencies, such as the Office of Superintendent of Financial Institutions (OSFI) in Canada, set the regulations to counteract risks and protect depositors.
Major Risks for Banks
Why Do the Risks for Banks Matter;
Due to the large size of some banks, overexposure to risk can cause bank failure and impact millions of people. By understanding the risks posed to banks, governments can set better regulations to encourage prudent management and decision-making. The ability of a bank to manage risk also affects investors’ decisions. Even if a bank can generate large revenues, lack of risk management can lower profits due to losses on loans. Value investors are more likely to invest in a bank that is able to provide profits and is not at an excessive risk of losing money. The risks are listed below
Credit Risk:
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
While banks cannot be fully protected from credit risk due to the nature of their business model, they can lower their exposure in several ways. Since deterioration in an industry or issuer is often unpredictable, banks lower their exposure through diversification.
By doing so, during a credit downturn, banks are less likely to be overexposed to a category with large losses. To lower their risk exposure, they can loan money to people with good credit histories, transact with high-quality counterparties, or own collateral to back up the loans.
Operational Risk:
Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational 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. Losses that occur due to human error include internal fraud or mistakes made during transactions. An example is when a teller accidentally gives an extra $50 bill to a customer.
On a larger scale, fraud can occur through the breaching a bank’s cybersecurity. It allows hackers to steal customer information and money from the bank, and blackmail the institutions for additional money. In such a situation, banks lose capital and trust from customers. Damage to the bank’s reputation can make it more difficult to attract deposits or business in the future.
Market Risk:
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.
Commodity prices also play a role because a bank may be invested in companies that produce commodities. As the value of the commodity changes, so does the value of the company and the value of the investment. Changes in commodity prices are caused by supply and demand shifts that are often hard to predict. So, to decrease market risk, diversification of investments is important. Other ways banks reduce their investment include hedging their investments with other, inversely related investments.
Liquidity Risk:
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. If a bank delays providing cash for a few of their customer for a day, other depositors may rush to take out their deposits as they lose confidence in the bank. This further lowers the bank’s ability to provide funds and leads to a bank run.
Reasons that banks face liquidity problems include over-reliance on short-term sources of funds, having a balance sheet concentrated in illiquid assets, and loss of confidence in the bank on the part of customers. Mismanagement of asset-liability duration can also cause funding difficulties. This occurs when a bank has many short term liabilities and not enough short-term assets.
Short-term liabilities are customer deposits or short-term guaranteed investment contracts (GICs) that the bank needs to pay out to customers. If all or most of a bank’s assets are tied up in long-term loans or investments, the bank may face a mismatch in asset-liability duration.
Regulations exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outside funds.
NAME: MGBADA OGOCHUKWU EMELDA
REG NO:2017/245040
DEPARTMENT: ECONOMICS
THE ROLE OF COMMERCIAL BANKS IN ECONOMY
The banking system is a catalyst and engine of growth that is responsible for being a life wire to every sector of the economy. It is evident that no sector in the economy can flourish or prosper without the support and services of the banking sector, agricultural sector, manufacturing sector, mining or even services sector can’t do without banks. Commercial banks provide and encourage savings. The establishment of commercial bank especially in the rural areas makes savings possible, hence economic development is accelerated.
Commercial banks provide capital needed for development. Deficit spender unit obtain medium and short term loans and overdraft from commercial banks to start a new industry or to engage in other development efforts. They engage in trade activities through making use of cheques and other financial instrument possible. They encourage investment, provide direct loans to the government and individuals for investment purposes. They provide managerial advices to small-scale industrialists who do not engage in the service of specialist. Commercial banks also render financial advice to their customers including to invest in. Commercial banks create money as an instrument to the apex bank for all its activities. Commercial banks help to enhance development of international trade, these include acting as referees to importers, providing travelers cheque to those going abroad, opening letters of credit as well as providing credit for export. All these helps to promote international trade and relationship between nations, they provide backup liquidity to the economy. They are transmitters of monetary policy and they provide some “value added” from transferring funds from savers to borrowers and providing liquidity.
Role of Commercial Banks
• Mobilising Saving for Capital Formation: …
• Financing Industry: …
• Financing Trade: …
• Financing Agriculture: …
• Financing Consumer Activities: …
• Financing Employment Generating Activities: …
• Help in Monetary Policy:
INSURABLE RISK;A risk that conforms to the norms and specifications of the insurance policy in such a way that the criterion for insurance is fulfilled is called insurable.
CHARACTERISTICS OF INSURABLE RISK
• Large number of similar exposure units. …
• Definite Loss. …
• Accidental Loss. …
• Large Loss. …
• Affordable Premium. …
• Calculable Loss. …
• Limited risk of catastrophically large losses.
NAME: MGBADA OGOCHUKWU EMELDA
REG NO:2017/245040
DEPARTMENT: ECONOMICS
COMMERCIAL BANK
The term commercial bank refers to a financial institution that accepts deposits, offers checking account services, makes various loans, and offers basic financial products like certificates of deposit (CDs) and savings accounts to individuals and small businesses. A commercial bank is where most people do their banking. Commercial banks make money by providing and earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer deposits provide banks with the capital to make these loans.
Major risks for banks include credit, operational, market, and liquidity risk. Since banks are exposed to a variety of risks, they have well-constructed risk management infrastructures and are required to follow government regulations. Government agencies, such as the Office of Superintendent of Financial Institutions (OSFI) in Canada, set the regulations to counteract risks and protect depositors.
Credit Risk
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
While banks cannot be fully protected from credit risk due to the nature of their business model, they can lower their exposure in several ways. Since deterioration in an industry or issuer is often unpredictable, banks lower their exposure through diversification.
By doing so, during a credit downturn, banks are less likely to be overexposed to a category with large losses. To lower their risk exposure, they can loan money to people with good credit histories, transact with high-quality counterparties, or own collateral to back up the loans.
Operational Risk
Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational 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. Losses that occur due to human error include internal fraud or mistakes made during transactions. An example is when a teller accidentally gives an extra $50 bill to a customer.
On a larger scale, fraud can occur through the breaching a bank’s cybersecurity. It allows hackers to steal customer information and money from the bank, and blackmail the institutions for additional money. In such a situation, banks lose capital and trust from customers. Damage to the bank’s reputation can make it more difficult to attract deposits or business in the future.
Market Risk
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.
Commodity prices also play a role because a bank may be invested in companies that produce commodities. As the value of the commodity changes, so does the value of the company and the value of the investment. Changes in commodity prices are caused by supply and demand shifts that are often hard to predict. So, to decrease market risk, diversification of investments is important. Other ways banks reduce their investment include hedging their investments with other, inversely related investments.
Liquidity Risk
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. If a bank delays providing cash for a few of their customer for a day, other depositors may rush to take out their deposits as they lose confidence in the bank. This further lowers the bank’s ability to provide funds and leads to a bank run.
Reasons that banks face liquidity problems include over-reliance on short-term sources of funds, having a balance sheet concentrated in illiquid assets, and loss of confidence in the bank on the part of customers. Mismanagement of asset-liability duration can also cause funding difficulties. This occurs when a bank has many short term liabilities and not enough short-term assets.
Short-term liabilities are customer deposits or short-term guaranteed investment contracts (GICs) that the bank needs to pay out to customers. If all or most of a bank’s assets are tied up in long-term loans or investments, the bank may face a mismatch in asset-liability duration.
Regulations exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outside funds.
IJIGA CHRISTIAN ADAKOLE
2017/241255
EDUCATION/ ECONOMICS
THE RISK OF COMMERCIAL BANKS.
To begin our exploration of common banking risks, it can be valuable to learn the differences between the two primary categories of risk. Systemic risks, sometimes referred to as macro risks, affect the banking industry as a whole. Examples of systemic risks include the financial crisis in 2008, the implosion of the housing market the same year, and the financial challenges faced across the sector caused by economic instability in the wake of the coronavirus pandemic.
Micro risks, on the other hand, affect specific institutions or groups of similar institutions. Certain banking practices, including accidental or intentional acts on the part of banking employees, can be considered micro risks. Others may include cyber crimes like malware or ransomware attacks that attempt to access banking information unlawfully. Commercial banking liability is a complex field, but one factor is apparent; although the effects of macro and micro risks on banking institutions may differ, management of these risk exposures often takes similar approaches.
Typical Risk Exposures in Banking
Risks have evolved in the banking industry as new technologies and new business models have fundamentally changed daily operations. Information technology is the primary driver of this evolution; computer-based systems are used for data storage, electronic transfer of assets, and delivery of personalized banking services. While the goal of adopting technology in banking was to streamline operations, it opened the door to an entirely new class of risk: cyber liability. In fact, cyber criminality stands as the leading risk exposure across the banking industry. In 2019 alone, over 25% of all malware attacks reported to authorities targeted banks and financial institutions. The theft or unauthorized access of banking data has cost the banking sector billions of dollars in losses, including commercial banking liability claims, forensic investigations, recovery efforts, and regulatory fines.
Cybercrime is certainly not the only risk banks face in the modern era. There are risks associated with many banking practices, and these risks must be considered when selecting commercial banking liability insurance and risk management solutions. Typical banking risks include:
Risks to banking directors and officers from the actions of shareholders.
Claims of non-compliance of regulatory banking provisions.
Employee fraud and theft, including unauthorized access to or creation of accounts and embezzlement.
Liability claims arising from physical loss or damage of assets.
Derivative claims.
Liability claims of unfair, discriminatory, or predatory banking and loan practices.
Errors and omissions claims centered on wrongful transactions, foreclosures, and similar banking mechanisms.
Here are some risk that banks face:
Operational Risk—Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes.
Liquidity Risk—Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits.
Market Risk—Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads.
Credit Risk—Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations.
Moral Hazard—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.
To minimize the risk that bank face they should:
—methodically identify the risks surrounding their business activities
assessing the likelihood of an event occurring
—understand how to respond to these events
putting systems in place to deal with the consequences
monitoring the effectiveness of their risk management approaches and controls
—improve decision-making, planning and prioritization
Commercial Banks are typically known to face some risks in the course of their business operations. Some of these risks are internal, while others are externally-induced. Do you agree? If yes, clearly analyze these risks and what banks should do to minimize the adverse effects of these risks.
NAME: UMELO CHIDERA NICOLE
REGISTRATION NUMBER: 2017/249589
EMAIL: nicoleumelo@gmail.com
The risks faced by banks are:
1. Credit risk
2. Liquidity risk
3. Market risk
4. Operational risk
5. Reputational risk
6. Macroeconomic risks
These risks can be abated by careful and diligent actions of the banks. It can also be abated through great corporations of the government eg AMCON, NDIC and even the stock exchange.
Anene Victoria chioma
2017/242435
Economics
Victoria.anene.242435@unn.edu.ng
Toria20@simplesite.com
Commercial banks are faced with various risks ranging from credit risk, market risk, liquidity risk, operational risk and business risk in their day to day activities. These risk can be managed and curtailed through the following process.
Avoidance: A business strives to eliminate a particular risk by getting rid of its cause.
Mitigation: Decreasing the projected financial value associated with a risk by lowering the possibility of the occurrence of the risk.
Acceptance: In some cases, a business may be forced to accept a risk. This option is possible if a business entity develops contingencies to mitigate the impact of the risk, should it occur.
NAME: OKEKE JUDE CHIMOBI
REG NO: 2017/249556
DEPARTMENT: ECONOMICS
EMAIL: chimobiokeke@gmail.com
Truly, every commercial bank face risks both internal and external. How these risks are managed will determine if they will make profits or losses. These risks include:
1. Credit risk: This type of risk is associated with loans and credit given to debtors. When debtors default in their payment, banks may run loss of bad debt.
2. Liquidity risk: This is a type of risk that occurs when banks are not able to meet up with the cash required to fund obligations. For instance, a customer who wants to withdraw but is unable to do so due to lack of ready cash in the bank.
3. Market risk: Market risk is associated with a fall in the value of assets in a portfolio due to a change in the value of market risk factors.
4. Operational risk: This type of risk arises as a result of the day-to-day running, organization and operation of the bank. In the process of carrying out some functions, a bank may incur operational risk such as embezzlement, fire outbreak, etc.
5. Macroeconomic risk: Here, the aggregate economy which the bank finds itself could pose as a risk to the bank e.g, in an economy with severe insecurity issues, the bank may not be able to carry out its activities effectively due to the unconducive environment in the country.
6. Reputational risk: These are risks associated with the image and goodwill of the bank. For instance, an awful experience with a customer service attendant could cause the bank to loose a good amount of their customers.
CONCLUSION:
The above risk all reduce profitability of a bank if not properly managed and sometimes may not be predictable as with credit risk. Some of the possible suggestions to minimize the adverse effects of these risks include:
1. Diversification of investment and loan packages
2. Hedging
3. Avoid heavy investment in illiquid assets.
Name: Anayo Bright Udochukwu
Reg Number: 2017/249482
Department: Economics
What banks should do to minimize the adverse effects of these risks such as credit risks, operational risks, market risks, and liquidity risks includes the following:
To lower their risk exposure, they can loan money to people with good credit histories, transact with high-quality counterparties, or own collateral to back up the loans. To decrease market risk, diversification of investments is important. Other ways banks reduce their investment include hedging their investments with other, inversely related investments. Moreover, Regulations exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outside funds.
Name : ALI, CHUKWUEMEKA JAPHET
REG. NO: 2017/242427
ECONOMICS MAJOR
Commercial banks face a lot of risks just like any other business. They include:
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 the 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.
What Can Be Done?
Such types of losses commonly occur due to borrower insolvency. Hence, banks should conduct proper research 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 upon the type of commodity a bank holds. For instance, if a bank holds foreign exchange then they’re exposed to a Forex risk, in the case of gold, silver, or real estate, they are exposed to commodity risks, etc. similar is the case with equity risk.
What Can Be Done?
To mitigate market risks, banks usually leverage hedging contracts. They use contracts like forwards, options and swaps, and many more, to completely 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 face 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.
What Can Be Done?
Although there are no sure-shot methods of eliminating the 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 AI, ML, Blockchain, big data, etc. to yield positive results in terms of security.
What Can Be Done?
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 regulation 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 loss in their daily banking targets. They had to bear legal penalties and might face significant challenges by the regulatory committee.
What Can Be Done?
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.
What Can Be Done?
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 rumours 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.
What Can Be Done?
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.
What Can Be Done?
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.
What Can Be Done?
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.
What Can Be Done?
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.
Okororie Emmanuel Kelechi
2017/242947
Economics
Credit Risks
Credit risk is the risk that arises from the possibility of non-payment of loans by the borrowers. Although credit risk is largely defined as risk of not receiving payments, banks also include the risk of delayed payments within this category.
Often times these cash flow risks are caused by the borrower becoming insolvent. Hence, such risk can be avoided if the bank conducts a thorough check and sanctions loans only to individuals and businesses that are not likely to run out of income over the period of the loan. Credit rating agencies provide adequate information to enable the banks to make informed decisions in this regard.
The profitability of a bank is extremely sensitive to credit risks. Hence, even if credit risk rises by a small amount, the profitability of the bank can get extremely impacted. Therefore, to deal with such risks banks have come up with a wide variety of measures. For instance, banks always hold a certain amount of funds in reserves to mitigate such risks.
The moment a loan is made, a certain amount of money is appropriated to the provision account. Also, banks have started utilizing tools like structured finance to mitigate such risks. Securitization helps remove the concentrated risk from the bank’s books and diffuse it amongst the various investors in the capital markets. Credit derivatives like credit default swap have also come into existence to help banks survive in the event of a credit default.
Unpaid loans were, are and will always be a byproduct of conducting the banking business. Modern banks have realized this and are prepared to handle the situation without becoming insolvent until a catastrophic loss occurs.
Market Risks
Apart from making loans, banks also hold a significant portion of securities. Some of these securities are held because of the treasury operations of the bank i.e. as a means to park money for the short term. However, many securities are also held as collateral based on which banks have given loans to their customers. The business of banking is therefore intertwined with the business of capital markets.
Banks face market risks in various forms. For instance if they are holding a large amount of equity then they are exposed to equity risk. Also, banks by definition have to hold foreign exchange exposing them to Forex risks. Similarly banks lend against commodities like gold, silver and real estate which exposes them to commodity risks as well.
In order to be able to mitigate such risks banks simply use hedging contracts. They use financial derivatives which are freely available for sale in any financial market. Using contracts like forwards, options and swaps, banks are able to almost eliminate market risks from their balance sheet.
Operational Risks
Banks have to conduct massive operations in order to be profitable. Economies of scale work in the favor of larger banks. Hence, maintaining consistent internal processes on such a large scale is an extremely difficult task.
Operational risk occurs as the result of a failed business processes in the bank’s day to day activities. Examples of operational risk would include payments credited to the wrong account or executing an incorrect order while dealing in the markets. None of the departments in a bank are immune from operational risks.
Operational risks arise mainly because of hiring the wrong people or alternatively they could also occur if there is a breakdown of the information technology systems. A lapse in the internal processes being followed could also lead to catastrophic errors. For instance, Barings Bank ended up bankrupt because of its failure to implement appropriate internal controls. One trader was able to bet so much in the derivatives market that the equity of Barings Bank was wiped out and the bank simply ceased to exist.
Name: Oroke charity N
Regno:2017/243816
Depart : Economics
Course: Eco 324
The Risk of Commercial Banks
As a result of the role commercial banks play , they are exposed to the risks that affect both the securities markets and the economic conditions that affect consumers. To understand the risks associated with commercial banks, it is helpful to consider some key areas that affect banking operations.
Interest Rate Risk
Interest rate risk is one of the more prevalent risks for commercial banks. Generally, commercial banks are proficient at mitigating interest rate risk in their investment portfolios. However, interest rates are outside the domain of commercial bank operations. Instead, the Federal Reserve, the central bank of the U.S., exercises considerable influence over interest rates. As a result, commercial banks try to hedge their loans against any changes in the general interest rate level in the economy. For example, if a bank makes a business loan and charges the borrower 5 percent interest with a current interest rate level at 2 percent, the bank will make a profit of 3 percent if the rate remains at 2 percent throughout the life of the loan. However, if the general level of interest rates increases from 2 to 3 percent, the bank’s profit will decline to 2 percent. Hence interest rate stands as challenge to commercial Banks some times.
Default Risk
Because Commercial banks generally make most of their money on loans ,even though banks screen borrowers and analyze their financial position and ability to pay, commercial banks are still susceptible to borrower default. When borrowers are unable to pay, they default on a loan, causing the bank to lose money. Although a general analysis of a bank’s loan portfolio will indicate a small margin of default, widespread borrower default may jeopardize the solvency of a commercial bank.
Regulation risk
Commercial banks are also subject to regulation problem/risk. Depending on the type of bank, specialization and state in which they operate, commercial banks work within a framework of legal regulation. When regulations change, the bank’s operational framework changes, which may impact its ability to generate profits from loans. For example, the Federal Reserve may increase the amount of required reserves, forcing commercial banks to withhold more money to cover customer withdrawals. This decreases the amount of bank capital available to lend, which may reduce bank profits.
Opportunity Cost risk:
Although loans are a significant part of commercial bank operations, banks may quit lending for fear of widespread default. If a bank’s financial analysis expects diminished economic activity, a commercial bank may expect diminished capacity of borrower repayment. With a higher default rate, a bank may prefer to invest only a portion of its capital to make money from a few successful loans rather than risk more money with the potential for default.
Deposits risk
Commercial banks rely partly on attracting deposits from customers to fund banking investments and loans. To do so, many commercial banks offer traditional banking services, including certificates of deposit and checking, savings and money market accounts. In addition, banks may increase the interest rate payments on these accounts to make them more attractive to depositors. Without a consistent flow of deposit funds, commercial banks would be unable to operate at an optimal level.
All of the above risk of the commercial Bank , if not properly managed could possibly lead to either collapse of the Bank /fold-up , acquisition of such bank by another Bank .example Intercontinental Bank and Access Bank or even merging .example is Access Bank and Diamond Bank.
Name: Oroke Charity N
Reg no:2017/243816
Course :Eco 324
Department: Economics
Risk of commercial Banks
Commercial Banks face allot of risk, and they include the following :
Credit Risk
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
While banks cannot be fully protected from credit risk due to the nature of their business model, they can lower their exposure in several ways. Since deterioration in an industry or issuer is often unpredictable, banks lower their exposure through diversification.
By doing so, during a credit downturn, banks are less likely to be overexposed to a category with large losses. To lower their risk exposure, they can loan money to people with good credit histories, transact with high-quality counterparties, or own collateral to back up the loans.
Operational Risk
Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational 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. Losses that occur due to human error include internal fraud or mistakes made during transactions. An example is when a teller accidentally gives an extra $50 bill to a customer.
On a larger scale, fraud can occur through the breaching a bank’s cybersecurity. It allows hackers to steal customer information and money from the bank, and blackmail the institutions for additional money. In such a situation, banks lose capital and trust from customers. Damage to the bank’s reputation can make it more difficult to attract deposits or business in the future.
Market Risk
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.
Commodity prices also play a role because a bank may be invested in companies that produce commodities. As the value of the commodity changes, so does the value of the company and the value of the investment. Changes in commodity prices are caused by supply and demand shifts that are often hard to predict. So, to decrease market risk, diversification of investments is important. Other ways banks reduce their investment include hedging their investments with other, inversely related investments.
Liquidity Risk
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. If a bank delays providing cash for a few of their customer for a day, other depositors may rush to take out their deposits as they lose confidence in the bank. This further lowers the bank’s ability to provide funds and leads to a bank run.
Reasons that banks face liquidity problems include over-reliance on short-term sources of funds, having a balance sheet concentrated in illiquid assets, and loss of confidence in the bank on the part of customers. Mismanagement of asset-liability duration can also cause funding difficulties. This occurs when a bank has many short term liabilities and not enough short-term assets.
Short-term liabilities are customer deposits or short-term guaranteed investment contracts (GICs) that the bank needs to pay out to customers. If all or most of a bank’s assets are tied up in long-term loans or investments, the bank may face a mismatch in asset-liability duration.
Regulations exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outside funds.
Interest Rate Risk
Interest rate risk is one of the more prevalent risks for commercial banks. Generally, commercial banks are proficient at mitigating interest rate risk in their investment portfolios. However, interest rates are outside the domain of commercial bank operations. Instead, the Federal Reserve, the central bank of the U.S., exercises considerable influence over interest rates. As a result, commercial banks try to hedge their loans against any changes in the general interest rate level in the economy.
Default Risk
Commercial banks generally make most of their money on loans. Although banks screen borrowers and analyze their financial position and ability to pay, commercial banks are still susceptible to borrower default. When borrowers are unable to pay, they default on a loan, causing the bank to lose money. Although a general analysis of a bank’s loan portfolio will indicate a small margin of default, widespread borrower default may jeopardize the solvency of a commercial bank.
Regulation risk
Commercial banks are also subject to regulation. Depending on the type of bank, specialization and state in which they operate, commercial banks work within a framework of legal regulation. When regulations change, the bank’s operational framework changes, which may impact its ability to generate profits from loans. For example, the Federal Reserve may increase the amount of required reserves, forcing commercial banks to withhold more money to cover customer withdrawals. This decreases the amount of bank capital available to lend, which may reduce bank profits.
by
Anachuna Cynthia Chisom
2017/249481
A business bank is a monetary establishment which acknowledges stores from the general population and gives credits for the motivations behind utilization and venture to make benefit. We will remember other business bank of the world for our examination. The interior and outer danger that is related with business banks incorporates along these lines:
Business Risk:
The financial business today is impressively cutting-edge and broadened. Banks today have a wide assortment of procedures from which they need to pick. When such system is picked, banks need to zero in their assets on acquiring their essential objectives over the long haul.
Subsequently, there is consistently a danger that a given bank may pick some unacceptable methodology. Because of this off-base decision, the bank may endure misfortunes and wind up being procured or may just fall. Think about the instance of banks like Washington Mutual and Lehman Brothers. These banks picked the subprime course to development. Their system was to be the favored moneylender to individuals who have not exactly wonderful FICO assessments. Be that as it may, the entire space of subprime loaning became penniless and since these banks had hefty openings to such advances, they endured critical results as well.
Banks have no conceivable method to alleviate the dangers that are made by following improper business goals. Which targets were correct and which weren’t right? This inquiry must be replied looking back. At the point when Lehman Brothers was zeroing in their assets on subprime loaning, it probably seemed like the deliberately right activity!
Market Risks:
Aside from making credits, banks likewise hold a critical bit of protections. A portion of these protections are held in view of the depository tasks of the bank for example as an intend to stop cash for the present moment. Nonetheless, numerous protections are likewise held as security dependent on which banks have offered credits to their clients. The matter of banking is in this manner entwined with the matter of capital business sectors.
Banks face market hazards in different structures. For example assuming they are holding a lot of value, they are presented to value hazard. Additionally, banks by definition need to hold unfamiliar trade presenting them to Forex hazards. Additionally banks loan against items like gold, silver and land which opens them to product hazards too.
To have the option to relieve such dangers banks just use supporting agreements. They utilize monetary subordinates which are openly ready to move in any monetary market. Utilizing contracts like advances, choices and trades, banks can nearly wipe out market hazards from their monetary record.
Operational Risks:
Banks need to lead huge activities to be beneficial. Economies of scale work in the blessing of bigger banks. Thus, keeping up steady inward cycles for a huge scope is an incredibly troublesome undertaking.
Operational danger happens as the consequence of a bombed business measures in the bank’s everyday exercises. Instances of operational danger would incorporate installments credited to some unacceptable record or executing an off base request while managing in the business sectors. None of the offices in a bank are invulnerable from operational dangers.
Operational dangers emerge principally in view of employing some unacceptable individuals or then again they could likewise happen if there is a breakdown of the data innovation frameworks. A pass in the interior cycles being followed could likewise prompt disastrous blunders. For example, Barings Bank wound up bankrupt due to its inability to carry out fitting interior controls. One broker had the option to wager such a great amount in the subordinates market that the value of Barings Bank was cleared out and the bank just stopped to exist.
Liquidity Risk:
Liquidity hazard is another sort of hazard that is characteristic in the financial business. Liquidity hazard is the danger that the bank won’t meet its commitments if the contributors come in to pull out their cash. This danger is inalienable in the fragmentary save banking framework. Along these lines, in this framework, just a level of the stores got are kept down as stores, the rest are utilized to make advances. In this way, if every one of the contributors of the organization came in to pull out their cash at the same time, the bank would not have sufficient cash. The present circumstance is known as a bank run. This has happened on many occasions over the historical backdrop of present day banking.
Current banks are not exceptionally worried about liquidity hazard. This is on the grounds that they have the sponsorship of the national bank. In the event that there is a sudden spike in demand for a specific bank, the national bank redirects every one of its assets to the influenced bank. Hence, the contributors can be taken care of when they request their stores. This reestablishes contributor’s trust in the banks funds and the sudden spike in demand for the bank is turned away.
Numerous cutting edge banks have confronted bank runs. In any case, none of them have gotten bankrupt because of a bank run post the foundation of national banks.
Name: Ani, Gabriel Ogbonna
Reg. Number: 2017/249483
Email: anigabriel05@gmail.com
Commercial banks are faced with diverse risk, both internal and external. This risk mostly occur as result of large size of banks, nature of business and overexposure to risk which can cause bank failure and impact millions of people. The ability of a bank to manage risk also affects investors’ decisions. Even if a bank can generate large revenues, lack of risk management can lower profits due to losses on loans. Value investors are more likely to invest in a bank that is able to provide profits and is not at an excessive risk of losing money. No commercial bank can avert risk but the proper management of this risk will make them to remain in business.
Some of the risk that commercial banks face and it’s management are as follows;
CREDIT RISK
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
While banks cannot be fully protected from credit risk due to the nature of their business model, they can lower their exposure in several ways. Since deterioration in an industry or issuer is often unpredictable, banks lower their exposure through diversification.
By doing so, during a credit downturn, banks are less likely to be overexposed to a category with large losses. To manage their risk exposure, they can loan money to people with good credit histories, transact with high-quality counterparties, or own collateral to back up the loans.
LIQUIDITY RISK
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. If a bank delays providing cash for a few of their customer for a day, other depositors may rush to take out their deposits as they lose confidence in the bank. This further lowers the bank’s ability to provide funds and leads to a bank run.
Reasons that banks face liquidity problems include over-reliance on short-term sources of funds, having a balance sheet concentrated in illiquid assets, and loss of confidence in the bank on the part of customers. Mismanagement of asset-liability duration can also cause funding difficulties. This occurs when a bank has many short term liabilities and not enough short-term assets.
Short-term liabilities are customer deposits or short-term guaranteed investment contracts (GICs) that the bank needs to pay out to customers. If all or most of a bank’s assets are tied up in long-term loans or investments, the bank may face a mismatch in asset-liability duration.
Regulations exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outside funds.
OPERATIONAL RISK
Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational 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. Losses that occur due to human error include internal fraud or mistakes made during transactions. An example is when a teller accidentally gives an extra #50 bill to a customer. On a larger scale, fraud can occur through the breaching a bank’s cybersecurity. It allows hackers to steal customer information and money from the bank, and blackmail the institutions for additional money. In such a situation, banks lose capital and trust from customers. Damage to the bank’s reputation can make it more difficult to attract deposits or business in the future.
MARKET RISK
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading. Commodity prices also play a role because a bank may be invested in companies that produce commodities. As the value of the commodity changes, so does the value of the company and the value of the investment. Changes in commodity prices are caused by supply and demand shifts that are often hard to predict. So, to decrease market risk, diversification of investments is important. Other ways banks reduce their investment include hedging their investments with other, inversely related investments
NWANKWO BASIL CHUKWUEMEKA
2016/233850
ECONOMICS DEPARTMENT
300L
Commercial banks face risks in their day to day operations. While some of these risks are avoidable, others may not be easily foreseeable. However commercial banks should mitigate risks wherever and whenever possible.
Here are some of the risks commercial banks face:
LIQUIDITY RISK
This is a type of risk that occurs when banks are not able to meet up with the cash required to fund obligations. For instance, a customer who wants to withdraw but is unable to do so due to lack of ready cash in the bank.
CREDIT RISK
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
REPUTATIONAL RISK: this risk poses a threat to the reputation of the business. A major driving force of every business is goodwill and integrity. No bank wants to be found wanting in this regard.
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. Cyber security 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.
OPERATIONAL RISK
Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational type of risk is low for simple business operations such as retail banking and asset management.
Name: ABIAZIA RUFUS CHIDIEBUBE
REG. No: 2017/243371
DEPT: Economics
Level: 300
Commercial Bank risk is both internal and external. The major risks faced by banks include credit, operational, market, and liquidity risk.
Due to the large size of some banks, overexposure to risk can cause bank failure and impact millions of people. By understanding the risks posed to banks, governments can set better regulations to encourage prudent management and decision-making. The ability of a bank to manage risk also affects investors’ decisions. Even if a bank can generate large revenues, lack of risk management can lower profits due to losses on loans. Value investors are more likely to invest in a bank that is able to provide profits and is not at an excessive risk of losing money.
Credit Risk
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan.
Major Risks for Banks
Credit, operational, market, and liquidity risks
Prudent risk management can help banks improve profits as they sustain fewer losses on loans and investments.
Ways to decrease risks include diversifying assets, using prudent practices when underwriting, and improving operating systems.
Credit Risk
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
While banks cannot be fully protected from credit risk due to the nature of their business model, they can lower their exposure in several ways. Since deterioration in an industry or issuer is often unpredictable, banks lower their exposure through diversification.
By doing so, during a credit downturn, banks are less likely to be overexposed to a category with large losses. To lower their risk exposure, they can loan money to people with good credit histories, transact with high-quality counterparties, or own collateral to back up the loans.
Operational Risk
Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational 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.
Market Risk
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading. Other ways banks reduce their investment include hedging their investments with other, inversely related investments.
Liquidity Risk
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. Regulations exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outside funds.
Ways to decrease risks include diversifying assets, using prudent practices when underwriting, and improving operating systems.
Ideba Tochukwu Emmanuel
2017/241435
Risks have evolved in the banking industry as new technologies and new business models have fundamentally changed daily operations. Information technology is the primary driver of this evolution; computer-based systems are used for data storage, electronic transfer of assets, and delivery of personalized banking services. While the goal of adopting technology in banking was to streamline operations, it opened the door to an entirely new class of risk: cyber liability. In fact, cyber criminality stands as the leading risk exposure across the banking industry. In 2019 alone, over 25% of all malware attacks reported to authorities targeted banks and financial institutions. The theft or unauthorized access of banking data has cost the banking sector billions of dollars in losses, including commercial banking liability claims, forensic investigations, recovery efforts, and regulatory fines.
Cybercrime is certainly not the only risk banks face in the modern era. There are risks associated with many banking practices, and these risks must be considered when selecting commercial banking liability insurance and risk management solutions. Typical banking risks include:
Risks to banking directors and officers from the actions of shareholders.
Claims of non-compliance of regulatory banking provisions.
Employee fraud and theft, including unauthorized access to or creation of accounts and embezzlement.
Liability claims arising from physical loss or damage of assets.
Derivative claims.
Liability claims of unfair, discriminatory, or predatory banking and loan practices.
Errors and omissions claims centered on wrongful transactions, foreclosures, and similar banking mechanisms.
NAME:OKEKE NANCY OGADIMMA
REG NO:2017/249557
DEPARTMENT:ECONOMICS
EMAIL:ogadimmanancy@gmail.com
Commercial banks are typically known to face some risks in the course of their business operations. Some of these risks are internal while others are external.
Due to the large size of commercial banks ,overexposure to risk can cause bank failure. The major risks faced by banks include credit risk, operational risk, market risk, and liquidity risk.
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparts fail to meet contractual obligations. For example, when borrowers default on a principal or interest payment of a loan. Failure to meet contracts can also occur in areas such as derivatives and guarantees provided.
Operational risk can be defined as the risk of loss due to errors ,interruptions ,or damages caused by people, systems ,or processes. This operational type pf risk is low for simple business operations such as retail banking and asset management, and higher for operations such as sales and trading.
Also losses that occur due to human error like internet fraud or mistakes made during transactions. Fraud usually occur through the breaching of a bank’s cyber security. It allows hackers to steal customer information and money from the bank, and blackmail the institutions for additional money. In such a situation, the banks lose capital and trust from the customers and this therefore can damage a bank’s reputation and thereby making it difficult to attract deposits or business in the future.
Market risk
Mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.
Commodity prices also play a role because a bank may be invested in companies that produce commodities. AAs the value of the commodity changes , so does the value of the company and the value of the investment. These changes are caused by supply and demand shifts that are often hard to predict.
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in bounce back effect equally known as snow ball effect. If a bank delays providing cash for a few of their customers for a day, other depositors may rush out to take out their money/deposits as they lose confidence in the bank. This further lowers the bank’s ability to provide funds and leads to a bank run.
Banks face liquidity problems due to over-reliance on short-term sources of funds, having a balance sheet concentrated in illiquid assets, and loss of confidence in the bank on the part of customers. Mismanagement of asset-liability duration can also cause funding difficulties .this occurs when a bank has many short term liabilities and not enough short-term assets.
WAYS TO MINIMIZE ADVERSE EFFECTS OF THESE RISKS
Banks can lower the exposure of risks through diversification. By doing so, during a credit downturn, banks are less likely to be overexposed to a category with large losses. To lower their risk exposure ,they can loan money to people with good credit histories, transact with high-quality counterparts, or own collateral to back up the loans.
Also diversification of investments and hedging their investment with other inversely related investments can also help to lower the exposure of risks..
Regulations also exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the infloe of outside funds.
By understanding the risks posed to banks ,governments can set better regulations to encourage prudent management and decision-making.
Okaome Esther Chioma
2017/249554
estherokaome@gmail.com
It is often said that profit is a reward for risk bearing. Nowhere is this truer than in the case of banking industry. Banks are literally exposed to many different types of risks. A successful banker is one that can mitigate these risks and create significant returns for the shareholders on a consistent basis. Mitigation of risks begins by first correctly identifying the risks, why they arise and what damage can they cause. In this article, we have listed the major types of risks that are faced by every bank. They are as follows:
Credit Risks
Credit risk is the risk that arises from the possibility of non-payment of loans by the borrowers. Although credit risk is largely defined as risk of not receiving payments, banks also include the risk of delayed payments within this category.
Market risk
Apart from making loans, banks also hold a significant portion of securities. Some of these securities are held because of the treasury operations of the bank i.e. as a means to park money for the short term.
Operational risk
Operational risk occurs as the result of a failed business processes in the bank’s day to day activities. Examples of operational risk would include payments credited to the wrong account or executing an incorrect order while dealing in the markets.
Moral Hazard
The recent bailout of banks by many countries has created another kind of risk called the moral hazard. This risk is not faced by the bank or its shareholders. Instead, this risk is faced by the taxpayers of the country in which banks operate. Banks have become accustomed to taking excessive risk. If their risk pays off, they get to keep the returns.
Liquidity Risk
Liquidity risk is the risk that the bank will not be able to meet its obligations if the depositors come in to withdraw their money. This risk is inherent in the fractional reserve banking system. Therefore, in this system, only a percentage of the deposits received are held back as reserves, the rest are used to create loans.
Business risk
The banking industry today is considerably advanced and diversified. Banks today have a wide variety of strategies from which they have to choose.
Reputational risk
Reputation is an extremely important intangible asset in the banking business. Banks like JP Morgan bank, Chase bank, Citibank, Bank of America etc have all been in the business for hundreds of years and have stellar reputations.
Systematic risk
Systemic risk arises because of the fact that the financial system is one intricate and connected network. Hence, the failure of one bank has the possibility to cause the failure of many other banks as well.
Osuiwu Adimchinobi Peace
2017/249570
Economics department
Some of the risks of commercial banks include credit risk, market risk, strategic risk, liquidity risk, reputational risk and business risk.
To deal with this, commercial banks do the following:
1. Diversify their investments.
2. Employ qualified workers for the right job.
3. Thorough background check on potential borrowers.
4. Give advice on investments to be made with loans and supervise projects carried out with the loans.
5. Diversify the types of loans given based on their duration.
6. Never participate in any unfair or manipulative business practices.
7. Continuously ensure that their public relations efforts project them as a friendly and honest bank.
8. Do not depend on short-term sources of funds and concentrate highly on illiquid assets.
Name: Nnamani Great Ogomuegbunam
Reg no: 2017/249532
ECONOMICS
Commercial banks rely partly on attracting deposits from customers to fund banking investments and loans. To do so, many commercial banks offer traditional banking services, including certificates of deposit and checking, savings and money market accounts.
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 the 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.
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.
3. 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.
4. 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.
To mitigate these risks, 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.
Name: Ugorji Ijeoma Judith
Reg no: 2017/243088
Department: ECONOMICS
Risk refers to a possible event that could cause harm or loss. It is the possibility of something bad happening. In terms of business or finance, risk involves the uncertainty about the effect or implications of the outcome of a financial or business activity. Such activities could be investment, savings, starting up a business and even lending money to another to start a business. All these are financial activities involving risk.
Every human and non human entity is faced with uncertainty about the outcome of their day to day activities. No one is certain about the exact outcome of their daily involvement even though they may be aware of the possible outcomes which could be either positive or negative. Either way, risk is one inevitable phenomenon people face on daily basis.
Therefore, just like other entities, the commercial bank is a financial institution faced with a number of risk associated with day to day financial activities. Some of these risk are products of certain internal factors while some are posed by the effect of the macroeconomic environment in which the business operates in. These risk are discussed below.
VOLATILITY RISK: market flunctuations can be unnerving to investors. Stock prices of some companies may flunctuate up and down causing some potential investors not to invest in such stock. These flunctuations may be as a result of faulty products or political or market events.
INFLATION RISK: inflation is a general rise in prices level. It reduces purchasing power, which is a risk for investors receiving fixed rate of interest.
INTEREST RATE RISK: interest rate changes affects bond’s value. Rising interest rates will make newly issued bond more appealing to investors cause the newer bonds will have a higher rate of interest than older ones.
LIQUIDITY RISK: this refers to the risk that investors will not find a market for their securities potentially preventing them from buying or selling when they want.
CREDIT RISK: this is a fundamental risk faced by commercial banks . This is risk associated with giving out loans to businesses. When this loans are not paid as at when due, it affects the credit available to banks. This in turn affects credit creation function of the bank.
OPERATIONAL RISK: this is a major internal risk which arises on daily basis. This could be risk associated with daily transactions, attending to customers.
REPUTATIONAL RISK: this risk poses a threat to the reputation of the business. A major driving force of every business is goodwill and integrity. No bank wants to be found wanting in this regard.
Other risks faced by commercial banks include strategic risk, exchange rate risk, legal and compliance risk, concentration risk, solvency risk. Etc.
These risks however can be mitigated and the adverse effect can be minimized if banks can build up risk management strategies such as training their staff rigorously on risk management, proper and up to date records of every business transactions, regular monitoring and assessment of managerial activities, zero tolerance for incompetencies on the part of members of staff, transparent and accountable credit lending processes and other measures should be put in place to reduce or avert risk.
Name: Ugorji Ijeoma Judith
Reg no: 2017/243088
Department: Economics.
Risk refers to a possible event that could cause harm or loss. It is the possibility of something bad happening. In terms of business or finance, risk involves the uncertainty about the effect or implications of the outcome of a financial or business activity. Such activities could be investment, savings, starting up a business and even lending money to another to start a business. All these are financial activities involving risk.
Every human and non human entity is faced with uncertainty about the outcome of their day to day activities. No one is certain about the exact outcome of their daily involvement even though they may be aware of the possible outcomes which could be either positive or negative. Either way, risk is one inevitable phenomenon people face on daily basis.
Therefore, just like other entities, the commercial bank is a financial institution faced with a number of risk associated with day to day financial activities. Some of these risk are products of certain internal factors while some are posed by the effect of the macroeconomic environment in which the business operates in. These risk are discussed below.
VOLATILITY RISK: market flunctuations can be unnerving to investors. Stock prices of some companies may flunctuate up and down causing some potential investors not to invest in such stock. These flunctuations may be as a result of faulty products or political or market events.
INFLATION RISK: inflation is a general rise in prices level. It reduces purchasing power, which is a risk for investors receiving fixed rate of interest.
INTEREST RATE RISK: interest rate changes affects bond’s value. Rising interest rates will make newly issued bond more appealing to investors cause the newer bonds will have a higher rate of interest than older ones.
LIQUIDITY RISK: this refers to the risk that investors will not find a market for their securities potentially preventing them from buying or selling when they want.
CREDIT RISK: this is a fundamental risk faced by commercial banks . This is risk associated with giving out loans to businesses. When this loans are not paid as at when due, it affects the credit available to banks. This in turn affects credit creation function of the bank.
OPERATIONAL RISK: this is a major internal risk which arises on daily basis. This could be risk associated with daily transactions, attending to customers.
REPUTATIONAL RISK: this risk poses a threat to the reputation of the business. A major driving force of every business is goodwill and integrity. No bank wants to be found wanting in this regard.
Other risks faced by commercial banks include strategic risk, exchange rate risk, legal and compliance risk, concentration risk, solvency risk. Etc.
These risks however can be mitigated and the adverse effect can be minimized if banks can build up risk management strategies such as training their staff rigorously on risk management, proper and up to date records of every business transactions, regular monitoring and assessment of managerial activities, zero tolerance for incompetencies on the part of members of staff, transparent and accountable credit lending processes and other measures should be put in place to reduce or avert risk.
Udeh Rita Ezinne
2017/249578
ritaudeh563@gmail.com
Commercial Bank are typically known to face some risk in their day to day business operations. I agree that some of these risk are internal while some are external.
Some of the internal risk faced by commercial Banks include Strategic Risk, Reputation Risk, Credit Risk, etc, while some of the external risks which are not many include: Funding and Liquidity Risk, Market Risk, Other operational Risk, etc.
Credit Risk
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
While banks cannot be fully protected from credit risk due to the nature of their business model, they can lower their exposure in several ways. Since deterioration in an industry or issuer is often unpredictable, banks lower their exposure through diversification.
By doing so, during a credit downturn, banks are less likely to be overexposed to a category with large losses. To lower their risk exposure, they can loan money to people with good credit histories, transact with high-quality counterparties, or own collateral to back up the loans.
Strategic Risk
Risks like the Strategic Risk which is internal has to do with how well the bank carry out there duties that is, the strategies, plans, policies they employ to carry out their functions. If these plans and strategies that the bank in question employs is not working fine or not yielding good and expected results, there is a need to cross-check where the bank has gone wrong as customers might not even be patronizing the bank which would lead to the risk of solvency which is how much the bank has to keep itself in business as well as discharge her duties properly and effectively.
Operational Risk
Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational 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. Losses that occur due to human error include internal fraud or mistakes made during transactions. An example is when a teller accidentally gives an extra $50 bill to a customer.
On a larger scale, fraud can occur through the breaching a bank’s cybersecurity. It allows hackers to steal customer information and money from the bank, and blackmail the institutions for additional money. In such a situation, banks lose capital and trust from customers. Damage to the bank’s reputation can make it more difficult to attract deposits or business in the future.
Market Risk
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.
Commodity prices also play a role because a bank may be invested in companies that produce commodities. As the value of the commodity changes, so does the value of the company and the value of the investment. Changes in commodity prices are caused by supply and demand shifts that are often hard to predict. So, to decrease market risk, diversification of investments is important. Other ways banks reduce their investment include hedging their investments with other, inversely related investments.
Liquidity Risk
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. If a bank delays providing cash for a few of their customer for a day, other depositors may rush to take out their deposits as they lose confidence in the bank. This further lowers the bank’s ability to provide funds and leads to a bank run.
Reasons that banks face liquidity problems include over-reliance on short-term sources of funds, having a balance sheet concentrated in illiquid assets, and loss of confidence in the bank on the part of customers. Mismanagement of asset-liability duration can also cause funding difficulties. This occurs when a bank has many short term liabilities and not enough short-term assets.
Short-term liabilities are customer deposits or short-term guaranteed investment contracts (GICs) that the bank needs to pay out to customers. If all or most of a bank’s assets are tied up in long-term loans or investments, the bank may face a mismatch in asset-liability duration.
Regulations exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outside funds.
Yes I agree
Some of the risk faced by banks include
Credit risk; arising from a borrower who doesn’t make payment as promised
Liquidity risk ; occurs when a given security or asset cannot be-traded
Market risk; when the value of a portfolio decreases due to a change in market risk factors
Operational risk ; arising from the execution of a business function
Macro risk ; related to aggregate or general economy that the bank operates in
In order to avoid this risks a bank must be careful in their day to day activities, they must employ qualified staffs who will be more efficient in carrying out operations.
NAME:OZUEM DEBORAH OGHENEKEVWE
REG NO: 2017/249572
DEPT: ECONOMICS
EMAIL: deborah.ozuem.249572@unn.edu.ng
Truly, every commercial bank face risks both internal and external. How these risks are managed will determine if they will make profits or losses. These risks include:
1. Credit risk: This type of risk is associated with loans and credit given to debtors. When debtors default in their payment, banks may run loss of bad debt.
2. Liquidity risk: This is a type of risk that occurs when banks are not able to meet up with the cash required to fund obligations. For instance, a customer who wants to withdraw but is unable to do so due to lack of ready cash in the bank.
3. Market risk: Market risk is associated with a fall in the value of assets in a portfolio due to a change in the value of market risk factors.
4. Operational risk: This type of risk arises as a result of the day-to-day running, organization and operation of the bank. In the process of carrying out some functions, a bank may incur operational risk such as embezzlement, fire outbreak, etc.
5. Macroeconomic risk: Here, the aggregate economy which the bank finds itself could pose as a risk to the bank e.g, in an economy with severe insecurity issues, the bank may not be able to carry out its activities effectively due to the unconducive environment in the country.
6. Reputational risk: These are risks associated with the image and goodwill of the bank. For instance, an awful experience with a customer service attendant could cause the bank to loose a good amount of their customers.
CONCLUSION:
The above risk all reduce profitability of a bank if not properly managed and sometimes may not be predictable as with credit risk. Some of the possible suggestions to minimize the adverse effects of these risks include:
1. Diversification of investment and loan packages
2. Hedging
3. Avoid heavy investment in illiquid assets.
Igweh Sixtus Ozioma
2017/274588
Eco 324
Answer
Avoid: In general, risks should be avoided that involve a high probability impact for both financial loss and damage.
Transfer: Risks that may have a low probability for taking place but would have a large financial impact should be mitigated by being shared or transferred, e.g. by purchasing insurance, forming a partnership, or outsourcing.
Accept: With some risks, the expenses involved in mitigating the risk is more than the cost of tolerating the risk. In this situation, the risks should be accepted and carefully monitored.
Limit: The most common mitigation strategy is risk limitation, i.e. businesses take some type of action to address a perceived risk and regulate their exposure. Risk limitation usually employs some risk acceptance and some risk avoidance.
Closing Remarks
Today’s information technology can help perfect risk mitigation strategies by enhancing the ability to identify, evaluate and monitor risks. Furthermore, it enriches the ability of businesses to forecast events with greater accuracy.
NAME: OKONKWO FAITH MUNACHI
REG NO: 2017/242422
E-MAIL:faith.okonkwo.242422
ANSWER
The very nature of banking system therefore makes them prone to risks. Thus, the management of banks requires a lot of skill since multiple types of risks need to be mitigated. Some of these risks can be avoided whereas for the others the best that banks can do is to minimize their damage. Banks are faced with risks, both internal and external risks. Below are some of the risks and ways to mitigate or minimize them.
RISKS FACED BY BANKS
It is often said that profit is a reward for risk bearing. Nowhere is this truer than in the case of banking industry. Banks are literally exposed to many different types of risks. A successful banker is one that can mitigate these risks and create significant returns for the shareholders on a consistent basis. Mitigation of risks begins by first correctly identifying the risks, why they arise and what damage can they cause. In this article, we have listed the major types of risks that are faced by every bank. They are as follows:
Credit Risks
Credit risk is the risk that arises from the possibility of non-payment of loans by the borrowers. Although credit risk is largely defined as risk of not receiving payments, banks also include the risk of delayed payments within this category.
Often times these cash flow risks are caused by the borrower becoming insolvent. Hence, such risk can be avoided if the bank conducts a thorough check and sanctions loans only to individuals and businesses that are not likely to run out of income over the period of the loan. Credit rating agencies provide adequate information to enable the banks to make informed decisions in this regard. The moment a loan is made, a certain amount of money is appropriated to the provision account. Also, banks have started utilizing tools like structured finance to mitigate such risks. Securitization helps remove the concentrated risk from the bank’s books and diffuse it amongst the various investors in the capital markets. Credit derivatives like credit default swap have also come into existence to help banks survive in the event of a credit default.
Unpaid loans were, are and will always be a byproduct of conducting the banking business. Modern banks have realized this and are prepared to handle the situation without becoming insolvent until a catastrophic loss occurs.
Market Risks
Apart from making loans, banks also hold a significant portion of securities. Some of these securities are held because of the treasury operations of the bank i.e. as a means to park money for the short term. However, many securities are also held as collateral based on which banks have given loans to their customers. The business of banking is therefore intertwined with the business of capital markets.
Banks face market risks in various forms. For instance if they are holding a large amount of equity then they are exposed to equity risk. Also, banks by definition have to hold foreign exchange exposing them to Forex risks. Similarly banks lend against commodities like gold, silver and real estate which exposes them to commodity risks as well.
In order to be able to mitigate such risks banks simply use hedging contracts. They use financial derivatives which are freely available for sale in any financial market. Using contracts like forwards, options and swaps, banks are able to almost eliminate market risks from their balance sheet.
Operational Risks
Banks have to conduct massive operations in order to be profitable. Economies of scale work in the favor of larger banks. Hence, maintaining consistent internal processes on such a large scale is an extremely difficult task.
Operational risk occurs as the result of a failed business processes in the bank’s day to day activities. Examples of operational risk would include payments credited to the wrong account or executing an incorrect order while dealing in the markets. None of the departments in a bank are immune from operational risks.
Operational risks arise mainly because of hiring the wrong people or alternatively they could also occur if there is a breakdown of the information technology systems. A lapse in the internal processes being followed could also lead to catastrophic errors.
The banks are required to devise their own norms and procedures to identify the areas of operational risk and controlling thereof.
Liquidity Risk
Liquidity risk is another kind of risk that is inherent in the banking business. Liquidity risk is the risk that the bank will not be able to meet its obligations if the depositors come in to withdraw their money. This risk is inherent in the fractional reserve banking system. Therefore, in this system, only a percentage of the deposits received are held back as reserves, the rest are used to create loans. Therefore, if all the depositors of the institution came in to withdraw their money all at once, the bank would not have enough money. This situation is called a bank run. This has happened countless times over the history of modern banking.
Modern day banks are not very concerned about liquidity risk. This is because they have the backing of the central bank. In case there is a run on a particular bank, the central bank diverts all its resources to the affected bank. Therefore, the depositors can be paid back when they demand their deposits. This restores depositor’s confidence in the banks finances and the run on the bank is averted.
Reputational Risk
Reputation is an extremely important intangible asset in the banking business. Banks like JP Morgan bank, Chase bank, Citibank, Bank of America etc have all been in the business for hundreds of years and have stellar reputations. These reputations enable them to generate more business more profitably.
Customers like their money to be deposited at places which they believe follow safe and sound business practices. Hence, if there is any news in the media which projects a given bank in a negative light, such news negatively impacts the banks business.
Banks can save their reputation by ensuring that they never participate in any unfair or manipulative business practices. Also, banks need to continuously ensure that their public relations efforts project them as a friendly and honest bank.
Systemic Risk
Systemic risk arises because of the fact that the financial system is one intricate and connected network. Hence, the failure of one bank has the possibility to cause the failure of many other banks as well. This is because banks are counterparties to each other in a lot of transactions. Hence, if one bank fails, the credit risk event for the other banks becomes a reality.
They have to write off certain assets as a result of the failure of their counterparty. This writing off often leads to the bankruptcy of other banks and an unstoppable domino seems to take over. Systemic risk is an extremely bad scenario to be in.Market Risk
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.
Commodity prices also play a role because a bank may be invested in companies that produce commodities. As the value of the commodity changes, so does the value of the company and the value of the investment. Changes in commodity prices are caused by supply and demand shifts that are often hard to predict. So, to decrease market risk, diversification of investments is important. Other ways banks reduce their investment include hedging their investments with other, inversely related investments.
Business Strategy and Environment Risk
This risk arises on account of inappropriate or non-viable business strategy adopted by the banks; its total absence and the business environment that the bank operates in, including business cycle that the economy may be passing through. This risk can be mitigated by proper planning for identification of target areas, markets, products, customer base, etc. Lack of such a planning may pose a significant risk to the earnings and viability of a bank.
Legal Risk
Legal Risk arises from the potential that unenforceable contracts, lawsuits, or adverse judgments can disrupt or otherwise negatively affect the operations or condition of the branch.
Compliance Risk
Compliance risk arises due to non-compliance of statutory requirements, prudential norms and supervisory (Reserve Bank of India) directives/guidelines. Material non-compliance with laws, regulations and other stipulated requirements can act as a catalyst for increasing various other risks thereby increasing the overall risk of a bank.
Organisation Risk
Organisation risk arises on account of organisational bottlenecks in the form of inadequate or inappropriate structure, in relation to its business and the quality of its external and internal relationships. The organisation structure needs to be well defined and in tune with the legal and regulatory requirements for a bank. With frequent changes in the banking scenario, the organisation has to be flexible to meet the challenges posed by such changes.
Inappropriate relationships between the people within the organisation may affect the smooth functioning of the bank. Similarly, strained relationship between the people in the bank and the outsiders, viz., customers, regulatory authorities, group companies, etc. can pose a risk to the operations of the bank.
Management Risk
Management inadequacies and Corporate Governance. Management risk arises out of poor quality and lack of integrity of management. It is reflected in the quality of senior management personnel, their leadership quality, competence, integrity and their effectiveness in dealing with the problems encountered by the bank.
Name:Mgba Clara Chinecherem
Reg no:2017/249537
Dept: Economics
Commercial banks do suffer from both internal and external risks and they include:
Major risks for banks include credit, operational, market, and liquidity risk. Since banks are exposed to a variety of risks, they have well-constructed risk management infrastructures and are required to follow government regulations. Government agencies, such as the Office of Superintendent of Financial Institutions (OSFI) in Canada, set the regulations to counteract risks and protect depositors.
Credit Risk
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
Operational Risk
Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational 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.
Market Risk
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.
Liquidity Risk
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. If a bank delays providing cash for a few of their customer for a day, other depositors may rush to take out their deposits as they lose confidence in the bank. This further lowers the bank’s ability to provide funds and leads to a bank run.
Ways to manage risk
The basic methods for risk management—avoidance, retention, sharing, transferring, and loss prevention and reduction—can apply to all facets of an individual’s life and can pay off in the long run.
Commercial banks face risks in their day to day operations. While some of these risks are avoidable, others may not be easily foreseeable. However commercial banks should mitigate risks wherever and whenever possible.
Here are some of the risks commercial banks face:
1.Credit Risks: This is the danger of misfortune from a borrower who doesn’t make instalments as guaranteed. Henceforth the bank should only give credits with securities that can cover those advances.
2.Liquidity Risk: This danger happens when given security or resource can’t be exchanged rapidly sufficient for the market to keep away from misfortune or make the necessary increases. Thus the banks should attempt to set up resources available to be purchased on schedule just as get a very much educated intermediary to aid this capacity
3.Market Risk: This is an outer danger. This danger happens for the most part because the bank exercised in the capital market.
It is because of the unconventionality of value markets, product costs, loan fees, and credit spreads. To manage this danger and lessen the antagonistic impact radically, banks broaden their ventures or just contribute with contracts.
4. Operational Risks
Banks need to lead huge activities to be productive. Operational danger happens as the aftereffect of a bombed business measures in the bank’s everyday exercises.
Instances of operational risks would incorporate instalments credited to some unacceptable record or executing an off base request while managing in the business sectors, furnished theft, fire rate and so on.
None of the offices in a bank is insusceptible from operational dangers. Operational dangers emerge predominantly as a result of recruiting some inexperienced and untrained individuals or then again they could likewise happen if there is a breakdown of the data innovation frameworks.
Henceforth the bank should recruit trained people and ensure there is appropriate examination and support of innovation frameworks.
NAME: Emmanuel Treasure Adanne
Department: Economics
Reg No: 2017/242436
Email address: http://www.treasureadaemmanuel@gmail.com
Website: treshvinaemman54.blogspot.com
Answer:
Risk can be referred to like the chances of having an unexpected or negative outcome. Any action or activity that leads to loss of any type can be termed as risk. There are different types of risks that a bank might face and needs to overcome. Widely, commercial bank risks can be classified into two types: Financial Risk and non- financial risk.
Financial Risk as the term suggests is the risk that involves financial loss to banks. Financial risk generally arises due to instability and losses in the financial market caused by movements in stock prices, currencies, interest rates and more.
Financial risk can be divided into: Market Risk: This type of risk arises due to the movement in prices of financial instrument. Market risk can be classified as Directional Risk and Non-Directional Risk. Directional risk is caused due to movement in stock price, interest rates and more. Non-Directional risk, on the other hand, can be volatility risks. Commodity prices also play a role because a bank may be invested in companies that produce commodities. As the value of the commodity changes, so does the value of the company and the value of the investment. Changes in commodity prices are caused by supply and demand shifts that are often hard to predict. So, to decrease market risk, diversification of investments is important. Other ways banks reduce their investment include hedging their investments with other, inversely related investments.
Credit Risk: This type of risk arises when one fails to fulfill their obligations towards their counterparties. Credit risk can be classified into Sovereign Risk and Settlement Risk. Sovereign risk usually arises due to difficult foreign exchange policies. Settlement risk, on the other hand, arises when one party makes the payment while the other party fails to fulfill the obligations. Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities. Failure to meet obligational contracts can also occur in areas such as derivatives and guarantees provided.
Non-financial risks are subdivided into; Operational Risk: This type of risk arises out of operational failures such as mismanagement or technical failures. Operational risk can be classified into Fraud Risk and Model Risk. Fraud risk arises due to the lack of controls and Model risk arises due to incorrect model application.
Legal Risk: This type of financial risk arises out of legal constraints such as lawsuits. Whenever a company needs to face financial losses out of legal proceedings, it is a legal risk.
Business Risk or Strategic risks; The banking industry today is considerably advanced and diversified. Banks today have a wide variety of strategies from which they have to choose. Once such strategy is chosen, banks need to focus their resources on obtaining their strategic goals in the long run. Hence, there is always a risk that a given bank may choose the wrong strategy. As a result of this wrong choice, the bank may suffer losses and end up being acquired or may simply collapse.
Political risk is generally defined as the risk to banks interests resulting from political instability or political change. Political risk exists in every country around the globe and varies in magnitude and type from country to country. Political risks may arise from policy changes by governments to change controls imposed on interest rates. Moreover, political risk may be caused by actions of legitimate governments such as controls on prices, outputs, activities, and currency and remittance restrictions.
Liquidity Risk: This type of risk arises out of an inability to execute transactions. Liquidity risk can be classified into Asset Liquidity Risk and Funding Liquidity Risk. Asset Liquidity risk arises either due to insufficient buyers or insufficient sellers against sell orders and buys orders respectively. Funding liquidity risk is the risk that a company is unable to meet its immediate and short-term obligations in a timely manner. This risk is a major concern for cyclical companies where operating cash flows and debt obligation due dates might not match up perfectly
Conclusion:
The management of banks requires a lot of skill since multiple types of risks need to be mitigated. Some of these risks can be avoided whereas for the others the best that banks can do is to minimize their damage.
IWUALA CHIOMA FAVOUR
2017/249520
ECONOMICS
iwualafavour573@gmail.com
Some risks a bank faces can be internal or external.Some of the internal risks faced by banks include: Strategic Risk, Reputation Risk, Credit Risk, etc, while some of the external risks include: Funding and Liquidity Risk, Market Risk, Other operational Risk, etc. Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Reputation is an extremely important intangible asset in the banking business.Customers like their money to be deposited at places which they believe follow safe and sound business practices. Hence, if there is any news in the media which projects a given bank in a negative light, such news negatively impacts the banks business. Liquidity risk is another kind of risk that is inherent in the banking business. Liquidity risk is the risk that the bank will not be able to meet its obligations if the depositors come in to withdraw their money. This risk is inherent in the fractional reserve banking system. Therefore, in this system, only a percentage of the deposits received are held back as reserves, the rest are used to create loans. Therefore, if all the depositors of the institution came in to withdraw their money all at once, the bank would not have enough money. This situation is called a bank run. This has happened countless times over the history of modern banking.
Modern day banks are not very concerned about liquidity risk. This is because they have the backing of the central bank. In case there is a run on a particular bank, the central bank diverts all its resources to the affected bank. Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational 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. Losses that occur due to human error include internal fraud or mistakes made during transactions.
Prudent risk management can help banks improve profits as they sustain fewer losses on loans and investments.
Ways to decrease risks include diversifying assets, using prudent practices when underwriting, and improving operating systems.
NAME: OKPOR MARTHA ASHINEDU
REG. NO: 2017/241430
DEPARTMENT:ECONOMICS
LEVEL:300L
ANSWER:
Banks face a number of risks in order to conduct their business, and how well these risks are managed and understood is a key driver behind profitability. While some risks faced by banks are internal, the other risks are external. These risks include; credit risks, liquidity risks, market risks, operational risks, macroeconomic risks and reputational risks.
Credit risk describes the risk of default by a borrower who fails to repay the money borrowed. The credit risk causes economic downturn as banks fail due to default risk from clients, which has had a negative impact on the economic development of many nations around the world. The term hedging signals the protection of a business’s investment by limiting its level of risk, for example, by purchasing an insurance policy. Diversification of financial resources in variety of different investments has also been understood to minimize such risk. The capital adequatio is a bank’s capital maintained to absorb its outlying risks. Operational risk is the risk of loss due to errors, interruptions or damages caused by people, systems or processes. The operational risk is low for simple business operations such as retail banking and asset management and higher for operations such as sales and trading. Damage to the bank’s reputation can make it more difficult to attract deposits or business in the future. Thus, in order to prevent reputational risks, banks need to always live up to expectation to keep the reputation of their bank in tact.
Market risks mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets. To decrease market risk, diversification of investments is important. Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. Regulations exist to lessen liquidity problems. They include a requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outisde funds.
Name:Meteke Joy Orimusue
Reg.no:2017/242430
Department:Economics
Website: metekejoy01.blogspot.com
Email:joymetex2000@gmai.com
RISKS AND RISK MANAGEMENT OF COMMERCIAL BANK
1.Credit risk
According to the Bank for International Settlements (BIS), credit risk is defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Credit risk is most likely caused by loans,acceptances, interbank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options, and in the extension of commitments and guarantees, and the settlement of transactions. In simple words, if person A borrows loan from a bank and is not able to repay the loan because of inadequate income, loss in business, death, unwillingness or any other reasons, the bank faces credit risk. Similarly, if you do not pay your credit card bill, the bank faces a credit risk.
Hence, to minimize the credit risk on the bank’s end, the rate of interest will be higher for borrowers if they are associated with high credit risk. Factors like unsteady income, low credit score, employment type, collateral assets and others determine the credit risk associated with a borrower.
2.Market risk
McKinsey defines market risk as the risk of losses in the bank’s trading book due to changes in equity prices, interest rates, credit spreads, foreign-exchange rates, commodity prices, and other indicators whose values are set in a public market. Bank for International Settlements (BIS) defines market risk as the risk of losses in on- or off-balance sheet positions that arise from movement in market prices. Market risk is prevalent mostly amongst banks who are into investment banking since they are active in capital markets. Market risk can be better understood by dividing it into 4 types depending on the potential cause of the risk:
Interest rate risk: Potential losses due to fluctuations in interest rate
Equity risk: Potential losses due to fluctuations in stock price
Currency risk: Potential losses due to international currency exchange rates (closely associated with settlement risk)
Commodity risk: Potential losses due to fluctuations in prices of agricultural, industrial and energy commodities like wheat, copper and natural gas respectively.
3.Operational risk
According to the Bank for International Settlements (BIS), operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputation risk. Operational risk can widely occur in banks due to human errors or mistakes. Examples of operational risk may be incorrect information filled in during clearing a check or confidential information leaked due to system failure.
Operational risk can be categorized in the following way for a better understanding:
Human risk: Potential losses due to a human error, done willingly or unconsciously
IT/System risk: Potential losses due to system failures and programming errors
Processes risk: Potential losses due to improper information processing, leaking or hacking of information and inaccuracy of data processing.
4.Liquidity risk
This risk is the risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss. However if you find this definition complex, the term ‘liquidity risk’ speaks for itself. It is the risk that may disable a bank from carrying out day-to-day cash transactions.
5.Business risk
In general,this risk is seen as the possibility that a company will have lower than anticipated profits, or that it will experience a loss rather than a profit. In the context of a bank, business risk is the risk associated with the failure of a bank’s long term strategy, estimated forecasts of revenue and number of other things related to profitability. To be avoided, business risk demands flexibility and adaptability to market conditions.
6.Systemic risk
The global crisis of 2008 is the best example of a loss to all the financial institutions that occurred due to systemic risk. Systemic risk is the risk that doesn’t affect a single bank or financial institution but it affects the whole industry. Systemic risks are associated with cascading failures where the failure of a big entity can cause the failure of all the others in the industry.
7.Moral hazard
Moral hazard is a risk that occurs when a big bank or large financial institution takes risks, knowing thatsomeone else will have to face the burden of those risks. Economist Paul Krugman described moral hazard as “any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.
HOW CAN THESE RISKS BE MANAGED OR AVOIDED?
i) Standards and Reports The first of these risk management techniques involves two different conceptual activities, i.e., standard setting and financial reporting. They are listed together because they are the sine qua non of any risk system. Underwriting standards, risk categorizations, and standards of review are all traditional tools of risk management and control. Consistent evaluation and rating of exposures of various types are essential to understand the risks in the portfolio, and the extent to which these risks must be mitigated or absorbed. The standardization of financial reporting is the next ingredient. Obviously outside audits, regulatory reports, and rating agency evaluations are essential for investors to gauge asset quality and firm level risk. These reports have long been standardized, for better or worse.
(ii) Position Limits and Rules A second technique for internal control of active management is the use of position limits, and/or minimum standards for participation. In terms of the latter, the domain of risk taking is restricted to only those assets or counterparties that pass some prespecified quality standard.
(iii) Investment Guidelines and Strategies Investment guidelines and recommended positions within position limits and prescribed rules. Beyond this, guidelines offer firm level advice as to the appropriate level of active management, given the state of the market and the willingness of senior management to absorb the risks implied by the aggregate portfolio.
(iv) Incentive Schemes To the extent that management can enter incentive compatible contracts with line managers and make compensation related to the risks borne by these individuals, then the need for elaborate and costly controls is lessened.
Name: ONAH GEORGE CHIEDOZIE.
REG. NO: 2017/241453.
DEPARTMENT: ECONOMICS
A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit. We will be including other commercial bank of the world in our study. The internal and external risk that is associated with commercial banks includes thus:
Business Risk:
The banking industry today is considerably advanced and diversified. Banks today have a wide variety of strategies from which they have to choose. Once such strategy is chosen, banks need to focus their resources on obtaining their strategic goals in the long run.
Hence, there is always a risk that a given bank may choose the wrong strategy. As a result of this wrong choice, the bank may suffer losses and end up being acquired or may simply collapse. Consider the case of banks such as Washington Mutual and Lehman Brothers. These banks chose the subprime route to growth. Their strategy was to be the preferred lender to people who have less than perfect credit scores. However, the whole area of subprime lending went bust and since these banks had heavy exposures to such loans, they suffered dire consequences too.
Banks have no possible way to mitigate the risks that are created by following inappropriate business objectives. Which objectives were right and which were wrong? This question can only be answered in hindsight. When Lehman Brothers was focusing their resources on subprime lending, it must have seemed like the strategically right thing to do!
Market Risks:
Apart from making loans, banks also hold a significant portion of securities. Some of these securities are held because of the treasury operations of the bank i.e. as a mean to park money for the short term. However, many securities are also held as collateral based on which banks have given loans to their customers. The business of banking is therefore intertwined with the business of capital markets.
Banks face market risks in various forms. For instance if they are holding a large amount of equity then they are exposed to equity risk. Also, banks by definition have to hold foreign exchange exposing them to Forex risks. Similarly banks lend against commodities like gold, silver and real estate which exposes them to commodity risks as well.
In order to be able to mitigate such risks banks simply use hedging contracts. They use financial derivatives which are freely available for sale in any financial market. Using contracts like forwards, options and swaps, banks are able to almost eliminate market risks from their balance sheet.
Operational Risks:
Banks have to conduct massive operations in order to be profitable. Economies of scale work in the favor of larger banks. Hence, maintaining consistent internal processes on such a large scale is an extremely difficult task.
Operational risk occurs as the result of a failed business processes in the bank’s day to day activities. Examples of operational risk would include payments credited to the wrong account or executing an incorrect order while dealing in the markets. None of the departments in a bank are immune from operational risks.
Operational risks arise mainly because of hiring the wrong people or alternatively they could also occur if there is a breakdown of the information technology systems. A lapse in the internal processes being followed could also lead to catastrophic errors. For instance, Barings Bank ended up bankrupt because of its failure to implement appropriate internal controls. One trader was able to bet so much in the derivatives market that the equity of Barings Bank was wiped out and the bank simply ceased to exist.
Liquidity Risk:
Liquidity risk is another kind of risk that is inherent in the banking business. Liquidity risk is the risk that the bank will not be able to meet its obligations if the depositors come in to withdraw their money. This risk is inherent in the fractional reserve banking system. Therefore, in this system, only a percentage of the deposits received are held back as reserves, the rest are used to create loans. Therefore, if all the depositors of the institution came in to withdraw their money all at once, the bank would not have enough money. This situation is called a bank run. This has happened countless times over the history of modern banking.
Modern day banks are not very concerned about liquidity risk. This is because they have the backing of the central bank. In case there is a run on a particular bank, the central bank diverts all its resources to the affected bank. Therefore, the depositors can be paid back when they demand their deposits. This restores depositor’s confidence in the banks finances and the run on the bank is averted.
Many modern day banks have faced bank runs. However, none of them have become insolvent due to a bank run post the establishment of central banks.
NAME: EZIKE MARYCYNTHIA CHIAMAKA
REG NO: 2017/242944
EMAIL: marycynthiachiamaka95@gmail.com
DEPT: ECONOMICS
According to studies, most of the risks of commercial banks are internal risks while the rest are externally, so it is ok to say that yes the risks are mostly internal. Some of the internal risks of the commercial banks include credit, operational, market, and liquidity risk. Since banks are exposed to a variety of risks, they have well-constructed risk management infrastructures and are required to follow government regulations. If a business sets up risk management as a disciplined and continuous process for the purpose of identifying and resolving risks, then the risk management structures can be used to support other risk mitigation systems. They include planning, organization, cost control, and budgeting. In such a case, the business will not usually experience many surprises, because the focus is on proactive risk management.
Response to Risks
Response to risks usually takes one of the following forms:
Avoidance: A business strives to eliminate a particular risk by getting rid of its cause.
Mitigation: Decreasing the projected financial value associated with a risk by lowering the possibility of the occurrence of the risk.
Acceptance: In some cases, a business may be forced to accept a risk. This option is possible if a business entity develops contingencies to mitigate the impact of the risk, should it occur.
When creating contingencies, a business needs to engage in a problem-solving approach. The result is a well-detailed plan that can be executed as soon as the need arises. Such a plan will enable a business organization to handle barriers or blockage to its success because it can deal with risks as soon as they arise.
Name: Okoye Amblessed Amarachi
Reg No: 2017/249560
Dept: Economics
Commercial banks face numerous risks and the way with which risks are managed determine profitability. These risks include:
1. Credit Risks: This is the risk of loss from a borrower who does not make payments as promised. Hence the bank should give loans with collaterals that can cover those loans.
Liquidity Risk: This risk occurs when a given security or asset cannot be traded quickly enough in the market to avoid a loss or make the required gains. Hence the banks should try to put up assets for sale on time as well as get a well informed broker to assist in this function.
3. Market Risks: This is a risk that occurs when the market value if an investment portfolio changes due to perceived changes in the value of market-risk-factors. Hence the banks ought to have perfect knowledge if the conditions Prevailing in the market.
4. Operational Risks: These risks arise from the execution of a bank’s day-to-day business: Hence the bank should endeavour to reduced the mistakes that may occur in the day-to-day running of their business.
5. Reputational Risks: They are formed from customer experiences in the bank with their personnel. The bank’s personnel should try to relate well with their customers.
Eric-nnaji Chiamaka Ngozi
2017/249499
Economics department
Commercial banks face risks which may be external or internally induced. It is external when the banks have little to no control over the cause and internal when they have substantial control over the cause.
Four of the major risks of commercial banks include:
1. Credit risk: This is an external risk. This risk occurs as a result of loan defaulters. This risks includes delayed payment of loans and no payment at all. To deal with this type of risk, banks perform a thorough background check on the borrower and analyze how capable he/she is to pay back. Banks also give advice, supervise or keep track on what the loan is used for and how profitable that venture is. Personally, I don’t think the issue unpaid loans are avoidable in the banking business but Banks should always make provision for this risk without becoming insolvent.
2. Market risks: This is an external risk. This risk occur mostly as a result of the bank’s activities in the capital market. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. To deal with this risk and reduce the adverse effect drastically, banks diversify their investments or simply invest with contracts.
3. Operational risks: This is an internal risk. Operational risks affect all the departments in a bank. This risk occurs as a result of failed or mistaken business processes in the bank’s day to day activities. An example of this risk would be crediting of a wrong account or executing a wrong order. To deal with this, banks should employ the right and qualified people for the right job. Also, maintain adequate power supply especially during working hours. Banks maintain cyber security to avoid hackers on their sites.
4. Liquidity risks: This is an internal risk. Liquidity risk refers to the inability of a bank to access cash to meet funding obligations when depositors come to withdraw their money. This risk is inherent in the fractional reserve banking system. To deal with this, the Central Bank supports the banks if this risk ever occur. Commercial banks should avoid having a balance sheet which is overly concentrated on illiquid assets and should not rely overly on short-term sources of funds. They should also diversify the types of loans (long-term, short-term and medium-term loans) they give.
NAME: OBODO CHISOM JESSICA
REG NO: 2017/249538
EMAIL: chisom.obodo.249538@unn.edu.ng
It is often said that profit is a reward for risk bearing. This is no different for the banking industry. Banks are literally exposed to many different types of risks. A successful bank is one that can alleviate these risks and create significant returns. Alleviation of risks begins by first correctly identifying the risks, why they arise and what damage can they cause.
I agree risks faced by banks can be externally induced and also internally induced. Some of these risks and how banks can minimize them are;
Credit Risks
Credit risk is the risk that arises from the possibility of non-payment of loans by the borrowers. Although credit risk is largely defined as risk of not receiving payments, banks also include the risk of delayed payments within this category. such risk can be avoided if the bank conducts a thorough check and sanctions loans only to individuals and businesses that are not likely to run out of income over the period of the loan.
Market Risks
Apart from making loans, banks also hold a significant portion of securities. Some of these securities are held because of the treasury operations of the bank i.e. as a means to park money for the short term. However, many securities are also held as collateral based on which banks have given loans to their customers. In order to be able to alleviate such risks banks simply use hedging contracts.
They use financial derivatives which are freely available for sale in any financial market. Using contracts like forwards, options and swaps, banks are able to almost eliminate market risks from their balance sheet.
Liquidity Risk
Liquidity risk is another kind of risk that is inherent in the banking business. Liquidity risk is the risk that occurs when a given security or asset cannot be traded quickly enough in the market to prevent a loss or make the required profit i.e the bank will not be able to meet its obligations if the depositors come in to withdraw their money. Modern day banks are not very concerned about liquidity risk. This is because they have the backing of the central bank. In case there is a run on a particular bank, the central bank diverts all its resources to the affected bank. Therefore, the depositors can be paid back when they demand their deposits. This restores depositor’s confidence in the banks finances and the run on the bank is averted. They may have faced such risk however, none of them have become insolvent post the establishment of central banks.
Operational Risks
Banks have to conduct massive operations in order to be profitable. Operational risk occurs as the result of a failed business processes in the bank’s day to day activities. Examples of operational risk would include payments credited to the wrong account or executing an incorrect order while dealing in the markets, armed robbery, fire incidence etc. None of the departments in a bank are immune from operational risks. Operational risks arise mainly because of hiring the wrong people or alternatively they could also occur if there is a breakdown of the information technology systems. Hence the bank should hire qualified persons and also make sure there is proper inspection and maintenance of technology systems.
Reputational Risk
Reputation is an extremely important intangible asset in the banking business. Customers like their money to be deposited at places which they believe follow safe and sound business practices. Hence, if there is any news in the media which projects a given bank in a negative light, such news negatively impacts the banks business. This risk can be minimized if banks ensure that they never participate in any unfair or manipulative business practices. Also, banks need to continuously ensure that their public relations efforts project them as a friendly and honest bank.
In summary , the management of banks requires a lot of skill since multiple types of risks need to be alleviated. Some of these risks can be avoided whereas for the others the best that banks can do is to minimize their damage.
ugwoke faith chinazaekpere
2017/249582
Economics
A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit.
It can also refer to a bank, or a division of a large bank, which deals with corporations or large/middle-sized business to differentiate it from a retail bank and an investment bank. Commercial banks include private sector banks and public sector banks.
1)CREDIT RISK:
The major risk banks face is credit risk. It follows that the major risk banks must
measure, manage and accept is credit or default risk. It is the uncertainty associated with borrower’ s loan repayment. For most people in commercial banking, lending represents the heart of the Industry.
2) CONCENTRATION RISK
A new methodology adopted to evaluate the volatility in portfolio performance
predicated on the risk profile of the institution. The banking industry has relied heavily on prior experience as a predictor of future credit performance. Concentration risk is the aggregation of transaction and intrinsic risk within the portfolio and may result from loans to one borrower or one industry, geographic area, or line of business. Senior management must
define acceptable portfolio concentrations for each of these aggregations.
Apart from making loans, banks also hold a significant portion of securities. Some of these securities are held because of the treasury operations of the bank i.e. as a means to park money for the short term. However, many securities are also held as collateral based on which banks have given loans to their customers. The business of banking is therefore intertwined with the business of capital markets.
3) MARKET RISK:
Banks face market risks in various forms. For instance if they are holding a large amount of equity then they are exposed to equity risk. Also, banks by definition have to hold foreign exchange exposing them to Forex risks. Similarly banks lend against commodities like gold, silver and real estate which exposes them to commodity risks as well. In order to be able to mitigate such risks banks simply use hedging contracts. They use financial derivatives which are freely available for sale in any financial market.
4) OPERATIONAL RISK:
Banks have to conduct massive operations in order to be profitable. Economies of scale work in the favor of larger banks. Hence, maintaining consistent internal processes on such a large scale is an extremely difficult task.Operational risk occurs as the result of a failed business processes in the bank’s day to day activities. Examples of operational risk would include payments credited to the wrong account or executing an incorrect order while dealing in the markets. None of the departments in a bank are immune from operational risks.
5) BUSINESS RISK:
The banking industry today is considerably advanced and diversified. Banks today have a wide variety of strategies from which they have to choose. Once such strategy is chosen, banks need to focus their resources on obtaining their strategic goals in the long run. Hence, there is always a risk that a given bank may choose the wrong strategy. As a result of this wrong choice, the bank may suffer losses and end up being acquired or may simply collapse.
6)REPUTATION RISK:
Reputation is an extremely important intangible asset in the banking business. Banks like JP Morgan bank, Chase bank, Citibank, Bank of America etc have all been in the business for hundreds of years and have stellar reputations. These reputations enable them to generate more business more profitably.Customers like their money to be deposited at places which they believe follow safe and sound business practices.
7) SYSTEMIC RISK:
Systemic risk arises because of the fact that the financial system is one intricate and connected network. Hence, the failure of one bank has the possibility to cause the failure of many other banks as well. This is because banks are counterparties to each other in a lot of transactions. Hence, if one bank fails, the credit risk event for the other banks becomes a reality.
8)MORAL HAZARD RISK:
The recent bailout of banks by many countries has created another kind of risk called the moral hazard. This risk is not faced by the bank or its shareholders. Instead, this risk is faced by the taxpayers of the country in which banks operate. Banks have become accustomed to taking excessive risk. If their risk pays off, they get to keep the returns.
In other to reduce this risk banks has to improve continuous process of improving credit risk management in the bank if necessary, taking into account the changing information technology ICT and Industry 4.0 and the changing economic reality.
NAME: IJE VORDA GOODNESS
REG NO:2017/249514
ECONOMICS DEPARTMENT
EMAIL: vordagoodness78@gmail.com
Banks face lots of risks in the day to day running of their activities and business ranging from credit risk, liquidity risk, market risk, operational risk, reputational risk and macroeconomics risk. However some of this risk may be due to internal factors or may be caused by factors beyond the control of the banks. However they’re ways to help banks manage this risk that they encounter in the discharge of their duties. They include
▪️ banks should spread risk by giving loans to more people.
▪️ Banks should inspect projects plan that customers/borrowers.
▪ Setting realistic interest rate for borrowers.
️▪ Valuation of mortgaged properties at periodic internal.
️▪ Annual review of account and management of account no reviewed beyond three months
️▪️ Adherence to provisioning requirements after taking into account of security, worth of borrowers and guarantors.
▪️ Filing of suits in time to follow up legal process.
▪ Proper record keeping of customers information and details.
️▪ Scrutiny of inwards and outward cash remittance
️▪ Banks should train their staffs to better understand customers and better customer services.
️▪️ Improvement in response system.
▪ All banks should maintain the required cash reserve ratio so that they have cash to pay customers when they demand so as not to send panic in the system.
️
NAME: Okoronkwo Uchechukwu David
REG NO: 2017/241455
DEPARTMENT: Economics
EMAIL: uchechukwu.okoronkwo.241455@unn.edu.ng
firstly, it should be understood that due to the large size of some banks, exposure to risk is high and thus can cause bank failure and impact millions of people, thus it is by understanding the risks posed to banks that governments can set better regulations to encourage prudent management and decision-making.
The ability of a bank to manage risk also affects investors decisions, even if a bank can generate large revenues, lack of risk management can lower profits because of losses to loans.
Some of the risks that commercial banks face are;
1, Credit Risk
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet up to contractual obligations, for instance when borrowers default on interest payment of a loan.
However, although banks cannot be fully protected from credit risk due to the nature of their business model, they can alternatively lower their exposure in several ways, that is since deterioration in an industry or issuer is often unpredictable, banks lower their exposure through the process of diversification and by doing so, during a credit downturn, banks are less likely to be overexposed to a category with large losses. Thus to lower their risk exposure, they can loan money to people with good credit histories, transact with high-quality counterparties, or own collateral to back up the loans.
2, Market Risk
Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. But Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.
thus to avoid this risk, banks must avoid investing heavily into such markets
3, Liquidity Risk
Liquidity risk refers to the ability of a bank to access cash to meet funding obligations. Obligations include allowing customers to take out their deposits. The inability to provide cash in a timely manner to customers can result in a snowball effect. If a bank delays providing cash for a few of their customer for a day, other depositors may rush to take out their deposits as they lose confidence in the bank. This further lowers the bank’s ability to provide funds and leads to a bank run.
However regulations exist to lessen liquidity problems and they include the requirement for banks to hold enough liquid assets to survive for a period of time even without the inflow of outside funds.
4, Operational Risk
Operational risk is the risk of loss due to errors, interruptions or damages caused by people, systems, or processes. The operational 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. Losses that occur due to human error include internal fraud or mistakes made during transactions.
On a larger scale, fraud can occur through the breaching a bank’s cybersecurity and it can allow hackers to have access / steal customer information and money from the bank, and blackmail the institutions for additional money. In such a situation, banks lose capital and trust from customers. Damage to the bank’s reputation can make it more difficult to attract deposits or business in the future.
5, Business Risk
The banking industry today is considerably advanced and diversified. Banks today have a wide variety of strategies from which they have to choose. Once such strategy is chosen, banks need to focus their resources on obtaining their strategic goals in the long run.
Although, there is always a risk that a given bank may choose the wrong strategy and as a result of this wrong choice, the bank may suffer losses and end up being acquired or may simply collapse
Also, Banks who chose the subprime route to growth, which is a strategy for a bank to be the preferred lender to people who have less than perfect credit scores, but if the was to bust and thes banks had heavy exposures to such loans, they are doomed to suffer dire consequences.
OKONKWO CHIDINMA ALISA
2017/243086
ECONOMICS 300 LEVEL
ANSWER
Actually from the list of risks faced by commercial banks, most of them are internal while the others are external. So yes, I agree that some of these risks are internal and others are external. Some of the internal risks faced by banks include: Strategic Risk, Reputation Risk, Credit Risk, etc, while some of the external risks which are not many include: Funding and Liquidity Risk, Market Risk, Other operational Risk, etc. Risks like the Strategic Risk which is internal has to do with how well the bank carry out there duties that is, the strategies, plans, policies they employ to carry out their functions. If these plans and strategies that the bank in question employs is not working fine or not yielding good and expected results, there is a need to cross-check where the bank has gone wrong as customers might not even be patronizing the bank which would lead to the risk of solvency which is how much the bank has to keep itself in business as well as discharge her duties properly and effectively. This basically implies that the bank in question should make sure that their plans are being carried out properly in order to achieve good results that would move the financial organization as well as the whole financial system forward.
Another risk which is the Legal and Compliance Risk that is external has to do with the issue of the government rules and regulations towards the commercial banks. If for example the bank in question does not follow the laid down rules of the government towards the banking sector, the financial institution would be compromised as they would now be operating as they wish. They could even wish not to pay their taxes. This would eventually lead that bank out of business if they do not retrace their steps as they meant to pay their taxes. So in order for banks of this nature not to be dragged out of business, they should endeavour to carry out their legal and Compliance duties well enough to reduce such risk.