Banking Risk

Management

Banking Risk
Management
Banking Risk (Eight type of Risks)
Credit Risk (Settlement Risk)

Market Risk
Operational Risk
Business Risk
Liquidity Risk

Reputational Risk
Systematic Risk
Moral Hazard

Credit Risk
Credit Risk
Potential that a bank Borrower or Counterparty will fail to meet its
obligations in accordance with agreed terms
Types of Credit Risk
Loans
Acceptances
Interbank Transactions
Trade Financing
Foreign Exchange Transactions
Types of Credit Risk ( Financial Instruments)
Financial Futures
Swaps
Bonds

Equities
Options
Extension of commitments and guarantees & settlement of transactions.

Credit Risk
Credit Risk Causes
Inadequate Income

Loss in Business
Death of the Borrower
Unwillingness/Inability to Pay
Fraud

Any other Reasons

Credit Risk vs. Rate of Interest
High Rate of Interest for HIGH Credit Risk Borrower
Steady /Unsteady Income

High/Low Credit Score

Education
Employment Type (Permanent, Semi-Permanent, Seasonal)
Past Credit History
Collateral Assets Pledged

Credit Risk
Interbank Transaction/Foreign Transaction
Transaction at one end Successful
Unsuccessful Transaction at the other End
Loss/Opportunity Cost
Transaction at one end is Settled
Delays in Settlement at the Other End
Investment Opportunities Lost

Credit Risk (Macro Forces)

Macro Forces affecting Economy
Economic Turmoil
Political Unrest

Specific Markets Issues

Specific Individuals

Settlement Risk
Settlement Risk
Closely Associated with Credit Risk

Depends on the Timing of the Exchange of value

Payment/Settlement Finality
Role of Intermediaries and Clearing House
Settlement Problem(Individual)

One NRI sending 1000 Oman Rial to his Parents in India

1.00 OMR = 175.234 INR (Sending rate)
Parents receives the money at the exchange rate of 174 INR
Incurred a Loss in the Transaction (INR 1234)

Settlement Problem (Bank)

Not able to Settle a Transaction at an Expected Time
During an expected Time duration
Bank Incur Credit Risk

Case of Deliberate Fraud

Market Risk

Risk of Losses in the Banks

Trading book due to Changes in
Equity Prices, Interest Rates,
Credit Spreads, ForeignExchange Rates, Commodity
Prices & other Indicators
whose values set in Public
Market
McKinsey & Co.

Market Risk

Risk of Losses in Onor Off-Balance Sheet

Positions that Arise
from Movement in
Market Prices
Bank for International Settlements (BIS)

Market Risk
Market Risk

Prevalent Mostly amongst Investment Banking

Active in Capital Markets
Investment banks (Goldman Sachs, Bank of America, JPMorgan, Morgan
Stanley and many others )

Potential Cause of Market Risk

Interest Rate Risk
Fluctuations in Interest Rate

Equity Risk
Potential Losses due to Fluctuations in Stock Price

Currency Risk

International Currency Exchange Rates ( linked with Settlement Risk)

Commodity Risk

Potential losses due to Fluctuations in Prices of Agricultural, Industrial and

Energy Commodities (wheat, rice, copper, coal, natural gas, nickel, gold etc.)

Operational Risk
Risk of Loss Resulting
from Inadequate or
Failed Internal
Processes, People and
Systems or from
External Events
Bank for International Settlements (BIS)

Operational Risk
Potential cause of Operational Risk

People (Human) Risk:

Losses due to a Human Error
Incorrect Information filled in during clearing a check
(Willingly or Unconsciously)

Technology (IT/System) Risk:

Losses due to System Failures
Programming Bugs/Errors
Information Leaked due to System Failure

Processes Risk
Potential losses due to Improper Information Processing
Leakage
Hacking of Information
Inaccuracy of data processing

Operational Risk

Data Risk

Security Breaches in which data is compromised could be classified as an

Operational Risk

CIA (Confidentiality, Integrity, Availability)

Operational Risk Consequence

Caused Decline of Britains Oldest Banks, Barings in 1995.

Growing Importance due to digitization for Banking Automated Process
Constant Technology Investments to Mitigate Exposure to security
Breaches

Business Risk
Possibility that a
Company will have
Lower than Anticipated
Profits, or that it will
Experience a Loss
Rather than a Profit
Investopedia

Business Risk
Business Risk
Failure of a banks Long Term Strategy
Estimated Forecasts of Revenue
Number of other things related to Profitability
Flexibility and Adaptability to Market Conditions

Long Term Consequence

Long Term Strategies are Imperative but NOT Adequate
Flexibility and Capacity to change
Back up Plan for Long Term Strategies
During 2007-08 global crisis, many banks collapsed

Many Survived
Failed Banks Didnt Have a Business Risk Management strategy

Liquidity Risk
Risk Stemming from the
Lack of Marketability of an
Investment that cannot be
Bought or Sold Quickly
Enough to Prevent or
Minimize a loss
Investopedia

Liquidity Risk
Liquidity Risk
Risk that may disable a bank from carrying out day-to-day Cash
Transactions

A small bank in Northern England and Ireland was taken over by the
government because of its Inability to Repay the Investors during the
2007-08 global crisis.

Reputational Risk
Possible Loss of the
Organizations Reputational
Capital

Financial Times

Potential Loss based on either

Real or Perceived Losses in
Reputational Capital

Federal Reserve Board

Reputational Risk
Loss of Brand Equity
Bank faces loss of Brand Equity
Banks Activities
Rumors about Bank
Willing or Unconscious Non-Compliance with Regulations
Data Manipulation in Balance Sheet

Bad Customer Service

Bad Customer Experience inside bank branches
Decisions taken by banks during Critical Situations

Inbuilt Feedback Loop & Brand Image

Customers
Investors
Opinion Leaders
Other Stakeholders

Systematic Risk
Global Consequence
Systemic risk is the risk that Doesnt Affect a Single Bank or Financial
Institution
It affects the Whole Industry

Associated with Cascading Failures where the failure of a big entity can
cause the failure of all the others in the industry
Rare Occurrence
Severe Impact

Downfall of the Entire Financial System (Country or World)

Subprime Crisis (2008)

The global crisis of 2008 is the best example of a loss to all the financial
institutions that occurred due to systemic risk

Moral Hazard

Moral Hazard is the Risk that a

Party to a Transaction has not
Entered into the Contract in Good
Faith, has Provided Misleading
Information about its Assets,
Liabilities or Credit Capacity, or has
an Incentive to take Unusual Risks
in a Desperate Attempt to Earn a
Profit before the Contract Settles

Investopedia

Moral Hazard

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
Paul Krugman (Nobel Prize winning
Economist)

Moral Hazard
Moral Hazard
Lack of Incentive to Guard against Risk where One is Protected
from its Consequences (e.g. by Insurance)

Consequence
A party that is protected in some way from risk will act Differently than
if they Didn't have that Protection.
People with Theft Insurance being Less Vigilant about where
they park their car
Salaried Salespeople Taking Long Breaks
Financial Bailouts of Lending Institutions by Governments, Central
banks or other institutions can encourage risky lending in the future

If those that take the risks come to believe that they will not have to
carry the full burden of potential losses
Taxpayers, Depositors, and Other Creditors often have to
shoulder at least part of the Burden of Risky Financial Decisions
Made by Lending Institutions

Moral Hazard
Moral Hazard
Lack of Incentive to Guard against Risk where One is Protected from its
Consequences (e.g. by Insurance)

Sub-Prime Crisis & Moral Hazard

Nearly 100 banking crises that have occurred internationally during the
last 20 years, all were Resolved by Bailout sat Taxpayer expense
Risks Inherent in Mortgage Lending became so widely Dispersed
that NO one forced to worry about the Quality of any Single loan.
Shaky Mortgages Combined, Diluting any problems into a larger
pool, the incentive for responsibility was undermined
Moral hazard as a root cause of the subprime mortgage crisis of 2008-09