“INTRODUCTION TO FINANCIAL INSTITUTION”

Financial institutions serve most people in some way, as financial operations are a critical
part of any economy, with individuals and companies relying on financial institutions for
transactions and investing. Governments consider it imperative to regulate banks and
financial institutions because they do play such an integral part in the economy. Historically,
bankruptcies of financial institutions can create panic. The major factor is interest rate which
effects overall the market.

WHAT IS RISK?

Risk is defined in financial terms as the chance that an outcome or investment's actual gains
will differ from an expected outcome or return. Risk includes the possibility of losing some
or all of an original investment.

“VARIOUS RISK FACED BY FINANCIAL INSTITUTIONS”

Since banks are exposed to a variety of risks, they have well-constructed risk management

infrastructures and are required to follow government regulations. There are four major
financial risks that can affect the financial market. Which are discuss as under:

I. Credit Risk

The credit risk is considered as a biggest risk for banks. It occurs when borrowers fails to
meet their obligations. If borrowers default on a principle or interest payment of a loan then
credit risk occurs. Customer can default on mortgages, credit cards, and fixed income
securities. Credit risk from banks cannot be fully minimized because of the nature of
banking business model. To reduce credit risk form banks, loans must be issued to people
having good credit history or have own guarantee to bank up the loans.

II. Operational Risk

Operational risk is one of the most difficult to measure objectively. In order to be able to
calculate it accurately, the company must have created a history log with the failures of this
type and recognized the possible connection between them. Risk of loss due to errors,
interruptions or damages incurred by customer, systems or processes. Internal fraud or
mistakes made during transactions are includes in losses due to human error. Cyber Security
is one of the cause of large scale frauds. 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.

Major companies such as Intel and Facebook have suffered great economic losses because
they did not anticipate operational risks.

In conclusion, the types of financial risks are different for each company depending on the

activities it carries out. However, it is essential to identify potential risks and assess their
impact.

III. Market Risk

Among the types of financial risks, one of the most important is market risk. This type of
risk has a very broad scope, as it appears due to the dynamics of supply and demand.

Market risk is largely caused by economic uncertainties, which may impact the performance
of all companies and not just one company. Variations in the prices of assets, liabilities and
derivatives are included in these sources of 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. When banks are involved in capital markets then Market risk occur. It’s due to the
unpredictability of equity markets, commodity price, interest rates, and credit spreads. Prices
of commodities also plays a role in market risk because it may be possible that band had
invested in companies that produce commodities. The price shift are caused by demand and
supply changes that are mostly difficult to predict. Market risk can be decreased, by
diversification of investment portfolio.

For example, this is the risk to which an importer company paying its supplies in dollars
and then selling the final product in local currency is exposed. In the event of devaluation,
that company may suffer losses that would prevent it from fulfilling its financial obligations.

The same applies for innovations and changes in the market. One example is the commercial
sector. Companies that have managed to adapt to the digital market to sell their products
online have experienced an increase in revenue.
 IV. Interest Rate Risk

This risk arises due to fluctuations in the interest rates. It can result in reduction in the
revenues of the bank due to fluctuations in the interest rates which are dynamic and which
change differently for assets and liabilities. With the deregulated era interest rates are market
determined and banks have to fall in line with the market trends even though it may stifle

their Net Interest margins

V. Foreign Exchange Risk

Risk may arise on account of maintenance of positions in forex operations and it involves
currency rate risk, transaction risks (profits/loss on transfer of earned profits due to time lag)
and transportation risk (risks arising out of exchange restrictions).

VI. Regulatory Risks

It is defined as the risk associated with the impact on profitability and financial position of a
bank due to changes in the regulatory conditions, for example the introduction of asset
classification norms have adversely affected the banks of NPAs and balance sheet bottom
lines.

VII. Technology Risk

This risk is associated with computers and the communication technology which is being
increasingly introduced in the banks. This entails the risk of obsolescence and the risk of
losing business to better technologically.

VIII. Strategic Risk

This is the risk arising out of certain strategic decisions taken by the banks for sustaining
themselves in the present day scenario for example decision to open a subsidiary may run the
risk of losses if the subsidiary does not do good business.

IX. Liquidity Risk

Financial risk management must consider a company's liquidity, as every organization must

ensure that it has sufficient cash flow to pay off its debts. Failing to do so may ruin investor
confidence.
Liquidity risk is just that. It is the possibility that a company will not be able to fulfill its
commitments. One of the possible causes thereof is poor cash flow management.

When banks are short of cash to meet funding obligations this is known as “Liquidity Risk”.
In case banks fails to provide cash to the customer for a day, other depositor may lose
confidence on the bank and rush to take out their deposits back. Mismanagement of assets
and liabilities can also cause funding difficulties. This occurs when banks has more short-
term liabilities as compare to short-term assets.

A company can have a significant amount of equity, but at the same time a high liquidity risk.
That is because it cannot turn those assets into money to meet its short-term expenses.

Real estate or bonds, for example, are assets that can take a long time to turn into
money. That is why each company must verify whether it has current assets to pay off short-
term commitments.