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BANKING
Critical Success Factors of Risk Management in Banks:
An Analysis in light of best Risk Management Practices
The banking sector is
exposed to an array of
risks; therefore lessening
these risks is a serious
concern for the banking
industry. The banking
sector needs a properly
laid-out risk management
strategy for achieving
its organisational goals
while eradicating the risk
factors. Successful risk
management is possible
when a well-drafted plan
is implemented. In the
era of competitiveness,
Financial Institutions
(FIs) also want to
play aggressively to
generate wealth for their
stakeholders. Hence,
to maintain higher
earnings they must expose
themselves to higher
risks. At the same time,
safety, solvency and
financial soundness of
the banks can never be
compromised. As a result,
56 THE CHARTERED ACCOUNTANT FEBRUARY 2023
Dr. D. D. Chaturvedi and Dr. Arun Mittal
Authors are Academicians. They may be reached at eboard@icai.in
effective risk management is the only way out which can
help banks to earn efficiently, and minimises various types of
risks that they are exposed to. There is a wide variety of risk
management services that the banking industry in India has
been following.
Concept of risk and Risk Management
T
he general definition of risk states that any organisation
could face undesirable occurrences based on the actions
taken with respect to the business processes. In the banking
sector, it’s believed if the firm is taking more risks than expected,
it may lead itself into difficult and undesirable situations. There
are different kinds of risks associated with banks such as credit
risk, market risk, liquidity risk and operational risk. Each of them
requires a specific and customizable risk management strategy.
Risk management is an umbrella term that imbibes a wide variety
of strategies that banks implement to minimize their risk. The
basic function of banks is to accept deposits and give loans to
those individuals and businesses who need them. Hence, the most
important strategy for minimizing risk for banks is to choose an
appropriate buyer.
Types of risks and risk management strategies
Credit Risk: It is one of the most common forms of risk that banks
are exposed to. The banks give hefty loans to businesses that
might turn out to be Non – Performing Assets (NPAs) and later
these may not be recovered because of different reasons. Such
instances have generated a heavy loss for the banks and pushed
the banks toward insolvency. Other types of losses that fall under
this category such as deterioration in the quality of investments,
delayed payments, etc. The creditworthiness is decided based
on the debt quality of the financial institutions which is again
impacted by such credit risks that banks are taking. Therefore,
to maintain an appropriate distribution concerning credit and
liquidity, banks must decide on the creditworthiness of their
customers before giving hefty loans.
Liquidity Risk: Liquidity means the ability of the FIs to pay
back their debts. The capital markets are dependent on liquidity
management ratios for investing or dealing in any kind. If the
banks are unable to overcome their debt obligations, they are said
to be trapped in a liquidity risk scenario. The external environment
might compel the FIs to use their capital income when they have
insufficient money to meet their obligations. The banks are mostly
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Risk management
is an umbrella term
that imbibes a wide
variety of strategies
that banks implement
to minimize their
risk.
working on borrowed money.
Therefore, they are responsible
to keep up with the compliance,
laws and guidelines. In
financial crises or recessions,
banks must be able to keep
high-quality assets that have
the potential to be converted
into cash in a shorter period.
The banks must have a regular
inflow of cash to abstain from
hedging against the liquidity
risk condition.
Market Risk: The stock market
goes through several deviations
and fluctuations, affecting the
banks which hold equity in
some organisations. Currently,
a trend is seen in the banking
sector, where the banking firms
are investing largely in equity
funds and have exceptional
trading portfolios which
suscepts them to market risks.
The banks might face losses
during the period of investment
or liquidation. This kind of risk
has two parts, connecting with
instability and liquidity. Even
though the liquidation period
is somewhat short, deviations
can be huge in an unstable
market. In a different situation,
the equity and stock markets
with a low volume trading
might be challenging to sell
without experiencing enormous
concessions in the funds. Apart
from the period of liquidation,
the inability of banks to monitor
their market portfolio can be
considered an operational risk
rather than a market risk.
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BANKING
Interest Rate Risk: The assets
and liabilities can be impacted
by the interest rates at which
banks deal. The balance sheets
of the financial institutions
seldom match which is the
reason behind varying interest
rates to meet the compliances.
The predictability of interest
rates can help banks position
themselves in the market. For
instance, if the interest rates
go higher, they can have it to
their advantage by investing
in high profit-yielding funds.
On the contrary, if the interest
goes down, more amount
of loans can be given which
can be recovered later. The
game of varying interests can
be used as an advantage if
strategically played. The effect
of changes or variability in
the loan interests has a great
amount of impact on the
macroeconomy for the investors
and controllers. For example,
a money-related situation
might create volatility, which
thereafter creates instability
in the bank. Since banks
take part in a development
change and transformation
in maturity, the changes in
the market interest rate might
prompt an inadmissible
number of banks and other
monetary organisations to
experience troubles or even
become insolvent in due course
of time. There is a need for
different assessment strategy
options in such exchanges.
Simultaneously, the banks need
to comprehend and deal with
their own openness to loan
interests and risks associated
with them.
Country Risk: The country
risk is the ability of borrowers
who are lending money within
the country to fulfill their said
obligations in due course of
time. Country risks can be
sorted under two headings.
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885
The principal sub-class of
the country risk is a kind of
sovereign risk, which alludes
to both the associated risks
of default by a sovereign
government on its unfamiliar
cash commitments. Other risks
are , immediate or regular
activities by the sovereign
government might influence
the capacity of different firms
in that country to utilise their
accessible assets to meet
unfamiliar liability-obligation
commitments. In the first case,
the sovereign risk tends to
consider the credit risk of public
state-run administrations.
However, these are not the
default risks that are entailed in
the list of other issuers who are
providing loans.
Solvency Risk: The risks
mentioned above might
be inevitable even after
Strategising and planning for
mitigation. In this situation,
the financial institutions might
have appropriate funds or
assets to be converted to
recover all such losses. In case
a bank does not have sufficient
capital to rectify the losses
which have been incurred, it is
then said to be a solvency risk.
The stability of a bank is highly
necessary and if a bank does not
hold enough capital, it might
be at risk of losing its stability
by falling prey to solvency
risk situations. A financial
institution must be exposed
to several risks while it is
operating. Thus, a good amount
of capital can be supportive of
the risks that the organisation
is taking. It is already clear that
risks invite losses, and a bank
must be prepared to face such
situations. The go-to fund for
banks when there is no option
is their capital. The risks must
be aligned with the losses
that it could possibly generate
based on which funds must be
FEBRUARY 2023 57
886
The stability of a bank
is highly necessary
and if a bank does
not hold enough
capital, it might be
at risk of losing its
stability by falling
prey to solvency risk
situations.
allocated to cover the risks that
are ahead of the investments.
Risk Management
Every business has the
possibility of facing risky
situations in any instance.
The factors which supposedly
contribute to the risky
circumstances can be closely
monitored and minimized with
the help of certain strategic
moves that can help the
businesses to save themselves
from cost overruns. The
process of risk management
entails determining the
aspects which are the main
reasons behind such risks,
evaluating or analysis of
the risk factors and finally
responding to those factors
by the best course of action.
The best way to mitigate risks
is by strategizing proactively
towards the risk factors and
not reactively. The hazardous
impact can be reduced by
means of proactive strategic
measures in the organisation.
Business organization must
analyse their tolerance level
for deciding whether to accept
or reject the risks coming
forth. Proactive measures
in risk management benefit
the organisation in several
ways, because of which the
enterprises do not have to face
surprise risks and they would
have the ability to tackle those
risks at the appropriate time.
58 THE CHARTERED ACCOUNTANT
BANKING
Decision-making plays a huge
role in any firm and the risk
management system builds its
foundation. . There are certain
approaches that businesses
might incorporate in dealing
with risks. These best practices
are described further. Muller
and Ralf (2009) highlighted
some critical success factors
for risk management namely
- Commitment and Support
from Top Management,
Communication, Culture,
Information Technology
(IT), Organisation Structure,
Training and Trust.
Best practices in risk
management
The risk management
system in banks has changed
considerably in recent years.
The guidelines that arose out
of the worldwide financial
emergency and the fines that
were imposed afterward set
off a rush of progress in the
risk capacities of the financial
institutions. These included
more prominent and detailed
capital, liquidity and financing
prerequisites, as well as better
expectations for formulating the
risks. The organisations were
pushed towards following the
laws and fulfilling all levels
of compliance required. The
banks were asked to present
their risk-appetite statements
for analysis of wealth and
their credit lending status in
the market. Some of the best
practices in risk management
in FIs and organisations
include evaluation of the
information source regularly
, consistent validation of the
scorecard model, analysing and
monitoring the model which
is being used to lend money,
optimisation of the data which
is available, additional usage of
AI (Artificial Intelligence) and
ML (Machine Learning) in the
FEBRUARY 2023
banking system to catch frauds
and other criminal activities in
the financial aspects, and finally
using the tools and technologies
to fight financial crime in the
best possible way.
Critical success factors for
managing risks effectively
The pertinent step in risk
management includes the
implementation of Critical
Success Factors (CSF) in banks
and financial enterprises.
It not only supports the
organisational objectives but
also helps in dealing with short-
term and long-term potential
risks. The CSF is typically a
set of prominent key result
areas which is beneficial to the
organisation in achieving the
goals as well as in managing
risks effectively. Different
scholars have articulated
their views with regard to
CSF so that the firms can
accomplish their goals using
CSFs. This is nothing but a
list of required actions to be
taken for creating a sustainable
risk culture. The decisions
which are made considering
the CSFs are based on sound
and strategic administration,
with an effective performance
management system, and
finally suitable investment
decisions on behalf of the
The factors which
supposedly
contribute to the risky
circumstances can be
closely monitored
and minimized with
the help of certain
strategic moves
that can help the
businesses to save
themselves from cost
overruns.
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 887

BANKING

company. The first step asks containing the various aspects

enterprises to define their risk of the risk management
appetite in simple terms at the spectrum in the banking To control the risk,
top management level. The industry. Banks must follow the the banks need to
next step is to mention the risk management compliances be vigilant and take
accountabilities so that business as issued by RBI and Banking necessary steps on
decisions can be made by regulations in the context of risk regular basis.
taking the risks into account. management. The second most
The risk appetite can be grown important step is to establish
and promoted within financial a risk management premise, The last step of the model
organisations with the help of which contains identification, contains review, analysis, and
incentive programmes and observation and monitoring revision.. Hence, banks keep
rewards whenever necessary. of the risk. The third step on revising their strategies
reflects the actions to respond for risk management. For
The administrative processes to the continuous updates example, during the Covid19
can be clubbed with the risk and changes in the business pandemic, the State Bank of
management system within the environment. The bank’s India took many important
firm so as to create the desired exposure to different categories steps to provide uninterrupted
risk culture. The frameworks of borrowers, investments, banking services by ensuring
used in the organisation can use of technology for service, the availability of ATMs
be designed based on the risk infusion of new technology, functioning, net banking,
appetite which can be used to new marketing and customer YONO app, mobile banking,
scale the current risk appetite management spectrum in the banking industry. Banks must follow the risk management
service strategies, etc. depends etc. to minimise operational
to the desired level. The most upon how the
compliances micro
as issued by and macro
RBI and Banking regulations in the context of risk of
management.
risk1 Similarly, the Bank
important step would be to environment
The second mostisimportant
responding. Baroda
step is to establish monitorspremise,
a risk management interest which contains
invest in the capabilities and This step requires measuring
skills required to effectively identification, observation and monitoring ofrate riskThe
the risk. in third
its trading book
step reflects the actions to
the risk in the changing Value at Risk (VaR) on daily
manage risks. The entire system respond to the continuous
environment, assessing it and updates and changes in the business environment. The bank’s
basis2.. Risk management is
must collaborate in different managing
exposure to it.different categories of borrowers, investments, useprocess.
of technology for service,
a continuous As and
work units and regular infusion of new technology, new marketing when the regulatory
and customer institutions
service strategies, etc. depends
monitoring of the system shall Figure 1: Comprehensive
upon Management
how the micro andModel
macro environment realise
is thatThis
responding. therestepisrequires
a need to
measuring the
take banks and financial firms Risk for
make the rules stringent, they
to the next level in giving their banking industry
risk in the changing environment, assessing it and managing it.
customers the best experience.
Comprehensive Risk Risk Management
Premise
Management Model for
banking industry Identification
Observation
To control the risk, the Monitoring
banks need to be vigilant
and take necessary steps on
regular basis. Figure 1 shows Guidance Types of Risks Action
a comprehensive model Credit Risk
Banking Regulations Measure
Capital Adequacy Market Risk Assess
Norms Liquidity Risk Manage
Basel III Norms Operational Risk Etc.
The pertinent step RBI Policy
in risk management
includes the Continuous
Improvement
implementation
of Critical Success Review
Factors (CSF) in Analysis
Revision
banks and financial
enterprises.
Source:Figure
Authors1: Comprehensive Risk Management Model for banking industry

Source: Authors
www.icai.org THE CHARTERED ACCOUNTANT FEBRUARY 2023 59
The last step of the model contains review, analysis, and revision.. Hence, banks keep on
revising their strategies for risk management. For example, during the Covid19 pandemic, the
State Bank of India took many important steps to provide uninterrupted banking services by
ensuring the availability of ATMs functioning, net banking, YONO app, mobile banking, etc.
888
act accordingly. Hence, the
framework given in Figure 1 is
a continuous process.
The Basel norms have been
instrumental in providing
guidelines for risk mitigation
in addition to the other
regulations. Basel norms have
evolved from Basel 1 to Basel
3. Basel 1 included the norms
regarding minimum capital
adequacy, whereas Basel 2 is
related to supervisory review
and lastly, Basel 3 covers the
market discipline. Overall, the
Basel norms cover a wide range
of risks which include credit
risk, market risk, operational
risk, and liquidity risk. Capital
by itself does not guarantee
a bank’s financial security.
These regulations are to ensure
that the best practices of risk
management are implemented.
The ICAAP (Internal Capital
Adequacy Assessment Process)
requirements under Pillar 2 and
the more recent stress-testing
guidelines are good examples
of how The Basel Committee on
banking system (BCBS) aims to
achieve this objective (Moody’s
Analytics, 2019).
60 THE CHARTERED ACCOUNTANT
BANKING
Conclusion
Risk management in banking
is a wide concept, though
highly critical. One must
go by books and be vigilant
and agile in uncertain times
to ensure that banks are not
badly affected by this risk and
maintain an appropriate and
sustainable risk-return level.
Accomplishing a compelling
risk management culture is
not an impossible task. It is
fundamentally a continuous
and iterative cycle that helps
organisations deal with
internal and external risks
that may come during their
operation. The banking sector
ought to persistently look at
developing and reshaping
the risk-appetite culture in a
proactive and strategic way that
perceives the two important
steps necessary. These steps
are generating a good value as
well as providing the required
security to its customers and
the organisation itself. This
initiative can be taken within
the business sphere in different
operational units to ensure that
the risk culture is consistent and
FEBRUARY 2023
proactive throughout. The CSFs
can assist the banks to manage
the risks in the most profitable
manner by leveraging the
already existing resources. The
financial sector can grow in a
sustainable manner by avoiding
the unnecessary threats that
are coming in the way or by
accepting some of the risks that
are tolerable. The last option
is to mitigate the risks after
identifying them through the
updated technologies widely
used in other sectors to assess
the external environment.
References:
• Annual Report of State Bank of
India, 2019-20
• Annual Report of Bank of
Baroda, 2020-21
• Moody’s Analytics: Essential
Guides Serving Financial
Markets, Regulation Guide: An
Introduction, 2019.
• Muller, Ralf (2009) Critical
Success Factors for Effective
Risk Management Procedures
in Financial Industries: A
Study from the Perspectives
of the Financial Institutions
in Thailand, Master Thesis,
Umeå School of Business Umeå
University. Thailand.
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