Risk Management in Banks
Welcome to Nagraj Educational Services, This
Risk Management in Banks
Welcome to Nagraj Educational Services, This
Video is about Risk Management in Banks.
Video is about Risk Management in Banks.
What is Risk?
What is Risk?
Risk is the probability of loss or failure.
Risk is the probability of loss or failure.
It is only a probability; it may end up with
good profits.
It is only a probability; it may end up with
good profits.
It is said, higher the risk, higher the returns.
It is said, higher the risk, higher the returns.
But risk has to be managed.
But risk has to be managed.
In Banking, Risk is defined as the possibility
of loss, injury, claims, or other adverse
In Banking, Risk is defined as the possibility
of loss, injury, claims, or other adverse
or unwelcome circumstances; a chance or a
situation involving such a possibility
or unwelcome circumstances; a chance or a
situation involving such a possibility.
Risk Management in Banking means the development
and execution of a plan to deal with
Risk Management in Banking means the development
and execution of a plan to deal with potential
losses.
losses.
Managing the exposure to losses or risk and
protection of the value of the assets are
Managing the exposure to losses or risk and
protection of the value of the assets are
important points.
important points.
What are the types of risks faced by a bank
or its customers?
What are the types of risks faced by a bank
or its customers?
Credit Risk; Market Risk; Operational Risk;
Liquidity Risk; Business risk; Reputational
Credit Risk; Market Risk; Operational Risk;
Liquidity Risk; Business risk; Reputational
Risk;
Systemic Risk; Moral Hazard; Speculative Risk;
Risk;
Systemic Risk; Moral Hazard; Speculative Risk;
Pure Risk; Property Risk; Real Risk;
Income Risk; Personal Risk
Pure Risk; Property Risk; Real Risk;
Income Risk; Personal Risk
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Before I go into the details of the various
types of risks, I am giving some posers
Before I go into the details of the various
types of risks, I am giving some posers to
the viewers to answer them.
the viewers to answer them.
Interested viewers can put their answers in
the comment or send a mail to me at nagrajkk@gmail.com
Interested viewers can put their answers in
the comment or send a mail to me at nagrajkk@gmail.com
The POSERS are:
1.
The POSERS are:
1.
What are the risks in your personal investments
and when the investments are considered
What are the risks in your personal investments
and when the investments are considered risk
free?
free?
2.
2.
Name any investments that are risk-free.
Name any investments that are risk-free.
3.
3.
Name any two investments carrying huge risk.
Name any two investments carrying huge risk.
4.
4.
Does credit risk apply only to banks or to
other lenders
Does credit risk apply only to banks or to
other lenders
5.
5.
What risks do an individual face when he purchases
a housing property?
What risks do an individual face when he purchases
a housing property?
6.
6.
When does a manufacturing company have a liquidity
risk?
When does a manufacturing company have a liquidity
risk?
Now let me go into the details
Credit risk or Default Risk: Banks lend public
Now let me go into the details
Credit risk or Default Risk: Banks lend public
money by way of loans.
money by way of loans.
When the borrowers default in repayment of
principal or interest or both, there is a
When the borrowers default in repayment of
principal or interest or both, there is a
default risk.
default risk.
The default may be intentional or unintentional.
The default may be intentional or unintentional.
There may be a project failure or there may
be extraneous circumstances on the part of
There may be a project failure or there may
be extraneous circumstances on the part of
the borrower or the required cashflow is not
coming or the market conditions for our
the borrower or the required cashflow is not
coming or the market conditions for our borrowers’
customers are not favourable and the income
or revenue of our customer may be affected.
customers are not favourable and the income
or revenue of our customer may be affected.
This is known as credit risk or default risk.
This is known as credit risk or default risk.
How it is managed?
How it is managed?
Banks take a credit guarantee with DICGC or
credit trusts.
Banks take a credit guarantee with DICGC or
credit trusts.
The Government when they formulated lending
schemes, they are also coming out with a credit
The Government when they formulated lending
schemes, they are also coming out with a credit
guarantee.
guarantee.
Then, in case of securities taken against
loans and advances, the securities are insured.
Then, in case of securities taken against
loans and advances, the securities are insured.
However, for the erosion in the value of net
worth of the borrower or the guarantor or
However, for the erosion in the value of net
worth of the borrower or the guarantor or
the erosion in the value of the security insurance
cover is subject to certain conditions.
the erosion in the value of the security insurance
cover is subject to certain conditions.
Now, let us go the Market risk: Market Risk
arises from the fluctuation in value of securities
Now, let us go the Market risk: Market Risk
arises from the fluctuation in value of securities
in the market or foreign exchange rate risk
or interest rate risk etc
in the market or foreign exchange rate risk
or interest rate risk etc
Operational risk: Inadequate internal processes,
people, skills of our people and people not
Operational risk: Inadequate internal processes,
people, skills of our people and people not
being understanding the internal systems and
procedures and system or from external
being understanding the internal systems and
procedures and system or from external agencies.
Liquidity risk: Not getting enough funds or
not getting enough cash flow to meet the current
Liquidity risk: Not getting enough funds or
not getting enough cash flow to meet the current
obligations
Business risk: Internal and External Factors
obligations
Business risk: Internal and External Factors
including foreign exchange exposures.
including foreign exchange exposures.
Internal factors are those which can be controlled
by the industry.
Internal factors are those which can be controlled
by the industry.
External factors are those beyond the control
of the individual businesses and may be
External factors are those beyond the control
of the individual businesses and may be some
examples like government policies, inflation,
fluctuation in interest rates, monetary
examples like government policies, inflation,
fluctuation in interest rates, monetary policies,
fiscal policy change like taxation rates,
taxation mode, political circumstances, political
fiscal policy change like taxation rates,
taxation mode, political circumstances, political
systems, and stoppage of payments by external
countries regarding their imports.
systems, and stoppage of payments by external
countries regarding their imports.
Reputational risk: Reputational risk refers
to the potential for negative publicity, public
Reputational risk: Reputational risk refers
to the potential for negative publicity, public
perception or uncontrollable events to have
an adverse impact on a company's name, fame,
perception or uncontrollable events to have
an adverse impact on a company's name, fame,
image and reputation of the company thereby
affecting its revenue.
image and reputation of the company thereby
affecting its revenue.
Bank’s reputational risk is the risk of
loss of name, fame and image of the bank
Bank’s reputational risk is the risk of
loss of name, fame and image of the bank.
It can cause damage to a bank's brand and
reputation.
It can cause damage to a bank's brand and
reputation.
Systemic risk.
Systemic risk.
We need to understand the difference between
Systemic Risk and Systematic Risk.
We need to understand the difference between
Systemic Risk and Systematic Risk.
Systemic risk refers an event that can spark
a major collapse in a specific industry or
Systemic risk refers an event that can spark
a major collapse in a specific industry or
a particular economy.
a particular economy.
Collapse of one major bank affect all other
banks, i.e., a particular industry or a particular
Collapse of one major bank affect all other
banks, i.e., a particular industry or a particular
market or a particular economy.
market or a particular economy.
Systematic risk refers to a risk arising from
macroeconomic factors like inflation, deflation,
Systematic risk refers to a risk arising from
macroeconomic factors like inflation, deflation,
interest rates changes, currency fluctuations,
exodus of foreign exchange, recession, wars,
interest rates changes, currency fluctuations,
exodus of foreign exchange, recession, wars,
epidemic or pandemic diseases affecting the
entire economy.
epidemic or pandemic diseases affecting the
entire economy.
An individual company cannot control systematic
risk.
An individual company cannot control systematic
risk.
Moral hazard: It is a situation when one of
the parties to the contract involves in a
Moral hazard: It is a situation when one of
the parties to the contract involves in a
risky event knowing that it is protected against
the risk but the other party will incur the
risky event knowing that it is protected against
the risk but the other party will incur the
loss or incur the cost.
loss or incur the cost.
It arises when both the parties have incomplete
information about each other.
It arises when both the parties have incomplete
information about each other.
Or it may be a suppression of fact by one
of the parties or giving incomplete information
Or it may be a suppression of fact by one
of the parties or giving incomplete information
or a deliberate action the part of such parties.
or a deliberate action the part of such parties.
Speculative Risks: Risk voluntarily taken
which may result in profit or Loss.
Speculative Risks: Risk voluntarily taken
which may result in profit or Loss.
Pure Risk: Fires, wind, damage, flooding and
other natural disasters that cause damage
Pure Risk: Fires, wind, damage, flooding and
other natural disasters that cause damage
to personal belongings.
to personal belongings.
Liability risks are also considered pure risks
and pertain to potential litigation agains
Liability risks are also considered pure risks
and pertain to potential litigation against
a person or organization.
a person or organization.
Property risk.
Property risk.
The possibility of financial loss occurring
as the result of owning a real estate investment.
The possibility of financial loss occurring
as the result of owning a real estate investment.
Property risk might arise from such things
as liability, legal issues, partner problems
Property risk might arise from such things
as liability, legal issues, partner problems
that can force a sale, fire or theft, loss
of rental income and purchasing a property
that can force a sale, fire or theft, loss
of rental income and purchasing a property
with an imperfect title.
with an imperfect title.
Such properties are taken as a security by
a bank.
Such properties are taken as a security by
a bank.
Any loss on such causes will cause the value
of the property to fall down or it may go
Any loss on such causes will cause the value
of the property to fall down or it may go
down to zero.
down to zero.
Real Risk versus Perceived Risks: Normally
the perceived risk is greater than the actua
Real Risk versus Perceived Risks: Normally
the perceived risk is greater than the actual
investment risk.
investment risk.
Reverse may also be true.
Reverse may also be true.
Income risk is the risk that the income stream
paid by a fund will decrease in response to
Income risk is the risk that the income stream
paid by a fund will decrease in response to
a drop in interest rates or market conditions.
a drop in interest rates or market conditions.
For example, banks have invested in Mutual
funds say for example Rs 100 crores and
For example, banks have invested in Mutual
funds say for example Rs 100 crores and they
are getting an income of Rs 10 crores.
are getting an income of Rs 10 crores.
The income of the fund gets reduced by external
factors and the share will come to Rs 8
The income of the fund gets reduced by external
factors and the share will come to Rs 8 crores
or even Rs 6 crores or it may be zero crores.
or even Rs 6 crores or it may be zero crores.
This risk is most prevalent in money market
and short-term markets.
This risk is most prevalent in money market
and short-term markets.
In long term, risk, income risk may be managed.
In long term, risk, income risk may be managed.
Personal Risk.
Personal Risk.
Personal risk is anything that exposes to
the risk of losing something of value.
Personal risk is anything that exposes to
the risk of losing something of value.
Usually, Personal risk is associated with
our financial investments and insurance.
Usually, Personal risk is associated with
our financial investments and insurance.
The promised income or appreciation in the
value of securities or the cover may not
The promised income or appreciation in the
value of securities or the cover may not happen.
Whenever we take any of these investments,
we stand a certain amount of risk of losin
Whenever we take any of these investments,
we stand a certain amount of risk of losing
some money.
some money.
How Banks manage the Risks?
How Banks manage the Risks?
When it is inevitable after the action is
taken, we have to accept and budget for the
When it is inevitable after the action is
taken, we have to accept and budget for the
losses.
losses.
There is no action but to write off when the
loss eventually happens.
There is no action but to write off when the
loss eventually happens.
When the risk is known, or when the risk is
more than the expectation or the risk perceived
When the risk is known, or when the risk is
more than the expectation or the risk perceived
is more than the expectation, it is better
to avoid, eliminate, withdraw or not get involved
is more than the expectation, it is better
to avoid, eliminate, withdraw or not get involved
in carrying the risk or taking such risks.
in carrying the risk or taking such risks.
Mitigation –Banks or financial institutions
take calculated risks.
Mitigation –Banks or financial institutions
take calculated risks.
The risk can be mitigated, reduced or it can
be optimized.
The risk can be mitigated, reduced or it can
be optimized.
Sharing: Again, banks take calculated risks.
Sharing: Again, banks take calculated risks.
Opportunities are there only when risk is
taken.
Opportunities are there only when risk is
taken.
We cannot work in a zero-risk environment.
We cannot work in a zero-risk environment.
We cannot expect them.
We cannot expect them.
So, the risk has to be shared or transferred,
or outsourced or get an insurance on the property
So, the risk has to be shared or transferred,
or outsourced or get an insurance on the property
or investments.
or investments.
For example, the bank gives loan for goods
and documents of title to goods.
For example, the bank gives loan for goods
and documents of title to goods.
When the goods lose value on any reason, the
risk can be covered by obtaining an
When the goods lose value on any reason, the
risk can be covered by obtaining an insurance
beforehand.
beforehand.
For Vehicles—Bank finances the vehicles,
insurance policy can be taken and transferred
For Vehicles—Bank finances the vehicles,
insurance policy can be taken and transferred
in favour of the bank.
in favour of the bank.
Exploitation: Risk is perceived as an opportunity
and it is taken positively and suitable
Exploitation: Risk is perceived as an opportunity
and it is taken positively and suitable strategies
worked out to take advantage of the benefits
of a potential event.
worked out to take advantage of the benefits
of a potential event.
Whenever banks find an opportunity for new
business in a new area, in a new country or
Whenever banks find an opportunity for new
business in a new area, in a new country or
a new geographical location or in an undefined
environment, banks shall exploit the environment
a new geographical location or in an undefined
environment, banks shall exploit the environment
and take the risk factors into account.
and take the risk factors into account.
Risk prevention: Techniques and management
practices that prevent unnecessary or
Risk prevention: Techniques and management
practices that prevent unnecessary or foreseeable
risks which involves Improving quality, improving
systems and methods forecasting and use
risks which involves Improving quality, improving
systems and methods forecasting and use of
best practices.
best practices.
How to Manage reputational risks
Banks have to take steps to protect against
How to Manage reputational risks
Banks have to take steps to protect against
data breach.
data breach.
Banks shall Vigilance about customer service
and customer care complaints.
Banks shall Vigilance about customer service
and customer care complaints.
Banks can keep employees happy to prevent
the reputation risk.
Banks can keep employees happy to prevent
the reputation risk.
Banks can make the values truly operational.
Banks can make the values truly operational.
Vision, Mission Values, Beliefs can be communicated
at all levels of the organisation.
Vision, Mission Values, Beliefs can be communicated
at all levels of the organisation.
Banks can practice ethical conduct.
Banks can practice ethical conduct.
improve corporate governance.
Improve corporate governance.
Banks shall have the mechanism to manage external
reputation.
Banks shall have the mechanism to manage external
reputation.
This can be done by proper liaison and rapport
with the media.
This can be done by proper liaison and rapport
with the media.
Managing Foreign exchange risks
the risks.
Managing Foreign exchange risks
the risks.
Fundamentally, foreign exchange is an open
market.
Fundamentally, foreign exchange is an open
market.
There is an element of fluctuation of their
exchange rates across the globe and the foreign
There is an element of fluctuation of their
exchange rates across the globe and the foreign
exchange market works round the clock in different
countries.
exchange market works round the clock in different
countries.
So, the seller and the buyer of foreign exchange
agree to share
So, the seller and the buyer of foreign exchange
agree to share
Diversification: using funds in more than
one capital market and in more than one currency,
Diversification: using funds in more than
one capital market and in more than one currency,
taking advantage of different markets.
taking advantage of different markets.
Arbitrage is an example.
Arbitrage is an example.
Natural hedging, Netting of Payments, Leading
and lagging, Cross hedging.
Natural hedging, Netting of Payments, Leading
and lagging, Cross hedging.
Getting an Overseas loan or Money market hedging
are other methods of managing foreign exchange
Getting an Overseas loan or Money market hedging
are other methods of managing foreign exchange
risks.
risks.
THANKS FOR WATCHING THIS VIDEO
PLEASE SUBSCRIBE to my channel if not already
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PLEASE SUBSCRIBE to my channel if not already
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You may find other important videos on Banking
concepts.
You may find other important videos on Banking
concepts.
Please view them and give your opinion.
Please view them and give your opinion.
Do not forget to answer the posers given in
this video.
Do not forget to answer the posers given in
this video.
Thank you once again.
Thank you once again.
