Financial Risks

Financial Risks

• Bank risk refers to potential losses a bank faces
• Key risks include credit, interest rate, market, liquidity, and operational risks.
• Risk measurement aims to estimate potential losses from adopted activities
• For financial risks, it involves identification, quantification, estimation, and management of risks from financial market activity.
• The level of assumed risk impacts capital needed to adopt such risks
• Senior management defines the risk appetite concerning capital access
• Financial institutions must manage financial risks to generate profitability covering implicit costs and remunerate shareholders.
• Effective risk management enhances process planning, focusing on corporate objectives.
• Additional benefits are reduction of unforeseen costs, better resource allocation, increased efficiency, a positive organizational culture, accountability, transparency, and good governance.
• Questions essential for any financial institution or risk management entity include: risks faced, level of risk, risk capacity, desired risk, current risk exposure and future risk plans.
• Units monitoring, analyzing, and controlling limits are essential to business plans
• Financial risks include solvency, market and credit risks to be managed.
• Correct valuation of assets and liabilities is crucial for quantifying risks
• The risk function should identify, locate, analyze, and monitor the entity's risks
• Four phases to identify and manage risks

Defenses required

• Identification: qualitative identification of risk factors
• Evaluation: quantitative evaluation of risk factors using accepted methodologies
• Conduct: manage risk according to the entity's risk appetite
• Reporting: deliver orderly, recurrent reports of all risk factors using approved methodologies.
• The risk function is strategically important in any entity
• Full support from top management is essential for the appropriate risk function performance
• Top management defines strategy and the entities execution program
• All phases are subject to uncertainty relating to the risk function
• Any risk assumption decision defines tolerance thresholds based on the impact, the probability of occurrence, and the consequences of identified risks.
• Risk is linked associated with changes in asset or liability value due to external variables, generating losses
• Uncertainty about the results of entity management generates risks with origins classified as exogenous or management-related (endogenic).

Credit Risk

• Refers to the potential for loss if a counterparty defaults on financial commitments
• Credit risk includes losses as well as losses from deterioration credit quality and economic provisions

Credit Risk: Risk Factors

• Credit risk is segmentable into these groups
• Issuer
• Settlement
• Counterparty
• Delivery
• Metrics to quantify credit risk measure potential losses throughout the operations
• Risk stems from non-compliance, a borrower's obligations, and value losses due to economic decline and weakened assets
• Concentration risk refers to excessive exposures, which could affect the entity
• Both sectoral concentration and borrower affect concentration
• Establishing risk limits is a binding part of frameworks the risk function and entity Limits should be easily implementable, measurable, and adapted to different risk types.
• The initial steps in the business include requesting a request approval
• Technical support for processes must come from the unit implementing them, with the supporting risk area, and this needs to be submitted higher
• Middle office follow-up returns are essential after assessment

Market Risk

• It is the exposure financial positions in the markets and changes in value related
• Four Groups of Assets
  • Equities: includes indexes, derivatives, stocks and all their indexes
  • Interest Rates: consists of deposits, bonds, derivatives
  • Exchange rates: consists of currency and derivativess
  • Commodities: oil gold etc.
• It is created by volatile market, which are all quoted markets, that are subject to supply demand
• Market includes policy, the global economic situation, monetary, views etc
• Horizon of metrics are usually shorter
• The methods of measuring market risk are divided into two main groups
  • Quantifying change due to variations on market variables
  • Estimating probability of losses
• Objectives for acheiving
  • Identify valuation criteria, sensitivity Metrics outlined for income assets, additional matrices are also displayed

Market Risk Additional metrics

- Identify valuation criteria for all types of instruments
- Use historical data for instruments values based on certain confident criteria intervals

• Important points for Metrics
  • They only need valuation models and their derivatives
  • Metrics are of the first differentiation and do not use historical
  • It focuses specifically on valuation

Valuation

• Value at Risk's metrics date back to the 1990s
• JP Morgan, the investment bank, first proposed this approach that has been used
• Three major strategies for calculation have evolved the years
  • Parametric techniques
  • Historical Simulation
  • The Monte Carlo simulation

Structural Risks within financial institutions

• Balance sheet or liabilities asset management from market to liquidity
• Main objectives are Maxing assets between profits and the modulated exposures

Fundamental Methodology

• Four Points are
  • The first quantification of the measures includes, estimating on what the value is, apply to its future
  • Secondly know that the value if something happened to the portfolio -Third there probabilistic component taking into account a quantification to losses and Value at risk

Capital Implications

• Banks prioritize securing adequate capital to maintain and strengthen their financial status. Risk occurs where capital investment loses money or experiences unfavorable market fluctuation, which could dud -Portfolio assessments help define adequate capital so managers and regulators study to identify this for the correct measurement, which may not be easy and will require skill

Measuring The Riskiness Of a Company

-Measure the risk by calculating a firms expected end of period net worth

• Calculate the probability of possible net worth -The bank will become insolvent if the income is too negative, therefore it offsets the initial capital -The two ways that the banks theoretically are insolvent -One, if the liquidity is so low the debts cannot pay, or a negative cash flow cannot -Two, that the set amounts outweighs, if the asset is reduced by the cost of Bankruptcy
• First the risk must be to determined and then look at it from a basic to advanced level -Ideally the complete co variant that covers, all pertinent actives that could occur -The Risk matrix is what the bank engages between, to give the expected returns -The Matrix variance must be applied if you think the average will change, this includes economic changes

Risk Factors That Effect Capital

-The Capital change gives expected net wealth from several formulas.

Capital to Weighted asset ratio

• The capital assets must meet the requirements based on banks riskiness -To reduce its risk is what it aims to do

Risk Framework

-These are determined by financial institutions to achieve their objectives -Officer in charge is The Chief, to set framework approved by the directors -Is therefor important for the limit metrics, authorization reports

Risk Appetites

• The core principles -What risk must we consider? -What are the levels? -What is the total amount we can take? -Are we being safe as we are taking on?

Credit Risk

• The non payments due to obligations, can cause the solvent of the banks borrow to deteriorate to the state of their assets