Financial Services: Key Types of Risks

Key Types of Risks

• Financial services are exposed to multiple risks affecting operations and profitability.
• Credit risk constitutes the potential for loss when a borrower does not repay a loan or fulfill obligations.
• Market risk is the potential for losses in financial markets due to unfavorable price movements.
• Liquidity risk refers to the situation where a business cannot meet its immediate financial obligations due to liquid assets and liabilities being unbalanced.
• Investment risk is a mix of credit, market, and liquidity risks managed together to provide target returns.
• Operational risk stems from processes, systems, and human factors involved in managing risks, including both internal and external events.

Enterprise and Strategic Risks

• Enterprise Risk Management (ERM) is a holistic approach, offering a comprehensive view of all risks to enable informed executive decisions.
• Firms are shifting towards collective risk reporting to gain clarity on risk exposure.
• Internal strategic risks stem from strategy, execution, financial management, and regulatory compliance.
• External strategic risks involve unforeseen shifts in the global economy, political landscape, competitive environment, and technological advancements.

Key Elements of Risk Management

• Risk is defined as variability that can be quantified through probabilities, often drawing upon historical data.
• Uncertainty is variability that cannot be quantified, often linked to unique events or a lack of data.

Framework for Managing Risk

• A robust framework includes Risk Policies and Governance, Risk Oversight, and Daily Risk Management
• Risk Policies and Governance involves establishing policies at the board level.
• Risk Oversight is conducted by business units with independent management functions, ensuring identification, assessment, and control.
• Day-to-Day Risk Management is integrated into business management, owned by business units instead of solely by the risk function.

Types of External Risks

• External risks stem from changes in the global economy, political events, and competitive market dynamics.
• Additional external considerations include social and market forces, environmental factors, technological advancements and cybersecurity.

Economic and Political Risks

• Economic risk is the economy shaped by behavior and resource allocation of humans, and anticipating consumer and market impacts. Firms not adapting to a recession may face challenges with inventory.
• Political risk comes from political shifts, impacting financial services, market changes, demand for financial products, and regulatory environment.

Competitive, Social, and Technological Risks

• Firms must navigate the competitive space and the performance of competitors will influence market dynamics. Gaining market share could force others to leave the market, while a company collapse could open acquisition.
• Technological and cybersecurity growth leads to productivity and economic benefits, but comes with data security and operational risks, and firms have to adapt to remain secure and competitive.

Understanding Risk Management in Business Evolution

• Originally, workers moved to employer location but modern firms can outsource customer communications overseas. This enhances operational efficiency as consumer data is effectively used and consumers gain access to info on products and services.

Cyber Risk A New Frontier

• New tech introduces cyber risk regarding theft or damage of data on computers and it systems.
• New fields like info security aims to combat cyber risk, and UK government releases guidelines on cyber threat, which emphasizes proactive management by corporate governance

Types of Stakeholder & Third Party Risks

• External shareholders can pose great risks to a firm, from parents, institutional investors and large customers
• Risks from a parent can disrupt subsidiary plans unless handled carefully, and shareholders can influence business strategy through voting rights if unmanaged.

Managing Stakeholder Relationships

• Managing Over-reliance on a customers can cause heavy concentration risks.
• Establish high-level relationships to effectively oversee stakeholder risks, acknowledge diverse objectives, and oversee expectations on news.

Environmental, Social, and Governance (ESG) Risks

• A World Bank study finds water scarcity can lead to some countries losing up to 6% of GDP, with expectations of 55% water demands to rise by 2050. This has risk to all intensive areas like food and beverage as well as energy.
• Governance risks touch upon corporate governance as well as ethical practices.
• ESG risks lead to negative impacts on business like revenue reduction, reputational damage or missed savings as well opportunities for innovation
• COSO framework puts focus on integrating ESG in enterprise-wide risk management systems to create value as well make decisions.

Analytical Tools for Management

• PESTLE analysis looks at external macro environment and a business like political, economic, social, technological, legal, and environmental factors.
• This is often conducted collaboratively to find potential risks.
• Planning for business includes disaster recovery from risks impacting operations, and business process analysis views internal and external factors impacts those processes.
• Risk is categorized internally into three main types like strategic, operational, and financial risk.

The 3 Types of Internal Risks

• Strategic risk, as defined by European Banking Authority, involves changes to earnings plus capital arising from changes or poor decision making.
• Operational risk comes from losses from inadequate internal processes or systems, while financial risks involve failure or insufficient cash.
• There is assessment of internal risks including strategic as well operational, and financial, achieved through multiple techniques

The Systematic Approach to Risk Management

• Focus on finding, measuring and controlling potential losses while improving opportunity
• Risk assessment through tests, workshop, stress analysis for managing and finding risk

Management and Involving Early Risk

• Is about finding revenues against actual to see viability of projects, or regulatory issues.
• If underestimated it's important to involve management staff to protect the firm and improving volatility of earnings.
• Involving management to see potential impacts to include risk mitigation strategies to reduce these impacts as well reduce risk.

Risk Appetite and Risk Profiles

• There can be a level of risk where before controls applied, and its crucial to see the potential.
• The remains still exists and its important to know what level of risk remains once controls are used.
• Risk Appetite is the amount and type of organization which accepts on purposes of the objectives.
• The different risk types is critical as well for guiding the decision, risk profile to see specific risks which is in an event in how they may happen and potential impacts

Importance of Risk Culture

• The risk values will infulence risk within organization. The actions will outcome for customers as incentives prioritize welfare.
• The regulations that take place to combat things like terrorism or virtual assets. There are EU directives which take the AML measures from crypto.

Risks that are Cyber

• There is private key stolen, that can be accessed without recourse for original owner.
• It is important for EU as GDPR to impose limits on protection when there penalties for non compliance
• Organization needs to manage limits
• In digital world assets have to encrypt and stored securely to combat from things like hot storage and cold storage, there are high volatility by ownership which is susceptible for invest

Fintech & Rep Risk

• There needs to be compliance to manage the trust from clients and regulators from negative to save the data and data for regulatory violations
• That means companies have balance between all the clients