Risk Management in Banking

Risk Definition & Policies

• Risk is the possibility of something bad happening, involving uncertainty about the effects of an activity.
• It focuses on negative consequences, such as harm to health, wealth, property, or the environment.
• Business risk is the possibility of unfavorable events minimizing gains and maximizing losses.
• Banking risk management identifies, evaluates, and mitigates potential negative occurrences from bank operations and investments.

Risks and Risk Management in Banks

• Risk management is crucial in banking as banks manage money for others.
• Risk teams typically separate fraud and compliance operations.
• Fraud risk management handles risks associated with fraud operations.
• Compliance risk management handles risks linked to compliance issues.

Importance of Risk Management in Banking

• Banks are core financial institutions for national and global systems.
• Banks have significantly reduced risk compared to other industries.
• Risk management helps avoid wasting funds and disruptions to operations.

The Risk Management Process

• Risk identification involves defining the nature and origin of financial risks.
• Risk assessment and analysis evaluate the likelihood and severity of risks, prioritizing those needing most attention.
• Qualitative risk assessments are often used in banking due to the complexity of quantifying some risks.
• Quantitative risk assessments use metrics like financial data, interest rates, etc., for a more objective analysis.

Mitigation

• Mitigation involves designing bank policies and processes to limit the potential of risks.
• This is aimed at minimizing the damage caused by threats.

Monitoring

• Monitoring gathers data on threat prevention and incident response.
• Research on emerging risk trends helps update the bank's risk management framework.
• Cooperation develops relationships between enterprise risks, creating a more centralized threat response.

Reporting

• Reporting documents and reviews the effectiveness of risk management efforts.
• Tracking the bank's overall risk profile is part of the process.

Types of Risk Management in Banking

• Credit risk is the risk of a bank not being repaid a loan.
• Mitigation involves understanding the bank's overall financial position to take losses.
• Market risk occurs when adverse events outside the banking industry negatively impact investments.
• Mitigation includes diversifying investments, focusing on stable industries, and maintaining liquid assets.
• Operational risk refers to daily occurrences like employee errors.
• It includes cybersecurity risk--attacks on the bank's digital systems.
• Mitigation involves hiring and training the right staff, technology security, and data collection programs.

Reputational Risk

• This refers to when a bank loses investor and customer confidence due to poor service, or management issues.
• Mitigation requires setting ethical values and properly training employees, as well as social media monitoring and addressing any issues found.

Liquidity Risk

• This risk is when a bank runs out of physical money, quickly, and cannot meet short-term obligations.
• A bank run happens when rumours of impending failure incite customers to withdraw their money.
• Banks can mitigate their liquidity risk by regularly forecasting cash flows and having a contingency funding plan

Compliance Risk

• Compliance risk involves not fully complying with laws and regulations, potentially facing fines or sanctions.
• It includes reputational damage from the loss of trust.
• Mitigation involves educating employees on laws and regulations.

Legal Risk

• Legal risk arises from not following laws, regulations, or contractual obligations, leading to court action or penalties.
• Common legal risks include disputes, regulatory issues, and interest rate risk.
• Currency risk is related to movements in foreign exchange rates.

Best Practices for Banking Risk Management

• Establishing a finance institution-wide risk governance framework ensures all staff are involved in risk management operations.
• Prioritizing identity verification and authentication ensures honesty in bank dealings.
• Automation of tasks like transaction monitoring improves the identification of suspicious activity and helps prevent errors.
• Understanding individual cases and overall financial risk allows proper allocation.

Continuously Assess, Analyse, and Act on Risk Metrics

• The risk management process needs to be dynamic to address new technologies, business trends, and regulatory changes.
• Risk management plans should be regularly evaluated and updated.

Risk Management

• Firms want to ensure stability as they grow, and understanding relevant risks is essential.
• Risk management helps to predict potential difficulties and avoid negative impacts through appropriate planning, allocation of resources, and decision-making.