Risk Management in Banking
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Questions and Answers

What is the definition of risk in a financial context?

  • Risk only concerns external threats, not internal vulnerabilities.
  • Risk indicates the likelihood of complete loss on investments.
  • Risk relates to the probability of actual returns falling below expected returns. (correct)
  • Risk is associated with high investment returns.

    • Which of the following constitutes a key risk that banks face?

  • Interest rate, operational, and foreign exchange risks. (correct)
  • Regulatory risk and customer satisfaction risk.
  • Market risk and physical asset risk.
  • Only credit and liquidity risks.

    • What has increased the focus on risk management following the financial crisis?

  • The development of new financial products.
  • Improving customer satisfaction levels.
  • Higher interest rates on loans.
  • Attention from supervisory bodies. (correct)

    • Which of the following is NOT a method of risk treatment?

    <p>Speculation</p> Signup and view all the answers

    Why is efficient risk management crucial for banks?

    <p>It is essential in competitive environments.</p> Signup and view all the answers

    How can risks be characterized based on their nature?

    <p>Risks can be either external or internal.</p> Signup and view all the answers

    What is necessary for the future success of banking institutions?

    <p>Sound risk management systems.</p> Signup and view all the answers

    What does operational risk entail?

    <p>Risk stemming from failures in internal processes.</p> Signup and view all the answers

    What is the most common cause of operational risk in banks?

    <p>Errors caused by human actions</p> Signup and view all the answers

    Which of the following best describes market risk?

    <p>Losses that occur as a result of adverse market movements</p> Signup and view all the answers

    What can banks use to measure their exposure to market risk?

    <p>Value at Risk (VaR)</p> Signup and view all the answers

    What significant operational risk event led to the collapse of Barings Bank in 1995?

    <p>A single rogue trader's actions</p> Signup and view all the answers

    Which of the following is an example of external fraud in the banking sector?

    <p>Hacking leading to stolen customer information</p> Signup and view all the answers

    What type of operational risk could result from a bank employee siphoning funds?

    <p>Internal fraud</p> Signup and view all the answers

    How can banks offset excessive market risk exposure?

    <p>Utilizing futures contracts</p> Signup and view all the answers

    What does the Basel Committee on Banking Supervision define as operational risk?

    <p>Loss resulting from internal processes, people, and systems</p> Signup and view all the answers

    Which type of risk involves uncertainty in cash flow due to changing interest rates?

    <p>Interest rate risk</p> Signup and view all the answers

    What is primarily considered the main business of financial institutions?

    <p>Managing various financial risks</p> Signup and view all the answers

    Which risk relates to the possibility of losing money due to a borrower's failure to repay a loan?

    <p>Credit risk</p> Signup and view all the answers

    In the context of fintech, which of the following best describes digital disruption?

    <p>Changes in business models due to technology</p> Signup and view all the answers

    What risk involves potential losses due to fluctuations in foreign currencies?

    <p>Foreign exchange risk</p> Signup and view all the answers

    What type of risk is associated with technology and operational failures within a financial institution?

    <p>Operational risk</p> Signup and view all the answers

    Which type of risk is primarily linked to the financial stability of a country affecting foreign investors?

    <p>Country or sovereign risk</p> Signup and view all the answers

    Which of the following is an example of fintech?

    <p>Crowdfunding platforms</p> Signup and view all the answers

    What is a primary advantage of decentralised networks in financial systems?

    <p>They maintain transparency by allowing all nodes access to the same information.</p> Signup and view all the answers

    Which banking model involves engulfing incumbent banks, making them less relevant?

    <p>Disintermediated Bank</p> Signup and view all the answers

    How do new banks, as described in the content, differ from incumbent banks?

    <p>They leverage technology to offer services more efficiently.</p> Signup and view all the answers

    What role do fintech companies play in the Relegated Bank model?

    <p>They provide customer-facing platforms while banks handle risk management.</p> Signup and view all the answers

    What is a key feature of decentralisation that supports the robustness of blockchain technology?

    <p>Node independence leading to network resilience.</p> Signup and view all the answers

    What is the primary function of the Better Bank model?

    <p>To innovate and improve the 'customer relationship' aspect of banking.</p> Signup and view all the answers

    Which of the following describes a disadvantage of a centralised banking system?

    <p>Greater vulnerability to outages</p> Signup and view all the answers

    Which banking model is characterized by using multiple providers for financial services?

    <p>Distributed Bank</p> Signup and view all the answers

    What is one of the main causes of bank failures as highlighted in the content?

    <p>Bank runs initiated by depositors</p> Signup and view all the answers

    How did the bankruptcy of Lehman Brothers illustrate the risk of financial contagion?

    <p>It revealed numerous connections in the financial system.</p> Signup and view all the answers

    What was the role of the Bank Term Funding Program (BTFP)?

    <p>To prevent financial contagion following the collapse of SVB.</p> Signup and view all the answers

    What was a consequence of the bank runs in the late 1930s?

    <p>The establishment of the FDIC to guarantee deposits.</p> Signup and view all the answers

    What event led to the significant increase in bank failures between 2008 and 2015?

    <p>Increased defaults on mortgage repayments.</p> Signup and view all the answers

    During a bank run, what happens to the bank's cash reserves?

    <p>They are quickly depleted as depositors withdraw funds.</p> Signup and view all the answers

    Which bank experienced a massive withdrawal of $16.7 billion in just nine days?

    <p>Washington Mutual</p> Signup and view all the answers

    What impact did the excessive risk-taking in the financial sector lead to, particularly before the Great Recession?

    <p>Mass defaults on mortgage payments.</p> Signup and view all the answers

    Study Notes

    Risk Management in Banking

    • Risk is the probability of negative occurrences, often related to investment returns.
    • Banks face various risks: credit, operational, foreign exchange, interest rate, market, liquidity.
    • Risk management frameworks are crucial for banks, especially after the financial crisis, to manage key risks.
    • Risk treatment methods include: avoidance, reduction, transfer, retention.
    • Efficient risk management is necessary for banks to compete in the market.
    • Sound risk management systems are key for future banking success.

    Market Risk

    • Market risk arises from activities in capital markets or trading.
    • Positions in the market expose banks to adverse market movements, such as changes in bond prices and yields.
    • Banks use measures like DEAR and VaR to quantify their market risk exposure.
    • Market risk exposure can be offset by trading positions, including futures contracts.

    Operational Risk

    • Operational risk is the loss from errors, interruptions, or damages caused by people, systems, or processes.
    • Simple business operations like retail banking and asset management typically have lower operational risk.
    • Operational losses can arise from human error such as internal fraud.
    • External fraud, like hacking, can also lead to significant losses for banks.
    • Operational risks impact a bank's capital and customer trust.

    Fintech

    • Fintech refers to the use of technology to improve financial services.
    • Fintech encompasses a range of products, technologies, and business models, including cashless payments, crowdfunding, and virtual currencies.
    • It has significant implications for the financial services industry.

    Blockchain

    • Blockchain is a distributed ledger technology that records transactions across multiple computers.
    • Each block contains information about a transaction, which is linked to the previous block in a chain.
    • Features include:
      • Decentralization: Data is shared across a network, eliminating a single point of failure.
      • Immutability: Once a transaction is validated and added to the blockchain, it cannot be altered.
      • Security: The decentralized and encrypted nature of the technology makes it difficult to tamper with.
      • Transparency: All participants have access to the same information, promoting trust and reducing fraud.
      • Resilience: The decentralized network remains operational if a node fails.

    Banking Business Models

    • Better Bank: Incumbent banks digitize and modernize to retain customer relationships and core banking services.
    • New Bank: New technology-driven banks emerge, offering cost-effective and innovative services, requiring banking licenses.
    • Distributed Bank: Fragmentation of financial services with consumers using multiple providers, banks and fintech companies collaborate in joint ventures.
    • Relegated Bank: Fintech and bigtech companies dominate front-end customer platforms for various financial services, relegating incumbent banks to risk management and operational processes.
    • Disintermediated Bank: Incumbent banks become less relevant as balance sheet intermediation and trusted third parties are replaced by agile platforms and technologies.

    Bank Failures

    • Bank runs occur when depositors withdraw money en masse due to fears of bank failure.
    • Bank runs can deplete cash reserves and lead to bank defaults.
    • The 2008 financial crisis saw numerous bank failures, including Washington Mutual and Wachovia Bank, due to customer panic and withdrawals.

    Financial Contagion

    • Financial institutions are interconnected through lending, borrowing, and investments.
    • Financial difficulties at one bank can spread to others due to this connectedness.
    • Contagion is evident during credit bubbles and financial crises.
    • The collapse of Lehman Brothers triggered a domino effect, exposing systemic risks in the financial system.

    Banking Regulation and Intervention

    • The FDIC guarantees bank deposits up to a certain limit to instill confidence in the banking system.
    • The Bank Term Funding Program (BTFP) was introduced in 2023 to prevent financial contagion after the collapse of Silicon Valley Bank.

    Lessons from Bank Failures

    • Bank failures highlight the importance of sound risk management practices and regulatory supervision.
    • Overexposure to certain sectors, like real estate, can increase vulnerability to financial shocks.
    • The financial system's interconnectedness necessitates measures to mitigate contagion effects.
    • Understanding the interconnectedness of the banking system is crucial to prevent future crises and protect the economy.

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    Related Documents

    BEO3001 Session 1: Bank Risk Management PDF

    Description

    Explore the intricacies of risk management in banking, touching on various risks such as credit, market, and operational risks. Learn about risk treatment methods and the essential frameworks that help banks navigate today's financial landscape post-crisis. This quiz will enhance your understanding of how banks manage their risk exposure effectively.

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