Banks can minimize risks across its verticals by deploying a robust risk management strategy.
FREMONT, CA: The banking sector is inherently a risk-prone industry. The financial risks can range across credit, operational, market, and liquidity aspects. The financial institutes need a well-structured risk management infrastructure to counter the risks and streamline its processes. Investors are significantly influenced by the ability of a bank to counter risks. Further, a bank without a proper risk management system will experience lower profits due to the losses on loans. Here are the four risk-prone aspects in the banking sector, along with the strategies to counter them.
Credit Risk Management
Credit risk refers to the borrower’s inability to meet contractual obligations corresponding to the bank. For instance, a borrower can default on a principal payment of a loan. Defaults can also occur from credit cards, mortgages, and fixed income securities.
Banks can minimize credit risks by lowering exposure in several ways. For instance, it's a fact that any industry can be suddenly affected by market conditions. Diversification enables the bank to distribute the risk factor across several industries. Thus, a credit downturn related to a particular industry can be compensated by diversified credit returns from other industries.
Operational Risk Management
Operational risks refer to the potential losses resulting from interruptions or inadequate systems, workforce, or processes. While the operational risk is low for retail banking and asset management, risks are higher for operations such as trading and sales. Banks are also under constant risk resulting from internal fraud or a cyber attack. For instance, an attacker might hack into the bank’s database and steal customers’ data. The hacker may demand exorbitant amounts of money from the bank. Such an incident not only causes loss of capital for the banks but also results in irreparable damage to its reputation. Operational risks can be minimized by incorporating technology and streamlining the processes to meet modern security challenges.
Liquidity Risk Management
Liquidity risk is a serious threat that refers to a bank's inability to access cash for funding purposes. Further, liquidity problems can result in a snowball effect. For instance, if a bank procrastinates providing cash to the customers, it can result in customers losing trust in the bank. The customers will rush to take their deposits, creating further pressure on the bank. Liquidity risk can be countered by ensuring enough cash to survive even when there is a sufficiently large number of customers wishing to take out their deposits.
Realizing the potential of the risks and adhering to the above risk management strategies will assist the banks in actualizing risk management.
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