1.4 Risk

Question 1

Risk

Answer 1

Potential failure and losses

Question 2

Pure risk

Answer 2

Pure risk - only has a downside

Question 3

Speculative risk

Answer 3

Both downside and upside

Question 4

Difference between risk and uncertainty

Answer 4

Risk can be measured based on past experiences

Uncertainty (more unknown/ can’t be predicted)

Question 5

Bank can manage the exposure of risk by

Answer 5

Identifying, accessing and monitoring the likelihood and consequences of events that leads to bad outcomes for banks, customers and stakeholders.

Question 6

Key questions a bank must ask and answer:

Answer 6

1. How much risk is the bank comfortable with?
2. What may prevent the bank from achieving a return?
3. How can risk and reward be assessed and managed?
4. Consequences of failing to achieve the expected return?

Question 7

Risk appetite

Answer 7

How much risk it is prepared to take in meeting its strategic objectives

Integrated into business plans and monitored by banks

Question 8

Risk tolerance

Answer 8

Level os risk that the bank can absorb with its available resources

Question 9

Banks stakeholders

Answer 9

Customers
Employees
Financial sector
Economy
Society
Environment

(Must act with due diligence the bank)

Question 10

Types of risk

Answer 10

Fiancial
Legal
Reputational
Overarching

Question 11

FINANCIAL RISK

Answer 11

1. Credit risk
2. Liquidity risk
3. Concentration risk
4. Market risk
5. Strategic risk
6. Operational risk

Question 12

Credit risk

Answer 12

Borrowers/ other debtors fail to repay all or some part of their loan (including interest)

Lending money is a main function of bank

• unpaid debts = less profit, reduce liquidity

Question 13

Liquidity risk

Answer 13

Bank might become unable to meet its payment obligations

If it can’t satisfy depositors demand for cash then it will weaken the trust in the financial system

Question 14

Concentration risk

Answer 14

Faced by a bank which is not well diversified in lending and investments

Question 15

Market risk

Answer 15

= increase of loss from movement in prices in the financial market

Question 16

2 types of market risk

Answer 16

1. Interest risk rate = movement in interest rates affects the interest a bank pays out on it depositors and receive from its loans.
2. Foreign exchange risk = changes in currency exchange rate can affect the returns that international banks expect.

Question 17

Strategic risk

Answer 17

= arise from banks long term business strategy
Banks must try to to align their strategies with current/expected financial trends.
Can be impacted by macroeconomic conditions irrespective of unexpected events.

Question 18

Operational risk

Answer 18

= risk of loss due to failed internal processes, people and systems or from external events.

Cybercrime - can result in loss of data, intellectual property or customers financial details
Can get regulatory fines and reputational loss

Question 19

LEGAL RISK

Answer 19

1. Litigation risk
2. Regulatory risk
3. Compliance risk
4. Conduct risk

Question 20

Litigation risk

Answer 20

Risk that an individual or organisation will make a legal claim against the bank in a civil court
Also risk of a criminal charge if a bank contravenes a law

Question 21

Regulatory risk

Answer 21

Risk that changes in financial regulations which result in increased compliance costs for a bank.

Tighter regulation = restricts banks operation + reduce its profitability

Question 22

Compliance risk

Answer 22

Related to the risk of sanctions in the case of non-compliance with laws and regulations

E.g. paying fines and penalties

Question 23

Conduct risk

Answer 23

Bank will fail to behave in accordance with its stated objectives and responsibility to its customers.

It is closely connected to the other legal risks.

Question 24

REPUTATIONAL RISK

Answer 24

Threat to the good name or standing of an organisation

Social media use - bad reputations can develop quickly.

Results from actions and conduct of the company

E.g. financial crisis 2007-0&

Question 25

OVERARCHING RISK

Answer 25

Two overarching risk:

1. Systemic risk
2. Climate risk

Question 26

Systemic risk

Answer 26

Failure in one part of a system will spread to the whole system.

The fact that banks lend to each other and each bank holds the assets/liabilities of other banks on its balance sheet.

Example was Silicon Valley Bank (SVB) in March 2023 but HSBC brought the bank and took on its bad debts

Question 27

Four top long term global risks in 2023

Answer 27

1. Failure to mitigate climate change
2. Failure to adapt to climate change
3. Natural disasters and extreme weather events
4. Biodiversity loss and ecosystem collapse

Question 28

Climate risk has two further risk types:

Answer 28

1. Physical risk
2. Transition risk

Question 29

Physical risk

Answer 29

Arises from the direct impacts of climate related and environmental hazards.

E.g. storms/ floods and banks will face credit risk.
Insurers will have to make large compensation payments

Question 30

Transition risk

Answer 30

Arises from the transition to a low carbon economy

E.g. banks may hold shares and bonds in fossil fuel companies and these assets will increasingly lose value as people turn to renewable energy