1.4 Risk Flashcards
Risk
Potential failure and losses
Pure risk
Pure risk - only has a downside
Speculative risk
Both downside and upside
Difference between risk and uncertainty
Risk can be measured based on past experiences
Uncertainty (more unknown/ can’t be predicted)
Bank can manage the exposure of risk by
Identifying, accessing and monitoring the likelihood and consequences of events that leads to bad outcomes for banks, customers and stakeholders.
Key questions a bank must ask and answer:
- How much risk is the bank comfortable with?
- What may prevent the bank from achieving a return?
- How can risk and reward be assessed and managed?
- Consequences of failing to achieve the expected return?
Risk appetite
How much risk it is prepared to take in meeting its strategic objectives
Integrated into business plans and monitored by banks
Risk tolerance
Level os risk that the bank can absorb with its available resources
Banks stakeholders
Customers
Employees
Financial sector
Economy
Society
Environment
(Must act with due diligence the bank)
Types of risk
Fiancial
Legal
Reputational
Overarching
FINANCIAL RISK
- Credit risk
- Liquidity risk
- Concentration risk
- Market risk
- Strategic risk
- Operational risk
Credit risk
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
Liquidity risk
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
Concentration risk
Faced by a bank which is not well diversified in lending and investments
Market risk
= increase of loss from movement in prices in the financial market
2 types of market risk
- Interest risk rate = movement in interest rates affects the interest a bank pays out on it depositors and receive from its loans.
- Foreign exchange risk = changes in currency exchange rate can affect the returns that international banks expect.
Strategic risk
= 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.
Operational risk
= 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
LEGAL RISK
- Litigation risk
- Regulatory risk
- Compliance risk
- Conduct risk
Litigation risk
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
Regulatory risk
Risk that changes in financial regulations which result in increased compliance costs for a bank.
Tighter regulation = restricts banks operation + reduce its profitability
Compliance risk
Related to the risk of sanctions in the case of non-compliance with laws and regulations
E.g. paying fines and penalties
Conduct risk
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.
REPUTATIONAL RISK
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&
OVERARCHING RISK
Two overarching risk:
- Systemic risk
- Climate risk
Systemic risk
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
Four top long term global risks in 2023
- Failure to mitigate climate change
- Failure to adapt to climate change
- Natural disasters and extreme weather events
- Biodiversity loss and ecosystem collapse
Climate risk has two further risk types:
- Physical risk
- Transition risk
Physical risk
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
Transition risk
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
