2. Major Types of Risk

Question 1

What are the key risks faced by banks?

Answer 1

Credit, liquidity, operational, market & legal risks

Question 2

What isn’t credit risks?

Answer 2

• risk of loss arising from the default of a counterparty — failure to pay when payment is due.
• can also occur when there’s a potential for change in the credit quality of the counterparty, viewed as becoming likely to default — counterparty risk

Question 3

What is liquidity risk and what are the types of liquidity risks?

Answer 3

Banks deal with funds in very large quantities and size. The ability to transact large amounts of funds or instruments is dependent on the liquidity of the market in which the bank operates in. As such, liquidity risk is another key risk for banks. In fact, due to the deliberate maturity mismatch of assets and liabilities in a typical bank’s balance sheet it can be said that a bank can afford to suffer losses, but it can never be in a position where it has no access to liquidity.

Question 4

What are the types of liquidity risks?

Answer 4

1. Market liquidity risk/trading liquidity risk—the risk of loss arising from the inability
   to trade certain instruments owing to the absence of counterparties, lack of market depth or sudden market disruptions. The impact includes widening bid-ask spreads, thin trading volumes and market price that moves in large and sudden jumps (price gapping).
2. Funding liquidity risk—the risk of loss arising from the inability to access cash or to obtain funding when needed (e.g. when liabilities are due). This includes the inability to refinance obligations (“roll over”) at reasonable rates.