Week 8: Banking Risks Flashcards
What is Bank Risk Management?
- Identification of risk:
- identify risks as the results of the uncertainty from specific risk factors.
- measurement of risk:
Given an identified risk, risk measures will try to assess
- Expected losses
- unexpected losses
- Management of risk
- Given an identified risk and the exposure to this risk the management will how much risk the bank should take according to the banks appetite.
Name some Common banking risks.
- Credit risks
- Market Risks
- Interest rate risk
- Liquidity risk
- Foreign exchange risk
- Country and sovereign risk
- Operational risk
What is credit risk?
The potential that a counterparty will fail to meet its obligations in accordance with agreed terms
The source of the risk is the deterioration of the creditworthiness of the borrower.
What is Market risk?
The risk of losses in on and off balance sheet positions arising from movements in market prices.
What is Interest rate risk? What are the two types of interest rate risks? And what are the sources ?
The risk that unexpected changes in interest rates affect the banks performance.
The source of the risk is:
- mismatch between fixed rate assets and liabilities
- rate sensitive assets and liabilities.
Two types of interest rate risks:
- Refinancing risk
- reinvestment risk
What is Liquidity risk?
Generated by the mismatch in the size and maturity between the assets and the liabilities.
The risk that the bank doesn’t have sufficient liquid assets to meet requirements without impairments to its financial or reputational capital
What is foreign exchange risk?
The risk that interest rate fluctuations affect the value of a banks asset, liabilities and off balance sheet activities.
What is Country and sovereign risk?
Country risk: Risk that economic, social and political conditions of a foreign country will adversely affect a banks commercial and financial interests.
Sovereign risk: possibility governments will default on debt owned by a bank.
What is operational risk
The risk resulting from inadequate or failed internal processes.
What are some Risk Management Strategies?
Risk decomposition:
Identify risks one by one and handle each of them separately.
Risk aggregation:
Reduce risks by being well diversified.
How is credit risk managed?
Credit risk is managed using risk aggregation one of the ways to do that is by diversification.
How is risk decomposition implemented?
The trading room is organised so that a trade is responsible for trades related to just one market variable or a small group of market variables.
How is risk aggregation implemented?
Risk managers will implement risk aggregation approach which means calculating the market risk the traders have taken at the end of each day from the movements in all the market variables.
What can be done to maximise the benefits if diversification?
Borrowers should be in different geographical areas and industries however diversified banks are still exposed to systemic risks.
What are some risk mitigation techniques ?
Gaurantees: to reduce the “loss given default” in the banking book;
Derivatives: to implement hedging strategy and reduce volatility of earnings
Insurance policies: to remove the exposure to unwanted risks
