Bank Risk Management
Need for Bank Risk Management
Repeated financial disasters faced by financial, non-financial and government bodies have created the need for bank risk management policies.
Apart from regulatory requirements, bank risk management is needed by the bank managers for the following reasons:
- Creation of benchmarks for calculation of reward-risk ratios. Investment of capital is then directed to options with high reward risk ratios.
- Estimation of the probable losses. This leads to wise risk taking decision by investors as the risk monitoring part is already put in place. Banks also learn to handle their available liquidity well.
The risks encountered in Bank Risk Management
- Performance risk-This occurs in case where employees are not properly monitored.
- Credit risk-Sometimes the associates are unable to honor their payment obligations. This leads to a change in the net value of assets of the bank
- Operational risk-This arises due to the failure of banks to properly execute their various operational procedures. Untimely collection of revenues, inability in meeting the set guidelines and the like fall in this category.
- Market risk-Change in market conditions leads to change in the net asset value of banks. The factors here are mostly changes in prices of finished products, fluctuation in exchange rates, equity rates change as also oscillating interest rates
Characteristics of Bank Risk Management Policies
One of the characteristics of bank risk management policies is that it needs to be updated on a regular basis. Banks that are involved in trading go in for
- Intra day risk management on selective areas
- Regular measurement of the overall risks faced by the bank
Regulators are however, more interested at knowing the overall risks as compared to the individual portfolio items. Another characteristic of bank risk management policy is that it is usually not carried out in a decentralized fashion. The economic theory of risk management states that the risk of a particular portfolio is usually not determined by a simple addition of the component risks.
Bank risk management policies despite their worthiness are resource intensive. They demand considerable time and money. But violation of prescribed regulations in the capital market attracts heavy penalty. So managers do a cost benefit analysis whenever portfolio composition changes.
Types of risk measurement approaches
- Value at risk analysis: Here we use the distribution on asset return for the purpose of estimation.
- Scenario analysis: A prediction is made regarding the change in the value of a portfolio. The resultant estimated figure is the estimated loss. A detailed analysis of the types of risk measurement approaches entails description of intricate analytical methods, avoided here.