Risk Management For Banking Companies
Risk management is the process of assessing risk and developing strategies to manage the
risk. In ideal risk management, a prioritization process is followed whereby the risks with
the greatest loss and greatest probability of occurring are handled first.
In practice the process can be very difficult, and balancing between risks with high
probability of occurrence but lower loss & risks with high loss but lower probability of
occurrence can often be mishandled.
Financial firms face four common risks:
Market risk refers to possibility of incurring large losses from adverse changes in financial
asset prices, such as stock prices. Standard risk management involves use of statistical
models to forecast probabilities & magnitudes of large adverse price changes.
Credit risk is the risk that a firms borrowers will not repay their debt obligations in full.
The traditional method for managing credit risk is to establish credit limits at the level of
the individual borrower & industry sector. Quantitative models are increasingly used to
measure and manage credit risks.
Funding risk is the risk that a firm cannot obtain the funds necessary to meet its financial
obligations, for example short-term loan commitments. Three common techniques for
mitigating are: diversifying over funding sources, holding liquid assets, and establishing
contingency plans, such as backup lines of credit.
Operational risk is the risk of monetary loss resulting from inadequate or failed internal
processes, people, and systems.
A defining characteristic of commercial banking is extending credit to borrowers of all
