No matter the country, the banking sectors play a crucial role in managing the economy. One must, hence, know about the risks associated with the banking sector, and how the process of risk management planning can help you face an unavoidable situation or help you understand what risk management is, and types of risk management for the Indian Banking Sector.
Before we begin, let’s first understand what the risk management process is.
The risk management planning meaning is quite simple, it refers to ‘a situation where an unexpected occurrence of a particular outcome is established or better quantifiable and thus insurable.’ A risk can be described as an unplanned occurrence, resulting in loss or reduced earnings with financial consequences.
Due to the ambiguity or unpredictability of the trade operation in the future, a process that can provide benefits or result in loss can be considered a risky proposition. It can be defined further as the uncertainty of the result. The risk management process is a multi-layered procedure where accuracy and precision over risk controls is the game-changer.
Since risk is directly proportional to the return, there are more chances of facing operational risk in banks, the more money it may expect to make. The method of recognition, assessment, and control is known as the risk management process. But risks differ for different sectors, apart from those risks that are prevalent for all businesses and organizations.
As generally referred to, the significant risks in the banking industry can be narrowly divided into:
Let’s understand the different types of risk management or types of risk in banking in detail.
The Bank liquidity risk management planning process safeguards the funding of long-term assets by short-term liabilities during the project risk management process, thereby subjecting the liabilities to rollover or refinancing.
The liquidity risk in banks demonstrate in various aspects -
Interest-rate risk occurs when interest rate adjustments influence an institution’s Net Interest Margin or Market Value of Equity (MVE).
IRR can be interpreted in two ways - its impact is on the Bank’s earnings or its effect on the Bank’s asset, liability, and off-balance sheet (OBS) positions’ economic value.
The risk management process of adverse deviations of the trading portfolio’s mark-to-market value due to market fluctuations is referred to as a market risk during the time needed to liquidate the transactions. It is the product of adverse fluctuations in the degree of volatility of interest rate instruments, equities, commodities, and currencies at market rates. It is also known as Price Risk.
The term Market risk refers to:
Forex risk is the risk that, as a result of adverse exchange rate changes, a bank can suffer losses during a time when it has an open position in an individual foreign currency, either spot or forward, or a combination of the two.
Market liquidity risk occurs when a bank is not able to conclude a significant trade in a given instrument close to the current market price.
Credit risk is defined more specifically as the capacity of a bank borrower or counterparty to fail to fulfill its obligations under the agreed terms. Loans for most banks are the primary and most obvious source of credit risk. It is the most critical danger in the Indian scenario, where the NPA level of the banking system is considerably high.
Now, let’s consider the two variations of credit risk –
Credit risk is dependent on both external and internal factors.
Internal factors of the risk management process for banking sectors include deficiency in credit policy and loan portfolio management, deficiency in evaluating the financial condition of the borrower before lending, undue reliance on collateral, and failure of the Bank in post-sanction follow-up, etc.
External factors of the project risk management planning process for banking sectors are the state of the economy, oil price fluctuations, foreign exchange rates, and interest rates, and so on. Credit risk cannot be minimized but can be mitigated by the implementation of various risk reduction processes.
Banks should determine the borrower’s creditworthiness before sanctioning the loan, i.e., the borrower’s credit rating should be done in advance. Credit rating is the critical instrument for credit risk assessment and also promotes the pricing of the loan.
Banks can reduce their credit risk by implementing a routine assessment and rating scheme to all investment opportunities since they can gain critical details on the inherent vulnerabilities of the account.
Banks should set prudential limits on different dimensions of credit – Current Ratio benchmarking, Debt-Equity Ratio, Debt Service Coverage Ratio, Profitability Ratio, etc.
Single/group borrowers should have a maximum exposure limit. Flexibility should be given to allow for adjustments for very different circumstances. Operating staff’s alertness at all levels of credit dispensation – evaluation, disbursement, review/renewal, post-sanction follow-up can also be useful in preventing credit risk.
The Basel Committee for Banking Supervision has described the operational risk of the risk of loss arising from insufficient or failed internal processes, individuals, and systems or external events. The operational project risk management planning process has become relevant for banks because of the following reasons –
Here are two of the most popular operating threats:
In reality, apart from these types of risk in banking the Risk Management process is a combination of uncertainty, risk, equivocality, and error management. Uncertainty – where the results cannot be calculated even arbitrarily, occurs due to a lack of knowledge. This uncertainty is converted into risk (where outcome prediction is possible) as the collection of information advances.
Initially, the Indian banks have used risk controls that kept pace with the legal environment and Indian accounting standards. But with the growing rate of deregulation and associated changes in the customer’s behavior, banks are exposed to mark-to-market accounting.
Therefore, the challenge for Indian banks is to create a coherent risk management process and system that stays consistent with corporate objectives and sensitive to market developments. Since the market is competitive, banks should keep a watchful eye on the country’s integration of regulatory systems, shifts in international accounting standards, and, eventually and most critically, changes in the business practices of clients.
TRC Corporate Consulting facilitates and supports your organization to turn operational challenges into growth possibilities that enable sustainability and generates long-term gains. Our risk management process innovates the competencies of conventional project risk management techniques and risk controls to deliver practical solutions for your business.
At TRC, our risk management process experts offer the following:
Businesses partner with TRC Corporate Consulting to devise and implement risk management process and risk controls for the following:
Our tested and proven risk management planning process can help you achieve a competitive advantage and deliver sustainable business growth. For any questions related to our risk management services, contact us!
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