Banking Risk Management

1. Introduction

In this paper we will try to introduce the complex universe of banking risks. Banks play a central role in the economy due to the fact that they guard the savings of the population, they offer means of payment for goods and services and they finance businesses.

For fulfilling all these functions in a safe and efficient way, banks have to benefit of the entire confidence of the population. The stability of the banking system represents a problem of general public interest but it can be done without an adequate management of the risks that banks confront themselves.

2. Banking risk definition

Banks and other lending institutions must constantly balance risks and rewards. Too high a price on loan products, and you lose the customer; too low, and you starve the profit margin or take a loss. Too much capital on reserve, and you miss investment revenue; too little, and you risk regulatory noncompliance and financial instability.

When every department, line of business and region measures and reports risks differently – with disparate risk management systems – it can be difficult to exactly measure overall risk exposure and strike the right balance.

Between all the groups of risk exists a permanent interaction because they express different aspects of the same potential risk- current banking operations. So, for example, a real excessive exposition at the crediting risk may generate the liquidity risk if the bank does not have sufficient liquid assets needed to fulfil its falling due obligations without the help of the sums resulted from the reimbursement of the credit received by the client. The risk of liquidity, at its turn, can generate the bankruptcy risk if the bank is not able to procure fast its adverse resources. More than that, in the banking system, the problems that a bank confronts itself can affect negatively other partner banks (that are creditors to her) so that it there is a permanent danger of contagiousness. This risk is called systematic risk and is administration is done by the central bank. This does not mean that each bank should not follow in permanence the solvency of its partners by using all the information that it has.

3. Classification of banking risk according to

the banking characteristics

The carrying out risks is associated to the operation from the sphere of financial services. The following types are comprised here:

3.1 The operational risk or the task risk, expresses the probability that the bank can become incapable of assuring services for the clients in a profitable way. In this context are important not only the offer of services but also the capacity of the top management to evaluate and control the expenses generated by the carrying out of these services;

3.2 The technological risk that is associated to the quality and structure of the financial products offer which have an own cycle of life and tend to be replaced by better services. The incorrect decision of launching on the market a product or of introducing a new one can generate significant losses and there exists the risk that the moment chosen is not the most adequate from the point of view of maximizing the banking profit;

3.3 The risk of the new product is associated to the innovations from the sphere of the financial products. It expresses the cumulated probability that more adverse events taking place, as : the demand is under the level anticipated, exceeding the planed level of specific costs, the lack of professionalism of the managerial team, etc ;

3.4 The strategic risk expresses the probability of not choosing the proper strategy in the given conditions. It is inherent to any selection of markets, products and geographical zones that are implied in defining the strategy of the bank in a complex environment.

3.5 The group of the environment risk comprises a class of risks with powerful possible impact over the banking performance, but over which the bank has, in the best scenario, a limited control. These risks express the probability that an adverse change of the environment to affect negatively the profit of the bank:

3.6 The fraud risk is an internal risk that we have still included in this group due to the fact that for a bank, seen as an entity, documents and especially the employee’s intentions represent an external variable hard to control. The fraud risk is an internal risk that expresses, actually, the probability of committing thefts or other acts contrary to the interests of the bank by the banks employees. Frauds can affect the profitableness of the bank when they can not be detected or recuperated;

3.7 The economic risk is associated to the evolution of the economic environment in which the bank and its employees act. It can be manifested at the local, regional, national or international level. It expresses the probability of diminishing the performance of the bank as a consequence of an adverse evolution of the environment conditions. These influence the quality of the placements, the volatility of the resources and the potential of risk;