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Cool Times in risk management?

Introduction Any activity is associated with risk – a loss or gain. Financial risk management is not about avoiding risk. Rather, it is about understanding and communicating risk, so that risk can be taken more confidently and in a better way. (David Koenig, The Professional Risk Manager Handbook)

Risk management can be defined as an approach to dealing with risks and managing them. It deals with designing and implementing procedures that minimize the occurrence of loss. Actually it starts with identifying various risks associated with financial industry.

Risk in finance

A financial risk is a chance that an investment’s actual return will be different than original expected. Or all of the original investment.

A fundamental idea in finance is the relationship between risk and return. The greater the amount of risk that an investor is willing to take on, the greater the potential return. The reason for this is that investors need to be compensated to taking on additional risk.

Types of financial risk

Financial institutions provide important benefits through their various functions and they are: borrowing and lending, price determination, information aggregation and coordination, liquidity and efficiency Due to these multifarious functions, financial institutions encounter many risks in their operations and they can be categorized as under

– Credit risk

– Liquidity risk

– Interest rate risk

– Market risk

– Off balance sheet risk

– Foreign exchange risk

– Country risk

– Sovereign risk

– Technology risk

– Operational risk

– Insolvency risk

A note on risks

Credit risk

The risk that promised cash flows from loans and securities held by financial institutions may not be paid in full

Liquidity risk

The risk that a sudden and unexpected increase in liability withdrawals may require a financial institution to liquidate assets in a very short period of time and at low prices

Interest rate risk

The risk incurred by a financial institution when the maturities of its assets and liabilities are mismatched and interest rates are volatile

Market risk

The risk incurred in trading assets and liabilities due to changes in interest rates, exchange rates and other asset prices

Off balance sheet risk

The risk incurred by a financial institution as the result of its activities related to contingent assets and liabilities

Foreign exchange risk

The risk that exchange rate changes can affect the value of a financial institution’s assets and liabilities denominated in foreign currencies

Country risk

The risk that a foreign entity, private or sovereign, may be unwilling or unable to fulfill obligations for reasons beyond its control

Sovereign risk

The risk arising due to immunity enjoyed by the sovereign entity from legal and other recovery processes in which the lender has no legal recourse against the sovereign entity which fails to fulfill its obligations

Technology risk

The risk incurred by a financial institution when its technological investments do not produce anticipated cost savings

Operational risk

The risk that existing technology or support systems  may malfunction; that fraud may occur that impacts the financial institution’s activities; and / or external shocks such as hurricanes and floods occur

Insolvency risk

The risk that a financial institution may not have enough capital to offset a sudden decline in the value of its assets relative to its liabilities

How to recall various risks faced by financial institutions?

Just remember COOL TIMES

C – Credit Risk, Country risk (2)

O – Operational risk

O – Off balance sheet risk

L – Liquidity risk

T – Technology risk

I – Interest rate risk, insolvency risk (2)

M – Market risk

E – Exchange (foreign exchange) risk

S – Sovereign risk


Now that we are comfortable with identifying and recalling the various financial risks, our further tasks like measurement and management may not be difficult

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One Response to “Cool Times in risk management?”

  1. Arvindh Kumar
    December 30, 2011 at 5:07 am #

    Hats Off to you Dr Guru. Wonderful elucidation of the various risks faced by the banks.

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