Risk Management in a Banking System
A risk is an essential part of our daily lives. Despite the complexity of this concept, we often and easily operate it in practice, describing a particular life situation. For us, a risk is primarily a possible profit or loss of something. Commercial activities, as well as any other activities related to the formulation and achievement of certain goals, include:
- situation analysis;
- strategy formulation;
- resource planning;
- organization of a process;
- measurement and evaluation of results;
- operational corrective strategic and tactical actions
The bank system is a risk system. A well-managed bank will have a system in place to identify this optional amount of risk and profit, and it will make sure that the bank’s risk does not differ and crash the whole banking system. Theoretically, this problem is simple: it should take any project that identifying it future value and future risks which are can be connected with this project, but in practice the banks problem is difficult because risk-taking decisions are made all over the bank, and each decision affects on the bank from the different positive and negative parts. As a result, risk decisions cannot be assessed in isolation but should be assessed in terms of their impact on the Bank’s overall risk.(Stulz,2014)1
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How it works
Overall there exists such as thing as Risk Appetite, “”risk appetite is the amount of risk, on a broad level, that an entity is willing to accept in pursuit of its mission “”(ISACA)2. In other words, risk appetite is an amount of risk for every company which is company ready to take according to its financial ability and lucidity of its risk. What does it mean in a bank system, it means that every bank in the world ready to take a risk.
The Basel Committee on Banking Supervision (BCBS) is the primary global standard setter for the different kinds of regulation of banks and provides a forum for regulator cooperation around the whole world. (BIS, 2018)3. What does it mean? Let’s think about this fact, that every country around the world has a constitution which is the main document for every country, according to the constitution we can create different laws and regulations. So, the BIS is a kind of World Bank constitution, which is created and controls the whole banks, bank politics and also the BIS controls kinds of risk which are banks can take.
Bank risk can be classified by the BIS (BIS,2011)4 on the following grounds, but not limited to: The degree of uncertainty – the sources of occurrence, the level of materiality (potential consequences, damage), the probability and at a sign of accounting in the calculation of capital adequacy.
At the stage of uncertainty – risks with partial uncertainty (which can be estimated and hedged) and full uncertainty – which are an impossible to standardize and effectively assess from a qualitative point of view. According to the sources of occurrence-internal (which the Bank can largely assess and control) on the level of potential consequences – moderate, increased, high, critical.
The readiness of the organization, risk-taking can vary from a complete unwillingness of the organization to risk until organization is ready to him. In practice, the extreme values are rare, each Bank is looking for a middle ground, using the concept of risk appetite. Excessive conservatism leads to the loss of potential income, excessive predisposition (take, for instance, “”Lehman Brothers Holdings Inc”” at 2008 and “”Washington Mutual, Inc”” at 2008) – can lead to disastrous consequences, up to the termination of activities.
Credit risk is the risk of losses due to untimely, incomplete fulfillment of financial obligations by debtors under the terms of the contract. Financial obligations include obligations on loans received, including interbank loans, bonds, other placed funds, a natural person, a legal entity or even the state can act as a debtor. Market risk – the risk of loss or loss of profit due to adverse changes in the market value of financial instruments, as well as exchange rates or precious metals.
Operational risk – the risk of losses as a result of the unreliability of internal procedures, dishonesty of employees, etc. Liquidity risks are risks expressed in the inability to Finance their activities, i.e. to ensure the growth of assets and fulfill obligations without incurring losses in amounts unacceptable for financial stability.
In the process of banking activities, banks constantly receive a set of uncertainties and risks, professional activities are complicated, new technologies are developed, new banking and financial products appear, therefore, without a developed risk management system, a well-thought-out policy of their management, it is impossible to exist both the banking system as a whole and a separate Bank in particular.