MANAGEMENT OF BANKS

CIA -3

ARTICLE SUBMISSION

TOPIC: RISKS FACED BY BANKS

A PROJECT REPORT

SUBMITTED BY:

MEERA JOSHY (1927436)

SUBMITTED ON:

4 MARCH 2020

SUBMITTED TO:

DR.P.SREELAKSHMI

INSTITUTE OF MANAGEMENT,

KENGERI CAMPUS, KUMBALGODU

BANGALORE-560060
 Risks faced by banks
It's often said that profit is a risk-bearing reward. That is truer nowhere than in the banking
industry. Banks are exposed to many different kinds of risks, literally. A good banker is one
that can reduce those risks and regularly produce positive returns for shareholders. Risk
mitigation starts with first accurate recognition of the threats, why they occur and what harm
they can cause. In this article we listed the major types of risks every bank faces. The following
are:
Operational Risks:
Banks must carry out large-scale operations in order to be profitable. The economies of scale
work for the benefit of larger banks. It is therefore extremely difficult to maintain consistent
internal processes on such a large scale.
Operational risk arises as a result of the failure of the bank's day-to-day business processes.
Examples of operational risk would include payments credited to the wrong account or
incorrect order while trading on the markets. None of the banking departments are immune
from operational risks.
Main operational risk example in India was that ₹ 11400 crore fraud in the Punjab National
Bank.The well known fraud of Punjab National Bank has brought attention to how banks
manage operational risk. Due to complete failure of the banks audit process some culprits used
to continue there as usual business transactions without being noticed at any point.The main
reasons for the Punjab National Bank fraud was that failure of internal audit process,no tranfer
of employees and involvement of few employees with the clients could take control of such
large amounts of such large amounts of money for a long time.
Operational risks exist mainly due to the recruiting of wrong people or, potentially, they could
also occur if information technology systems are broken down. Lapses in the internal processes
that are being followed could also lead to catastrophic errors. For example, Barings Bank has
ended up bankrupt due to its failure to implement effective internal controls. One trader was
able to bet so much on the derivatives market that Barings Bank's equity had been wiped out
and the bank had literally ceased to exist.
Credit Risks:
Credit risk is the risk that results from the probability of non-payment by borrowers of loans.
While credit risk is largely defined as the risk of non-payment, banks also include the risk of
delayed payments in this category.
Often these cash flow threats are triggered by the creditor being insolvent. This risk can
therefore be minimized if the bank performs a thorough check and penalizes loans only to
individuals and businesses that are unlikely to be out of profits for the duration of the loan.
Credit rating agencies shall provide adequate information to allow banks to make informed
decisions in this regard.
The profitability of the bank is extremely sensitive to credit risk. Thus, even if the credit risk
increases by a small amount, the profitability of the bank can be highly affected. Therefore, the
banks have come up with a wide range of measures to deal with such threats. For example,
banks often keep a certain amount of funds in reserve to reduce these risks.
A certain amount of money is added to the payment account at the time the loan is made. Banks
have also started to use methods such as structured finance to minimize these risks.
Securitization helps to remove the concentrated risk from the bank's books and distribute it
among the different investors in the capital markets. Credit derivatives such as credit default
swap have also come into existence to help banks avoid a credit default.
Unpaid loans have been, are and will always be a by-product of the conduct of banking
business. Modern banks have understood this and are prepared to deal with the situation
without becoming insolvent until a catastrophic loss occurs.
Most of the banks in India face credit risk but one main example of credit risk in India is Punjab
National Bank.
Market Risks:
In addition to investing, banks still hold a significant portion of securities. Some of these
securities are kept on account of the bank's treasury activities, i.e. as a way of storing money
for the short term. Nevertheless, several securities are also held as collateral on the basis of
which banks have issued loans to their customers. The banking business is therefore
intertwined with the capital market business.
Banks face business risks in a variety of ways. For example, if they hold a large amount of
equity, they are exposed to equity risk. Banks must also, by necessity, retain foreign exchange
exposure to Forex risks.
In order to be able to minimize these risks, banks actually use hedge contracts. We use financial
derivatives that are freely available for sale on any financial market. Through forward
contracts, options and swaps, banks are able to almost remove market risks from their balance
sheet.
Liquidity risk:
Liquidity risk is another form of risk inherent in the banking business. Liquidity risk is the risk
that the bank will not be able to fulfill its obligations if the depositors come in to withdraw their
money. This risk is inherent in the system of fractional reserve banking. Accordingly, in this
scheme, only a fraction of the deposits earned are held back as reserves, while the remainder
are used to build loans. Therefore, if all the depositors of the company had come in to withdraw
their money at once, the bank would not have had enough money. The situation is called a bank
run. This has occurred numerous times in the history of modern banking.
Modern-day banks are not very concerned about liquidity risk. It's because they've got the
support of the central bank. In the case of a bank being closed, the central bank diverts all its
money to the bank concerned. Depositors can therefore be repaid when they inquire for their
deposits. This restores the confidence of the depositor in the finances of the banks and stops
the bank from running.
Many of today's banks have been hit with bank runs. Nevertheless, none of them became
insolvent due to the establishment of central banks by the government.
Reputation risk:
When risk arising from negative public opinion due to big fraud or scam and inability of the
banks to control operational risk.When there is no repayment of loan,large debt and there is
rising NPAs then these all lead to reputational risk.All of these case creates a negative image
of the banks.This negative image led to damage to the reputation of the bank.
In short, credit loss and business loss both together will lead to the reputation loss for
banks.This reputation loss is called as reputation risk.In India main example of reputation risk
is that case in which Videocon group gets ₹ 3250 crore loans from ICICI bank.In this case in
2017 the ICICI bank classified this loan as an NPA and the current outstanding is ₹ 2810 crore.
With the large amount involved the reputation of the bank is at stake.
Systemic risk:
Systemic risk exists because the financial system is one complex and interconnected network.
Therefore, the failure of one bank also has the possibility of causing the failure of many other
banks. This is because banks are counterparties to one another in a number of transactions.
Thus, if one bank fails, the other banks ' credit risk event becomes a reality.
As a result of the loss of their counterparty, they have to write off certain properties. This write-
off also leads to the collapse of other banks, and an irresistible domino seems to take over.
Systemic risk is a very bad scenario.For example, when the subprime crisis erupted in 2008,
the entire global financial system appeared to collapse.
Consequently, the very existence of the financial system makes them vulnerable to systemic
risks. Systemic risks do not affect the individual bank, but they affect the whole system. There
is therefore very little that an individual bank can do to defend itself in the event that such a
danger materializes.
Thus, we can say that bank management therefore requires a great deal of expertise, as several
types of risks need to be mitigated. Some of these risks can be avoided, while the best that
banks can do for others is to mitigate their harm.
 References

• https://gradeup.co/types-of-risk-in-banks-i-8337fe50-3a36-11e8-aa45-621c42c83b4f
• https://www.managementstudyguide.com/risks-faced-by-banks.htm
• https://www.business-standard.com/about/what-is-pnb-scam
• https://corporatefinanceinstitute.com/resources/knowledge/finance/major-risks-for-banks/
• https://marketrealist.com/2019/10/bank-risks-everything-you-need-to-know/