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EAST AFRICA UNIVERSITY-GAROWE

BBA-SEMESTER-7

COURSE : MONEY & BANKING

GROUP ( 1) : PRESENTATION

GROUP MEMBERS:
1. MOHAMED QASIM OMAR
2. ABDIRAHAMAN ABDINUR ABDULLAHI
3. ABDDULLAHI ABDIRAZAQ ABDULLE
4. NASIIB ABDIQANI SULAYMAN
5. FARDOWSA OSMAN JAMA
6. MUNO ABDISALAM AW ALI
7. SAID ABDI BILE
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TOPIC : BANKS RISK MANAGEMENT

Introduction

The Great Depression spawned the most ambitious legislative program ever attempted
by the United States: The New Deal.
The New Deal created an environment where the federal government accepted
responsibility for a variety of issues originally left to individuals, states, and city
governments. This unprecedented increase in federal initiatives resulted in the
enactment of a myriad of bureaucratic agencies. These various agencies were all
denominated by their titles’ acronyms, creating notorious confusion around who was in
charge of what. This led U.S. citizens to use the term “alphabet soup” when describing
these regulatory bodies.

Alphabet soup has become a widely used metaphor to refer to an abundance of

incomprehensible language containing abbreviations. Most organizations that operate
today must adhere to the rules of various regulating bodies. Some industries, however,
are required to adhere to more than others – like the banking industry. Banks are highly
regulated in order to promote financial stability, foster competition, and protect
consumers. Due to the strictly monitored environment in which banks operate, it’s
critical that they have strategies in place to keep all their ducks in a row.

Risk management in banking main image

Risk management is an essential piece of banking operations. To demonstrate why, this

guide will provide an overview of risk management in banking, discuss specifically the
types of risk management in commercial banks, detail risk management practices in
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banks, go over the process of risk management in banks, and explain how to use
enterprise risk management software for banks.

Risk Management in Banking Overview

Just like any business, banks face a myriad of risks. However, given how important the
banking sector is and the government’s stake in keeping risks in check, the risks weigh
heavier than they do on most other industries. There are various types of risks that a
bank may face and is important to understand how banks manage risk.

Types of Risk Management

in Commercial Banks
Banking Risk Type

#1: Credit Risk

Credit risk, one of the biggest financial risks in banking, occurs when borrowers or
counterparties fail to meet their obligations. When calculating the involved credit risk,
lenders need to foresee and predict the possibility of them making back the loan,
principal, interest, and all.
Banks often lend out money. The chance that a loan recipient does not pay back that
money can be measured as credit risk. This can result in an interruption of cash flows,
increased costs for collection, and more.
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail
to meet contractual obligations. An example is when borrowers default on a principal or
interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed
income securities. Failure to meet obligational contracts can also occur in areas such as
derivatives and guarantees provided.

While banks cannot be fully protected from credit risk due to the nature of their
business model, they can lower their exposure in several ways. Since deterioration in an
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industry or issuer is often unpredictable, banks lower their exposure through

diversification.

By doing so, during a credit downturn, banks are less likely to be overexposed to a
category with large losses. To lower their risk exposure, they can loan money to people
with good credit histories, transact with high-quality counterparties, or own collateral to
back up the loans.

Banking Risk Type #2: Market Risk

Market risk mostly occurs from a bank’s activities in capital markets. It is due to the
unpredictability of equity markets, commodity prices, interest rates, and credit spreads.
Banks are more exposed if they are heavily involved in investing in capital markets or
sales and trading.

Commodity prices also play a role because a bank may be invested in companies that
produce commodities. As the value of the commodity changes, so does the value of the
company and the value of the investment. Changes in commodity prices are caused by
supply and demand shifts that are often hard to predict. So, to decrease market risk,
diversification of investments is important. Other ways banks reduce their investment
include hedging their investments with other, inversely related investments.

This refers to the risk of an investment decreasing in value as a result of market factors
(such as a recession). Sometimes this is referred to as “systematic risk.”

Banking Risk Type #3: Operational Risk

Operational risk is the risk of loss due to errors, interruptions, or damages caused by
people, systems, or processes. The operational type of risk is low for simple business
operations such as retail banking and asset management, and higher for operations
such as sales and trading. Losses that occur due to human error include internal fraud
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or mistakes made during transactions. An example is when a teller accidentally gives an

extra $50 bill to a customer.

On a larger scale, fraud can occur through breaching a bank’s cybersecurity. It allows
hackers to steal customer information and money from the bank, and blackmail the
institutions for additional money. In such a situation, banks lose capital and trust from
customers. Damage to the bank’s reputation can make it more difficult to attract
deposits or business in the future.

These are potential sources of losses that result from any sort of operational event; e.g.
poorly-trained employees, a technological breakdown, or theft of information.

Banking Risk Type #4: Reputational Risk

Let’s say a news story breaks about a bank having corruption in leadership. This may
damage their customer relationships, cause a drop in share price, give competitors an
advantage, and more.

Banking Risk Type #5: Liquidity Risk

Liquidity Risk Banks are also highly focused on the problems of having insufficient liquid
assets to compensate the cash needs or withdrawals from depositors and loan
demands. Usually, maintaining the liquidity positions of the banks is one of their crucial
tasks, because the consequences of having a low level of liquidity cause problems for
the banks in terms of banking insolvency. Solvency is related to the obligations that
banks are primarily giving promises to their customers. Faced with liquidity problems,
the banks need to borrow funds immediately with extra cost in order to meet their cash
needs. This kind of funding is usually done by the lender of last resort or interbank
markets. Immediate fund needs can be covered by the central banks or other sources,
but this process leads to additional costs for the banks
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With any financial institution, there is always the risk that they are unable to pay back
its liabilities in a timely manner because of unexpected claims or an obligation to sell
long-term assets at an undervalued price.

Risk Management Practices in Banks

Banks must prioritize risk management in order to stay on top (and ahead) of the
various critical risks they face every day. Risk management in banks also goes far
beyond compliance, as banks must be on the lookout for strategic, operational, price,
liquidity, and reputational risk. Staying on top of these risks demands a powerful and
flexible bank risk management program.

The number of individual regulatory changes that financial institutions and banks must
track on a global scale has more than tripled since 2011. There are millions of proposed
rules and enforcement actions across multiple jurisdictions that organizations must
follow. This requires regulatory change management to be a prominent practice within
any bank’s risk management program.

Regulatory change management can be described in the simplest terms as “managing

regulatory, policy and or procedures applicable to your organization for your industry.”
Regulatory compliance can be a burdensome and costly task for financial institutions, so
it is critical that organizations have the appropriate processes in place to identify
changes to existing regulations as well as new regulations that impact the ability of the
organization to achieve objectives. It is equally important that organizations are
informed of any potential consequences or fines should they not meet the regulation.

Once a regulatory change has been made, it is essential for organizations to assess how
they will implement the respective changes to their current policies, processes, and
training sessions. As changes are implemented, organizations should begin tracking
compliance with the updated regulation going forward.
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Risk Management Process in Banking Industry

Having a clear, formalized risk management plan brings additional visibility into
consideration. Standardizing risk management makes identifying systemic issues that
affect the entire bank simple. The ideal risk management plan for a bank serves as a
roadmap for improving performance by revealing key dependencies and control
effectiveness. With proper implementation of a plan, banks ultimately should be able to
better allocate time and resources towards what matters most.

Size, brand, market share, and many more characteristics all will prescribe a bank’s risk
management program. That being said, all plans should be standardized, meaningful,
and actionable. The same process for defining the steps within your risk management
plan can be applied across the board:

Risk Management Process in Banking Industry

Having a clear, formalized risk management plan brings additional visibility into
consideration. Standardizing risk management makes identifying systemic issues that
affect the entire bank simple. The ideal risk management plan for a bank serves as a
roadmap for improving performance by revealing key dependencies and control
effectiveness. With proper implementation of a plan, banks ultimately should be able to
better allocate time and resources towards what matters most.

Size, brand, market share, and many more characteristics all will prescribe a bank’s risk
management program. That being said, all plans should be standardized, meaningful,
and actionable. The same process for defining the steps within your risk management
plan can be applied across the board:
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Banks must create a risk identification process across the organization in order to
develop a meaningful risk management program. Note that it’s not enough to simply
identify what happened; the most effective risk identification techniques focus on root
cause. This allows for identification of systemic issues so that controls can be designed
to eliminate the cost and time of duplicate effort.

Assessment & Analysis Methodology

Assessing risk in a uniform fashion is the hallmark of a healthy risk management
system. It’s important to be able to collect and analyze data to determine the likelihood
of any given risk and subsequently prioritize remediation efforts.

Mitigate

Risk mitigation is defined as the process of reducing risk exposure and minimizing the
likelihood of an incident. Top risks and concerns need to be continually addressed to
ensure the bank is fully protected.

Monitor
Monitoring risk should be an ongoing and proactive process. It involves testing, metric
collection, and incidents remediation to certify that the controls are effective. It also
allows for addressing emerging trends to determine whether or not progress is being
made on various initiatives.

Connect
Creating relationships between risks, business units, mitigation activities, and more
paints a cohesive picture of the bank. This allows for recognition of upstream and
downstream dependencies, identification of systemic risks, and design of centralized
controls. Eliminating silos eliminates the chances of missing critical pieces of
information.
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Report
Presenting information about how the risk management program is going – in a clear
and engaging way – demonstrates effectiveness and can rally the support of various
stakeholders at the bank. Develop a risk report that centralizes information and gives a
dynamic view of the bank’s risk profile.

Refereces:
1. Risk management process in banking industry Tursoy, Turgut Near East Universit
2. Logic manager.com ( banks risk)
3. Investopedia.com
4. Corporatefinanceinstitute.coms