Q. What are the major risks for the Banks? Explain in detail.

Ans.:

Risk refers to the uncertainties which could result into unfavorable outcomes. Risk
materialization could have an adverse effect on the bank’s financial health, reputation etc.

Risk is defined in financial terms as the chance that an outcome or investment's actual gains will
differ from an expected outcome or return.

Risk includes the possibility of losing some or all of an original investment.

Banks are subjected to various kinds of risks, as given below:

1. Credit Risk: It arises from deterioration in the credit quality of the borrower. It occurs
when contractual obligations are not met by the counterparties
It is further divided into:
 Transaction Risk:
a) Default Risk
b) Credit Spread or Downgrade Risk

 Portfolio Risk:
a) Systematic or Intrinsic Risk
b) Concentration Risk
c) Guarantees or Letter of Credit Risk
d) Country Risk:

Market Risk: The Basel Committee on Banking Supervision defines market risk as
the risk of losses in on-balance or off-balance sheet positions that arise from movement in
market prices. Banking books are not subjected to Market Risk; however trading books are
exposed to the same. Therefore, it refers to adverse impact caused by the market variables on
the trading portfolio of the banks. It is further divided into:
A) Price Risk
B) Foreign Exchange Risk
C) Asset Liquidity Risk
D) Market Liquidity Risk

1. Operational Risk: It is caused due to breakdown in internal control, people and systems
or from external events.

According to 3rd Consultative Paper, these have been categorized based on the events:
 a) Internal Fraud
b) External Fraud
c) Employment Practices and workplace Safety
d) Clients, Products and business practices
e) Damages to physical assets
f) Business disruption and system failures
g) Execution delivery and process management.

2. Liquidity Risk: It arises due to Asset-Liability mismatch, that is, when long term assets
have been funded by short-term liabilities. So, it refers to the inability of the banks to
obtain funds to meet cash flow obligations at a reasonable rate.
a) Funding Risk
b) Time Risk
c) Call Risk

3. Interest Rate Risk: It refers to the adverse impact caused by the movements in interest
rates. It impacts earnings of the bank and decreases economic value of the assets.

4. Exit Strategy Risk

5. Reputational Risk