Types of Banking Risks
Financial risks represent one of the most critical types of risks that hold significant importance for any business. Given the vital role of banks, it is essential to understand and address these risks. Any action or endeavor that results in a loss can be categorized as a risk. The challenges that banking institutions face and need to overcome are outlined as follows:
Market Risks
Market risks arise from fluctuations and changes in the capital market. These risks denote the losses incurred by a company as a direct result of market volatility, particularly concerning stock and interest rate movements.
Credit Risks
Credit risks are among the most significant challenges faced by companies. They occur when an individual or entity fails to meet their contractual obligations to counterparties. Credit risks can be further classified into sovereign risks, which stem from difficult foreign exchange policies, and settlement risks, which arise when one party fulfills their payment while the other fails to meet their obligations.
Liquidity Risks
This type of risk stems from an organization’s inability to execute transactions and issues related to insufficient access to financial liquidity. Liquidity risks are generally categorized into asset liquidity risks, which occur when a bank cannot settle its obligations when they come due, and funding liquidity risks, arising from a lack of buyers or sellers corresponding to buy and sell orders.
Operational Risks
Operational risks pertain to failures within operational processes, such as poor management, technical failures, or internal operational breakdowns. These risks can be further segmented into fraud risks and model risks, where fraud risks arise due to inadequate controls, and model risks occur from the application of incorrect models.
Legal Risks
This type of financial risk emerges from legal constraints, such as lawsuits. These risks manifest when a company faces financial losses due to legal proceedings, thereby impacting its operations and constituting a legal risk.
Business Risks
Business risks threaten a company’s ability to achieve its goals. While an organization aims to maximize shareholder value, business risks can lead to decreased profit margins.
Non-Business Risks
Non-business risks are considered external risks beyond a company’s control. These refer to investment risks arising from external factors such as political and economic instability, as well as government interventions.
Financial Risks
The loss of capital in any activity indicates a financial risk. This signifies an organization’s inability to meet its debt obligations due to fluctuations and losses in the financial markets resulting from changes in currency, stock prices, and interest rates.
Understanding Banking Risks
Risk is defined as any unexpected or undesirable outcome that deviates from anticipated results. Banking risks refer to the possibility of financial loss resulting from investment decisions. In other terms, it implies that the actual returns from an investment may diverge from the expected returns. As investment risks escalate, investors typically seek higher returns to compensate for bearing these risks.