ACE Money Transfer - Blog

What Are the Biggest Risks for Banks & Their Solutions?

What Are the Biggest Risks for Banks & Their Solutions?

19 Oct 2020


Risks can be controlled if someone could predict the probability of upcoming events and activities. There may be various types of risks that any bank could face like credit, operational, systematic, market, reputational, and liquidity risks.

Banks are exposed to a variety of risks in everyday life. For that purpose, banks have well-defined risk management infrastructures to tackle such scenarios. They are required to follow regulations imposed by the government of the state to ensure smart business standards.

 Since some of the banks are operational at a large scale, so the impact of risk on the bank is directly proportional to its business in the market or either with clients. Therefore, it is the responsibility of the government or the state to make better practices and regulations to promote sensible management and decision planning.

Valued investors seek areas with high-profit value instead of places with an excessive risk of loss. The investor perspective is also based upon the risk management aptitude of the bank. Risk management policies of the banks enable them to sustain growth even after the insignificant losses that could originate unexpectedly.

Also Visit: How to Avoid Debit Card Fraud?

Credit Risk

It is a situation where the borrower fails to meet the necessary criteria for contractual obligations. Credit risk stands out amongst the top risk at any level of the bank. For instance, when a borrower is defaulted to meet the interest repayment of a loan. Defaults can occur on numerous types of services like credit cards, fixed income securities, and mortgages.

It is hard to presume moderate risk in this category, but one can reduce the threat by following certain ways. They can entertain loan applications by presenting it to the specific clients fulfilling eligibility standards.

The guidelines are usually based upon well-settled credit history, high-quality counterparties transactions. Henceforth, complete conduct of investigation is expected before accessing loans to encourage timely payments during payback. 

Operational Risk

 Whenever failure results due to inefficiency of the systems within a bank, such errors are referred to as operational risk. Operational risk is characterized as loss due to the mistakes, errors, damage caused by the individual client, or during a process. Everyday processes of banking operations include daily transactions, cross border transfers, cash deposits.

Other than that, there are times when the internal systems of the bank or the central system of the bank slow down. The operational risk is high for operations like trade and sale, whereas low for simplified business operations such as asset management and retail banking.

There are other mistakes like payment transfer in some other account other than what is mentioned or the accomplishment of processes in the inaccurate sequence. Human error-related losses consist of mistakes committed during transactions and internal fraudulent acts. Just like, if a teller handed over an extra 50$ to the person who presented a cheque of 20$.

The operational risk can be reduced by opting for automation in workflows to decrease human intervention and random mistakes. It is well-advised for a bank to use software from an authentic organization to eradicate errors and ensure smooth flows in operations.

Market Risk

The main reason is the stock pricing, interest charges, and unpredictability of equity markets. Market risk majorly is caused by the activities of the bank in the capital markets. Banks normally invest in stocks, upon which a gradual increase or decrease could result in a profit or either loss.

It is understood that besides the approval of loans, banks also possess a certain number of shares and third-party stocks. These banks investing in capital markets have a high-risk proportion of the loss. Most of the banks conduct business on commodity prices. As the value for the commodities changes, the value of the company changes synchronously.

In most of the situations, these prices fluctuate due to demand and supply shifts that are often unpredictable. So, to minimize the risk, diverse investments are requisite for the banks. To limit market risk, the bank usually leverages hedging agreements. 

Business Risk

Mostly bank sanction loans to different kinds of businesses. If any business fails to repay it, then the bank will face business risk. Business risks are dominantly influenced by credit risk. In simple words, when an average bank shows a disruption in producing profits within a specific period of time, then it is referred to as business risk.

Ultimately the loss of the business will be compensated by some of the other banks linked with it or usually collapse in large-scale banks. Examples of such banks are Washington Mutual and Lehman Brothers. Only the right policy can support reduce the elimination of such high risks. 

Cybersecurity

As there is no doubt, cyberattacks like distributed denial of service attacks are rapidly growing every year. Cybersecurity has advanced to an extent since the last decade. Hackers find it really interesting to break into the cyber-security system of the bank, steal the money and data of the people. Leaving bank reputation at arm's length from the aspect of their investors.

It is obvious from the previous events where hackers intruded into the layers of the bank security system and stole a large sum of amount. This eventually leads to a lack of trust from the people and financing parties. Damage to bank reputation causes a deterioration in the interest of attracting deposits or any business.

Though, the banks have started making considerable investments in the cybersecurity departments to promote the safety of the clients' data and valuables. The banks need to invest in top-of-the-line applications and software that provide maximum security and performance to mitigate cybercrimes. 

Liquidity Risk

Failure in the timely provision of the cash towards customers can result in a snowball influence. Liquidity risk is attributed to the capacity of a bank to access cash to meet funding assurances. Such as allowing customers to cash out from their account.

If a certain bank fails to accommodate its customers with requested cash within a day, it will create a rush for the remaining clients to draw out their deposits, losing reliance and trust in the bank. 

The significant reason that most of the banks face liquidity problems is due to mismanagement in the illiquid assets as most banks remain focused on short term liabilities and not on managing short term assets. Short-term liabilities include customer deposits or short-term guaranteed contracts that

the bank is liable to pay to its customer. For instance, if all of the assets are invested in long term assets and schemes, the bank will fall inadequate to manage short term asset-liabilities.

The regulations aid in decreasing liquidity problems hence by providing requirements such as for banks to hold enough liquid assets to survive a period of time without the cash flow based on outside funds. 

Compliance Risk

When a specific bank rushes to operate with rules and regulations that are not in compliance with the governing authorities, it results in financial and legal losses. Eventually, the bank experiences loss in daily banking operations.

Compliance risk can be expressed as the risk that arises from not supporting standards and regulations put forth on behalf of the financial institutions and regulatory authority. Usually, it is not considered as a greater risk, but it surely has a dominant impression. Besides, they might be penalized or face challenges concerning the regulatory committee. 

Government and the central bank also possess higher interests in controlling bank risks. To control the fallout, economy, and financial crisis accompanying several other distinctive factors, the government and central banks take part in the regulation of the banks.

Insufficient protocols for obligatory compliance with newly introduced regulations could result in penalties and other punishments.

Reputational Risk

The media is the quickest source of news spread in the modern world of digitalization. Reputational risk is always the most critical risk amongst all others. It is dependent on other risks like operational risk and security risk. In simpler words, a company fails to provide its customers with the security of their data or any other valuable items.

This results in the gossips and rumours across customers, spreading a layer of doubt on the services of the bank. This leads to a decrease in the number of users for the bank and new investments and considering bank in a questionable position. In such circumstances, the bank reputational risk charts tend to breach more than the predicted ratio incurring a loss.

The bank should always favour methods that support reliability and security for their customers. And they should also avoid methods that endanger customer-oriented valuables. Moreover, the aim to provide satisfactory and trustworthy services for their customers will lessen reputational risk.

Systematic Risk

It is considered nearly impossible to eradicate this category of the risk as it is purely dependent on the variations and sudden changes that are not being controlled by any organization or third party. Systematic risk is associated with external issues such as employee's strike, instability of the government, and fluctuations in the market.

The only possible solution to mitigate this risk is to continue monitoring factors responsible for the increase in loss. Banks should need to develop timely strategies to deal with such factors in time.

Moral Hazard

It is introduced recently in the global market when banks started making high-risk investments. Moral hazard is totally different from the above-mentioned risks. It is defined as kind when banks take risks knowing that someone else has to bear the loss in case if it backfires. The taxpayers are the victim of the loss incurred in this type of risk.

Although the central bank is tracking for banking operations very keenly, still some banks get a chance to make operations keeping out of sight of regulatory authorities. They get to indulge in illicit activities and formulate an imbalance on the taxpayers when their preparation turns out to be failing.

The only option to deal with such kind of risk is the regular monitoring of the regulatory authorities towards the bank's operational tendencies. The bank should not also involve in unsafe businesses and should follow the straight and proper path.

Innovation and Technology

In an era where innovation is taking control of every distinctive sector. Failure in the adoption of innovation leads to a competitive disadvantage. It is the responsibility of an organization to keep aware of the latest technology and terminologies to prosper in the modern progressive world.

Companies denying adopting the latest technology normally are disqualified from the competition since they disappoint to provide services such as their competitors. In such cases, clients move to areas where well equipped and latest technological services are available. An organization needs continuous up-gradation regarding their methods of services for clients and customers.

Possible Solution

It is a necessary duty of the ultimate government to map up such criteria that could govern the profit-loss ratios for the bank.

There are two major perspectives to reduce the tendency of the risks.

  1. Government Level
  2. Bank-Level

The criteria can be implemented on a branch to the top management level. A bank should always look up for diverse sources of investment schemes that could serve in both short and long term cashflows. As a client, it is always essential to invest in multiple areas to shorten the wave of loss caused by uncertainties in the system.

Most of the banks have invested a larger value in the risk management department. Their operational task is to monitor and predict the drastic changes that could lead to bear the loss. Early knowledge of the ambiguities assists redefine standards for managing better results.

In this article, we have discussed the major risks that are currently evolving due to the digitalization of the banking industry. It is not specific for any bank but, all the banks in the world are falling victim to these risks. The only best way possible to fight back these issues and risks is to go for more sustainable and secure financial solutions.

It is preferred to make use of advanced and efficient applications and software based on modern technology. The provision of reliable services for customers will ensure investments and guarantees for future businesses.

Banks should guarantee general practices under the premises of regulatory expectations to eradicate the chances for failure. This will support them to grow and evolve with business goals and prospects for progressive development. 


Business Updates

PREVNEXT
Win a Brand New Car, Honda CD70 Bikes and Much More!
Gambia Offer For Beneficiaries

Comments