The past decade has seen dramatic losses in the banking industry. Firms that had been performing well suddenly announced large losses due to credit exposures that turned sour, interest rate positions taken, or derivative exposures that may or may not have been assumed to hedge balance sheet risk. In response to this, commercial banks have […]
The risks contained in the bank’s principal activities, i.e., those involving its own balance sheet and its basic business of lending and borrowing, are not all borne by the bank itself. In many instances the institution will eliminate or mitigate the financial risk associated with a transaction by proper business practices; in others, it will […]
It seems appropriate for any discussion of risk management procedures to begin with why these firms manage risk. According to standard economic theory, managers of value maximizing firms ought to maximize expected profit without regard to the variability around its expected value. However, there is now a growing literature on the reasons for active risk […]
How are these techniques of risk management employed by the commercial banking sector? To explain this, one must begin by enumerating the risks which the banking industry has chosen to manage and illustrate how the four-step procedure outlined is applied in each area. The risks associated with the provision of banking services differ by the […]
The banking industry has long viewed the problem of risk management as the need to control four of the above risks which make up most, if not all, of their risk exposure, viz., credit, interest rate, foreign exchange and liquidity risk. While they recognize counterparty and legal risks, they view them as less central to […]
The area of interest rate risk is the second area of major concern and on-going risk monitoring and management. Here, however, the tradition has been for the banking industry to diverge somewhat from other parts of the financial sector in their treatment of interest rate risk. Most commercial banks make a clear distinction between their […]
In this area there is considerable difference in current practice. This can be explained by the different franchises that coexist in the banking industry. Most banking institutions view activity in the foreign exchange market beyond their franchise, while others are active participants. The former will take virtually no principal risk, no forward open positions, and […]
Two different notions of liquidity risk have evolved in the banking sector. Each has some validity. The first, and the easiest in most regards, is a notion of liquidity risk as a need for continued funding. The counterpart of standard cash management, this liquidity need is forecastable and easily analyzed. Yet, the result is not […]
Beyond the basic four financial risks, viz., credit, interest rate, foreign exchange and liquidity risk, banks have a host of other concerns as was indicated above. Some of these, like operating risk, and/or system failure, are a natural outgrowth of their business and banks employ standard risk avoidance techniques to mitigate them. Standard business judgment […]
The banking industry is clearly evolving to a higher level of risk management techniques and approaches than had been in place in the past. Yet, as this review indicates, there is significant room for improvement. Before the areas of potential value added are enumerated, however, it is worthwhile to reiterate an earlier point. The risk […]
