Various Risks associated with Banking Business
There are various kinds of risks associated with the banking such as credit risk, interest rate risk, foreign exchange rate risk, liquidity risk, equity price risk, commodity price risk, legal risk, regulatory risk, reputation risk, operational risk etc. They can be broadly converged into three categories viz. Credit Risk, Market Risk and Operational Risk. They have been briefly discussed below:
Credit risk is risk of loss arising from a borrower who does not make payments as promised. This event would be called “Default” and the person/ company/ entity would be called “Defaulter”. Due to this, credit risk is also known as “Default Risk”.
Market risk is the possible losses due to movement in the market prices. There are four standard market risk factors viz. stock prices, interest rates, foreign exchange rates, and commodity prices. Apart from there are associated market risks as follows:
- Equity risk, the risk that stock prices and/or the implied volatility will change.
- Interest rate risk, the risk that interest rates and/or the implied volatility will change.
- Currency risk, the risk that foreign exchange rates and/or the implied volatility will change.
- Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil) and/or implied volatility will change.
Operational Risk refers to the risk of loss from inadequate or failed internal processes, people, systems or external events including
- Incompetent management
- Improper planning
- Staff fraud
- Programming errors
- System Failure
- Increased competition
- Deficiency in loan documentations.
What are different approaches for risk assets calculation?
Banks have several approaches for risks assets calculations. They have been summarized in the below table:
Internal rating and external rating approaches
Standardized Approach / External Rating Approach
Under this approach the banks are required to use ratings from External Credit Rating Agencies to quantify required capital for credit risk. The Banks have to follow it without any discretion to modify. The Reserve Bank of India has identified 4 external domestic agencies for this approach. They are CRISIL, ICRA, Care and Fitch.
Apart from this, there are international agencies such as Moody’s, Fitch, Standard and Poor’s etc.