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Banks face a variety of financial and non-financial risks during the financial intermediation process, including credit, interest rate, foreign exchange rate, liquidity, equity price, commodity price, legal, regulatory, reputational, and operational risks. These hazards are intricately intertwined, and events that affect one risk category might have repercussions for a variety of others. As a result, bank top management should place a high priority on improving their ability to identify, assess, monitor, and control the overall level of risks they are taking.
Concept of Risk Management
In order to manage risk or an unknown event, the concept of risk management was developed. Risk management is the process of predicting future risks, analysing and evaluating those risks, and then taking remedial action to decrease or eliminate those risks.
Many businesses or entities use risk management now in order to mitigate the risk that they may encounter in the near future. When a company makes an investment decision, it tries to determine the amount of financial risk involved. High inflation, recession, capital market volatility, and bankruptcy are all examples of financial hazards. The magnitude of such risks is determined by the sort of financial instruments in which a company or individual invests.
Risk Management in Indian Banking Sector
Risk management is a relatively new practise in Indian banks, but it has grown in relevance as a result of greater rivalry, increased volatility, and market swings. The practise of risk management has boosted the efficiency with which Indian banks are governed, as well as the practise of corporate governance. The key characteristic of a risk management model is to minimise or reduce the risks associated with the products and services offered by banks. As a result, an effective risk management framework is required to mitigate internal and external risks.
Due to increased worldwide competition from international banks, the introduction of innovative financial products and instruments, and increased deregulation, Indian banks must establish risk management models or frameworks.
Risk Management Structure
Choosing between a centralised and decentralised risk management organisation structure is a fundamental challenge in developing an adequate risk management organisation structure. The global trend is to centralise risk management with an integrated treasury management function to get access to aggregate exposure information, natural netting of exposures, economies of scale, and easier reporting to senior management. The Board of Directors should clearly bear the primary responsibility for recognising the bank’s risks and ensuring that they are effectively managed.
By assessing the bank’s risk and risk-bearing capacity, the Board should set risk limitations. Overall risk management should be delegated to an independent Risk Management Committee or Executive Committee of top executives who report directly to the Board of Directors at the corporate level.
The goal of this top-level committee is to provide one group sole responsibility for reviewing the bank’s total risks and determining the degree of risk that is in the bank’s best interests. Simultaneously, the Committee should make line management more accountable for the risks under their control, as well as the bank’s performance in that area. The main responsibilities of the Risk Management Committee should be to identify, monitor, and measure the bank’s risk profile.
Classification of Risks in Banking sector
1. Credit Risk
Borrower risk, industry risk, and portfolio risk are all credit risks. It examines the creditworthiness of the industry, the borrower, and so on.
It is also known as default risk, and it assesses an industry’s, counter- party’s, or customer’s capacity to meet their financial transaction settlement promises.
The credit risk of a bank’s portfolio is influenced by both internal and external variables.
Internal causes include a lack of assessment of the borrower’s financial situation, insufficient risk pricing, improperly set lending limits, a lack of post-sanctions surveillance, and improper loan agreements or policies, among others.
2. Market Risk
Previously, managing credit risk was the principal duty or problem for almost all banks.
However, market risk began to emerge as a result of the banking sector’s modernization and advancement, such as interest rate fluctuations, changes in market factors, fluctuation in commodity or equity prices, and even variation in foreign exchange rates.
As a result, it became necessary to handle market risk as well. Because even minor changes in market variables have a significant impact on the economic value of banks, even little changes in market variables have a significant impact on the economic worth of banks.
3. Operational Risk
It is now necessary to manage operational risk in order to improve risk management practises.
Operational risk arises as a result of the banking sector’s and financial markets’ modernization, which has resulted in structural changes, increased transaction volume, and complicated support systems.
Operational risk cannot be classified as market or credit risk because it involves payment settlement, business disruption, legal, and administrative risk.
Conclusion
India’s banking sector has achieved significant progress in terms of technology, quality, and has begun to diversify and expand its horizons at a quick pace. However, as a result of increased globalisation and liberalisation, as well as technological improvements, these institutions are exposed to some hazards. Since risk plays such a large part in bank earnings, the larger the risk, the higher the return. As a result, maintaining risk and return parity is critical.
