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Bank Supervision | Risk Management in Bank Operations

Risk Management in Banking

In the course of their operations, banks are invariably faced with different types of risks that may have a potentially negative effect on their business. Risk management in bank operations includes risk identification, measurement and assessment, and its objective is to minimize negative effects risks can have on the financial result and capital of a bank. Banks are therefore required to form a special organizational unit in charge of risk management. Also, they are required to prescribe procedures for risk identification, measurement and assessment, as well as procedures for risk management.

The risks to which a bank is particularly exposed in its operations are: liquidity risk, credit risk, market risks (interest rate risk, foreign exchange risk and risk from change in market price of securities, financial derivatives and commodities), exposure risks, investment risks, risks relating to the country of origin of the entity to which a bank is exposed, operational risk, legal risk, reputational risk and strategic risk.

Liquidity risk is the risk of negative effects on the financial result and capital of the bank caused by the bank’s inability to meet all its due obligations.

Credit risk is the risk of negative effects on the financial result and capital of the bank caused by borrower’s default on its obligations to the bank.

Market risk includes interest rate and foreign exchange risk.

Interest rate risk is the risk of negative effects on the financial result and capital of the bank caused by changes in interest rates.

Foreign exchange risk is the risk of negative effects on the financial result and capital of the bank caused by changes in exchange rates.

A special type of market risk is the risk of change in the market price of securities, financial derivatives or commodities traded or tradable in the market.

Exposure risks include risks of bank’s exposure to a single entity or a group of related entities, and risks of banks’ exposure to a single entity related with the bank.

Investment risks include risks of bank’s investments in entities that are not entities in the financial sector and in fixed assets.

Risks relating to the country of origin of the entity to which a bank is exposed (country risk) is the risk of negative effects on the financial result and capital of the bank due to bank’s inability to collect claims from such entity for reasons arising from political, economic or social conditions in such entity’s country of origin. Country risk includes political and economic risk, and transfer risk.

Operational risk is the risk of negative effects on the financial result and capital of the bank caused by omissions in the work of employees, inadequate internal procedures and processes, inadequate management of information and other systems, and unforeseeable external events.

Legal risk is the risk of loss caused by penalties or sanctions originating from court disputes due to breach of contractual and legal obligations, and penalties and sanctions pronounced by a regulatory body.

Reputational risk is the risk of loss caused by a negative impact on the market positioning of the bank.

Strategic risk is the risk of loss caused by a lack of a long-term development component in the bank’s managing team.

 

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