Risk Management: Challenges for Banks and RegulatorsIntroductionA risk is an uncertainty that will have an impact on the operations of an institution if it is allowed to happen. During the operations of the banking institutions, the banks are faced with so many risks that may have negative impacts on their business operations, and some may have positive impacts. To avoid the negative impacts of the risks from putting down their businesses, banks have to employ strict and effective risk management measures. The process of risk management in the banks involves identification of the risks, measurement of the potential impact of the risk and assessment of the risk.
The aim of this is to minimize the negative impacts the risks can cause to the bank, and which might consequently affect the bank’s financial performance and the capital of the bank (Dunnan, 1998). It is therefore essential for the banking institutions to form a special unit within them that will be dealing with the issues of risk management. They are also to formulate procedures to be followed in the process of identifying risks, measurement and assessment as well as for the entire process of risk management.
Risks are however an innate thing in the business of banking and therefore risk management should be effected in order to achieve financial soundness. For example, the Bank of India has incorporated an approach for risk management and in tune with this, it has formulated policy documents that consider the business requirements and also the best internationally defined practices for risk management as defined by the national supervisor (Scott, 2008). Banking risksVarious risks that the bank faces during its operations include liquidity risk, credit risk, market risk, exposure risks, investment risks, strategic risks and reputational risks.
The most common risks that are faced are liquidity risks, interest rate risks and operational risks. Liquidity risk is the risk that results from negative impacts on the financial results and the capital of the bank that occurs when a bank is unable to meet all its obligations. Interest risks are the risk of negative effects on the financial results and capital of the bank as a result of changes in the interest rates.
Operational risk is the risk of negative impacts on the financial results and the capital of the bank as a result of omissions in the operations of the employees, lack of enough internal procedures and processes, inadequate management of information systems and unpredictable external events. Banks also face risks as a result of their country of origin and the risks faced by that country. A country may be facing political, economic, social and transfer risks which the banks will also experience (Greuning, & Bratanovic, 2009). With the rising competition and technological advancement in the banking industry, the banks have expanded their services in a wide range so that retail and wholesale customers can accesses them through the electronic distribution channels known as the e-banking.
The development of the e-banking however carries a lot of risks with it as well as several benefits. Such risks have to be recognised, immediately addressed and managed by the banks in the most discreet manner due to the significant characteristics and challenges faced by the electronic banking (Kondabagil, 2007). Such characterist that poses the banking system with risks is the extraordinary speed changes that are associated with the technology and customer service innovations.
Theses coupled with the interest risk, the operational risks and the liquidity risks influences the overall risk profile of the banking industry. The risks management procedures and units in the e-banking should therefore be tailored towards addressing the challenges as well as the risks associated. The management and the board of directors of the banks should therefore ensure that their institutions have updated their already existing risk management procedures and processes to incorporate the changing demands brought by the e-banking.
Principles of risk managementThere are several principles that need to be followed for effective management of risks. The management and board of directors in the banking institutions need to be aware of these and put them into practise to ensure effectiveness in risk management. Understanding of the methods of identifying and dealing with the risks in an organization can help in avoiding the difficulties which may arise later and also makes the management and the institution members to be prepared for such incidences.
The first principle to be understood is the organizational context (Cade, 1997). The managers of any banking institution should first and foremost consider the context of their organization so that they can know the best risk identification and treatment procedure to apply. This also entails a clear understanding the political, social economic, technological and legal environment in the organization. Another principle to be observed is stakeholder involvement. Stakeholders are the key players in any business organization. The management should therefore understand the role played by the stakeholders since it is very crucial to manage the stake holders properly for the success of any organization.
The stakeholders should be informed of the risks that can arise in any organization. The management should also be aware of how the occurrence of risks can impact the stakeholders. In a banking institution, the stake holders have the largest role to play. They face the most impact of the risks. Organizational objectives are another principle that should be considered in risk management. This is because risks that usually happen are in relation to the activities that take place in an organization, and the objectives that the organization aims to achieve.
It is very essential that the person who is designing the risk management procedures be aware of the business objectives so that the procedures can be directed towards the achievement of those objectives. In a banking institution, most of the objectives are monetary, money making, and safe keeping of the client’s money. The risks that occur in the banking institution affects the financial results and the procedures should therefore be based on the financial results (Angelopoulos, & Mourdoukoutas, 2001). Another principle that the management can apply in management of risks is the M-o-R (management of risks) approach.
The policies, processes, and strategies in this form of approach provide the general guidelines and models within a specific organization. These guidelines and models are founded on the experience and research carried out by professional risk managers from a variety of organizations and from different management backgrounds. Observing the best practices ensures that individuals who are involved in managing those risks which are associated with the activities of a business learns from the lessons and mistakes done by others.
The other principle is reporting. This entails accurate and clear date presentation and the transfer of data to the right person among the staff, the management team and the stake holders. This is very essential in risk management (Leaven, 2000). The principle of roles and responsibilities is also very important in risk management. A significant practice in risk management is clearly outlining the roles and responsibilities of the management team. The functions and duties of each individual must be observed with transparency both within and without the organization.
Transparency is also very important in the banking sector. Any institution that deals with financial matters needs a lot of transparency due to the possibility of fraud which is big risk to the banking institutions. Another principle to be observed is the support structure. This is the provision of standardized guidelines, information and funding within the organization especially to the individuals who are charged with the duty of managing risks that arise in specific areas. This involves a federal risk management group, a standardized risk management approach and guidelines for best practices in reporting and assessing risks.
In a banking institution, since risks are part of their daily activities, a support structure is very essential to prevent the risks form paralysing the banks operations once they occur (Greuning, & Bratanovic, 2003). . The principle of early warning signs should also be observed. This will help to deal with the risks early before they cause an impact to the bank’s operations. Early warning signs alert the management of an impending risk occurrence and are therefore able to get prepared to deal with it.
This will help avoid the impacts that the risk would have made, and to safeguard the institution form the losses that could have occurred if the risk could have happened. Risk management also requires a supportive culture that will ensure that those involved in risk management have the confidence to raise, discuss and manage the risk. Such a culture involves rewards for effective risk management skills. Any banks that adopt risk management policies need to keep re-evaluating and continuously improving the policies.
This will keep the policies up to date and will be able to deal with any newly arising form of risk.