Answer to Question #227449 in Management for Peter Masih

Question

Risk mitigation is one of the main function/concern of bank in volatile economy. In
course of business banks face different types of risks which may vary from one bank to
another. a. Which are the major risks banks are exposed to and how they mitigate it? (5 Marks)
b. Suppose the regulator asks one of the losses making Bank XYZ to close a few
branches to reduce cost thereby make the bank more sustainable/profitable. But XYZ
Bank refuses to close its few branches, citing some risk/s involved in the process. What
are the risks XYZ Bank perceives if it closes a few branches. (5 Marks)

Answer 1

Credit Risks

The risk of credit arises from the risk of not paying the borrowers' loans. While credit risks are largely defined as the risk of non-payment, banks also include the risk of delayed payments. Such risk may be avoided when only individuals and companies that are not likely to run out of income over the period of the loan are subject to a thorough check and sanctions lending. Credit rating agencies provide sufficient information so that banks can make informed decisions on this subject.

Market Risks

Besides making loans, banks also hold a large share of securities. Some of the securities are held due to the bank's treasury, i.e. to park the money for the short term. Many securities are, however, also held as collateral on the basis of which banks have lent their customers. The banking business is therefore interconnected with the capital markets business.

Banks simply use hedging contracts to mitigate such risks. They use financial derivatives that can be sold freely in any financial market. With contracts like forward, options and swaps, banks can almost eliminate market risks.

Business Risk

The banking industry is significantly advanced and diversified today. Banks currently have a wide range of strategies to choose from. Once such a strategy has been chosen, banks must focus their resources on achieving their long-term strategic objectives. Thus, a particular bank is always at risk of choosing the wrong strategy. The bank may suffer losses and become acquired or collapse simply because of this wrong choice. Banks should be proactive when engaged in risk management efforts with their bankers and other advisory team members. Use your experience to help other firms face similar risks. They can dig into and ask questions that could help uncover risks that you have not even seen and plan effective risk mitigation strategies.