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Risk management definition
Risk Management can be defined as the process of identifying, analyzing and reducing risks while making an investment decision. Ideally, any time an individual or management faces the choice of funds, there are risks and therefore natural occurrence of Risk Management. The risk appetite differs from person to person or from business to business. It is said that high risks bring high returns. However, there are ways to project and calculate the element of Risk and this is where Risk Management professionals are required. Fund Managers or Risk Management Professionals practice Risk management in order to diversify their portfolio and hence mitigate the exposure to risk.
Risk management in banks
Commonly Identified Risks
Banking is one function where Risk Management is a must as banking process involves high investment and thus exposed to several risks such as Credit Risk, Operational Risk, and Market Risk, etc.
Credit Risk brings forth the risk of non-recovery of loan given by banks/ financial institutions or risk of reduction in the value of the asset. The risk of pre-payment makes part of Credit Risk. Credit to countries with adverse foreign reserve or internal political/economic turmoil is also studied under Credit Risk
Interest Rate Risk
These are the Risks arising out of fluctuations in the rate of interest.
The net outflow of funds arising out of withdrawals/ nonrenewal of deposits is one such risk affecting the liquidity position of the bank. Another factor is non-recovery of cash receipts from loan recovery.
The risk of losses arising from fluctuations in market prices.
The rapid change in technology and innovations bring forth the risk of loss due to change or upgrade of technology by competitors.
Change in regulations affects the balance sheet position of banks.
Components of Risk Management Process
The process of Risk Management comprises of the steps as under
Identifying risks is to put down the different types of risks affecting investment proposal. The clarity in defining risks will help the rationalization of the same.
Once risks are potentially identified and enumerated. The next vital step is to be able to assess and quantify the risk along with examining the probability and timing of potential loss under various circumstances.
Risk Control is achieved by stating terms and guidelines that define the risk limits and therefore mitigate the chance of risk occurrence.
Mutual Funds are one of the most preferred funds by the investors while deciding their portfolio. However, mutual funds being market-linked carry risks too. Mutual Funds are of three types; Equity Funds, Debt Funds, and Balanced Funds. All the three carry different risks. Considering the investment objectives will help an investor to plan the investment. Equity Funds through carrying good returns but are high-risk funds affected by market volatility whereas Debt Funds like Bonds and Debentures fluctuate with varying interest rates. Balanced Funds offer safety only if markets are stable over a period of time. Therefore, Investors or Fund Managers need to project market and plan for long-term returns to make sense of the above portfolio.
financial risk management