Risk management in banks: Tough and challenging

By: SHOBHA BDR. RANA, www.thehimalayantimes.com

Banking business by nature involves tradeoff between risk and return. Over-emphasis on return at the cost of increased level of risk beyond a limit is not appropriate from the risk management prospective. Similarly, from a business perspective, inability to take calculated risk for achieving best returns is also not a good situation. The ideal situation is to manage the business by achieving best returns and at the same time to manage the risks well. Banks should continuously strive for a fine balance between risk and return.

Based on the global, regional and our in-country experience of the last few years, it is quite obvious that the success/sustainability or failure of banks largely depends on how well various risks are managed under a highly competitive, challenging and fast-changing business environment. The saying “survival of the fittest” appears true for banking business under this kind of environment. Accordingly, banks have a lesson to learn from the past, and manage the risks in line with the changing business and risk environment.

Proper risk management helps in keeping the bank’s financial results and reputation intact. It also helps in ensuring stakeholder’s expectations, e.g. shareholders get return on investments; employees get rewards in line with their contribution, and regulatory requirements are met as prescribed. If the banks fail to manage their risks properly, it not only impacts the related banks and their stakeholders but also the country’s economy.

There are various types of risks banks should manage to avoid negative impact on performance and sustainability. A simple example can be taken of the public notices issued by banks in newspapers relating to loan repayments and auctioning; these are directly linked to the credit risk of a bank. We have heard of few fraudulent transactions relating to ATM Cards; these are linked to internal control and operational risk of the banks. Loss or gain made by banks trading in gold due to fluctuation of gold price relates to market risk. Revision in interest rates on deposits and loans from time to time is directly linked to management of liquidity risk. The management of Strategic and Credit Risk helps in mitigating portfolio concentration risk, e.g risk arising due to excessive exposure under one particular segment/industry. Country risk emerges while undertaking a crossborder transaction, e.g. impact of recent closure of banks in Cyprus for foreigners keeping deposits in these banks. Banking involves various types of risks simultaneously and management of these risks effectively becomes an integral part of banking business.

In line with the importance of risk management, banks are expected to have a well-defined Risk Management Framework approved by their Boards. The framework ideally covers policies, procedures, roles, responsibilities, accountability, monitoring and reporting mechanisms including independent checks and controls. Similarly, banks should have a setup that coordinates overall risk management activities across the banks. Such roles can be performed by a dedicated manager, separate department or a committee depending on the size and complexity of the business. The risk management function should be independent of the day-to-day business and operational activities.