Process of Risk Management
The process of risk management in the banking sector involves the following activities:
- Risk Identification
- Risk measurement or quantification
- Risk mitigation
- Risk control and monitoring
- Risk pricing
Risk Identification
It involves identifying the different risks associated with a transaction the bank has taken at a transaction level and then assessing its impact on the portfolio and capital return.
All the transactions in a bank have one or more of the major risks such as liquidity risk, market risk, operational risk, credit/ default risk, interest rate risk, etc.
Certain risks are contracted at transaction level (credit risk) and others are managed at the aggregated level such as interest or liquidity risk.
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Risk Measurement
It is done with the aim to make an assessment about variations in earnings, loss due to default, market value, etc. due to the uncertainties associated with various risk elements. The risk measurement can be based on sensitivity, volatility, and downside potential. It has two components:
- Potential losses
- Probability of occurrence
Risk Mitigation
It is a strategy to prepare for and lessen the impacts of the risks faced by the banking organizations. Risk mitigation takes steps to minimize the negative effects of the risks for prolonged business continuity.
In risk mitigation, the lender must minimize their risks by diversifying the borrower pool. Therefore, banks must have a filtering apparatus to assess the exposure at regular intervals to ensure that they are not exposed to many risks at once.
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Risk Monitoring and Controlling
The banks take the following steps to control risks:
- An appropriate organizational structure
- Adopt a comprehensive risk measurement approach
- Set up a comprehensive risk rating system
- Adopt risk management policies consistent with the broader business strategy, capital strength, etc.
- Place limits on different types of exposures, including the interbank borrowings which include call funding purchased funds, core deposits to core assets, off balance sheet commitments, etc.
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Risk Pricing
Risk-based pricing refers to the offering of different interest rates and loan terms to different consumers on the basis of their creditworthiness. In risk-based pricing, the banks look at the elements related to the ability of the borrower to pay back the loan, employment status, presence of a co-signer, dent level, collateral, etc.
Now let’s see the weightage of the topic in each of the competitive exams:
| Name of the Exam | Number of Questions Expected |
| SBI | 1-2 |
| IBPS | 1-2 |
| RBI Assistant | 2-3 |
| RBI Grade B | 3-4 |
| NABARD | 1-2 |
You might also be interested in: Base Rate study notes. We hope that the above article on Risks in Banking Sector is useful for candidates appearing for upcoming government exams. We have inculcated all the updated and most relevant information here as per the official guidelines. For more such study-related resources, download and install the Testbook App and receive all the updates at once!
Q.1What do you mean by risks in the banking sector?
Ans.1
Risks in the banking sector are defined as the possibility of loss that may rise due to myriad reasons and uncertainties.
Q.2What are the risks in the banking sector in India?
Ans.2
These include credit risks, market risks, operational risks, liquidity risks, business risks, reputational, and systematic risks.
Q.3What is CAMELS framework?
Ans.3
The CAMELS framework is used to measure a bank’s level of risks with the help of its financial statements.
Q.4What is the use of the CAMELS framework?
Ans.4
It uses parameters like Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Sensitivity (CAMELS) to assess a bank’s ability to stand the risks.
Q.5What are the activities involved in risk management?
Ans.5
Risk Identification, Measurement or Quantification, Mitigation, Control, and Pricing are the activities involved in risk management in the banking sector.
