Finance and Management (FM) - Expected Question
Answer:
Introduction:
Risk management is a critical function in banking, ensuring financial stability and safeguarding depositors’ funds. Banks face various risks, including credit, market, operational, and liquidity risks. Effective risk management helps in sustaining profitability and regulatory compliance.
Types of Risks Faced by Banks:
Credit Risk:
- Arises when borrowers fail to repay loans.
- Example: Rising Non-Performing Assets (NPAs) in Indian banks.
Market Risk:
- Results from fluctuations in interest rates, exchange rates, or stock prices.
- Example: Losses due to stock market crashes or currency depreciation.
Operational Risk:
- Includes risks due to internal fraud, system failures, or cyberattacks.
- Example: Banking system hacking incidents.
Liquidity Risk:
- Occurs when banks cannot meet short-term obligations due to a cash crunch.
- Example: Yes Bank crisis in 2020.
Interest Rate Risk:
- Changes in interest rates impact banks’ earnings and lending capacity.
- Example: A sudden increase in repo rates can reduce loan demand.
Strategies to Mitigate Risks in Banking:
Credit Risk Management:
- Conducting strict credit assessments before lending.
- Implementing Basel-III Norms for capital adequacy.
Market Risk Management:
- Using derivatives like futures and options to hedge risks.
- Diversifying investment portfolios.
Operational Risk Management:
- Strengthening cybersecurity and fraud detection mechanisms.
- Conducting regular audits and employee training.
Liquidity Risk Management:
- Maintaining adequate cash reserves as per RBI’s Liquidity Coverage Ratio (LCR).
- Developing contingency funding plans.
Conclusion:
Risk management is essential for a bank’s sustainability and economic stability. Proactive policies, strict regulations, and advanced financial tools can help banks mitigate risks and improve their resilience in volatile markets.
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