When the public thinks of the modern bank, they likely think of a stable organization committed to providing ongoing financial services for years on end, without a struggle. Yet banks face risks today as much as they always have, and perhaps more so in the current financial market. Banking professionals must learn to identify and then protect themselves from common risks if they are going to succeed. Here are the four biggest risks for today’s banks, and steps you can take to protect yourself from them.
1. Credit Risk
Credit risk is, perhaps, the most obvious of the risks. Banks must do their best to determine the likelihood that a customer will pay back what is loaned to them. In light of the recent lending crisis, the modern bank is looking more closely at credit risk before lending to consumers.
Your bank will have to determine how much of a credit risk you are willing to take on a particular consumer. This is a question that you will have to answer for your individual situation. Each bank will have specific terms and conditions that it is willing to operate under, but you will need to determine what those are, and then stick with them as you bring on new credit customers.
2. Operational Risk
Operational risk is the risk that comes from within. These are the decisions you, as a bank, make internally that mess up yourself, and those employee decisions made on a day-to-day basis that can create problems for your organization. Inadequate internal controls and employee accountability can lead to serious risks for your bank.
How can you avoid this? The answer is easy to state, but hard to implement. Adding more internal rules and accountability may be the answer, but, unfortunately, the bending of internal rules is far too common in the banking industry. Fostering a sense of unity among your team members can be a helpful place to start. When everyone has a vested interest in seeing your bank succeed, the temptation to bend rules is lessened. Also, adding monitoring programs to help identify risky behavior and put a stop to it can help limit this type of risk.
3. Market Risk
Banks are at the whims of the markets. When the markets do not behave properly, banks lose money on their assets. Managing market risk is essential for today’s banks, especially with the volatile nature of the current markets.
Managing market risk is not something new to the modern bank, it’s just newly pressing because of recent market years. The best strategy, for managing market risk, is one of diversification. Ensuring that assets are held in a wide range of investment options will help limit this type of risk.
4. Liquidity Risk
If the market suddenly changed, would your bank be able to stay afloat? Have you spread yourself too thin? This risk is known as liquidity risk. This is the risk that you will not be able to stay buoyant if your funds suddenly ran out. This is more important now in the post-financial market crisis environment. Funding is no longer readily available and cheap, so you need to have a plan.
Unfortunately, liquidity risk is always going to be a vulnerability of the modern banking model. As you strive to transform your short-term deposits into long-term assets, you are always going to be at risk
So if it’s inevitable, how can you manage liquidity risk? The key to managing liquidity risk is to create mismatches between asset and liability maturity, and then to ensure that those mismatches keep enough funds flowing in the bank to both increase assets and meet obligations when customers ask for their money.
Each of these risks is interdependent, which can make managing them more challenging. A solid risk management plan is essential to keep the modern bank fully operational.