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risk management systems in the banking sector welcome to the risk management of everything channel on this channel you will find videos on risk management and the application of risk management to diverse areas and sectors if you are new here please consider subscribing to our channel and press the notification button so you can be notified when we upload new videos thank you risk management systems in the banking sector are discussed in this video now let us start risk is inescapable meaning banks must do everything in their power to mitigate it risk management is a challenge that many banks struggle to rise to meeting this challenge demands a clear understanding of the different types of bank risk to look for and the technologies that will help you overcome them banks are highly regulated in order to promote financial stability foster competition and protect consumers due to the strictly monitored environment in which banks operate it is critical that they have strategies in place to keep all their ducks in a row risk management is an essential piece of banking operations to demonstrate why this guide will provide an overview of risk management in banking discuss specifically the types of risk management in commercial banks detail risk management practices in banks go over the process of risk management in banks and explain how to use enterprise risk management software for banks just like any business banks face a myriad of risks however given how important the banking sector is and the government's stake in keeping risks in check the risks way heavier than they do on most other industries there are various types of risks that a bank may face banks are in the risky business while banks are providing financial services they are also acting as a middleman in the transactions but this role is causing various kinds of risks to the banks additionally banks also use their own financial statements like their balance sheet to complete the transactions and to absorb the risks associated with those activities usually most of the risks that banks are facing in their business are on their balance sheet activities therefore the discussion and necessary procedures for risk management are centered on this area consequently the balance sheet includes the risk related to the bank's traditional and trading activities the risk management concept begins with the discussion over why these risks should be managed ing to the economic theory core management principles are aimed at maximizing the shareholders wealth and this principle should also maximize the expected profit from their business if there are any losses from the activities harming the core principles and if the risks that occur in the business are not managed appropriately it could directly impact the bank's profitability and soundness categories of risks in banks broadly speaking are risks in the banking sector are of two broad categories namely systematic risks and unsystematic risks let us define these two types of risks in banks and understand the concept behind them 1. systematic risks it is the risk inherent to the entire market or a market segment and it can affect a large number of assets systematic risk is also known as undiversifiable risk or volatility and market risk systematic risk affects the overall market and not just a stock or industry in particular this type of risk is both unpredictable and impossible to avoid completely systematic risk is related to the bank's assets where their values are changed by systematic factors it is also called market risk and banks are usually engaged in market activities market risk can be related to any prices which are continuously traded on the financial markets based on the theory of diversification some of the investment risks can be diversified away but this is not possible with the rest certainly new opportunities like hedging provide the opportunity for market participants to hedge their risk but this is not completely diversified away from the risks that are related to the market conceptually derivative products provide one of the best tools to deal with price changes another important concept that can be discussed here is portfolio management portfolio management is also an important approach used to address the risk reduction that is related to the investment activities examples of systematic risk include interest rate changes inflation recessions and wars 2. unsystematic risks it is the risk that affects a very small number of assets it is also called non-systematic risk specific risk diversifiable risk and residual risk this type of risk refers to the uncertainty inherent to a company or industry investment in particular this risk includes the possibility of bringing down the entire financial system to a standstill this is caused due to a domino effect where the failure of one bank could ripple down the failure of its counterparties slash other stakeholders which could in turn threaten the entire financial services industry risks such as systemic risk which the banks have little or no control over can only be mitigated if banks have a strong capital base to ensure a sound infrastructure examples include a change in management a product recall a regulatory change that could drive down company sales and a new competitor in the marketplace with the potential to take away market share from a company in which you have invested it is possible to avoid unsystematic risks through diversification having discussed the two broad categories of risks in banks let us now discuss common types of banks risk common types of banks risk banks face a significant amount of risk here are 7 common types of risk banks are exposed to 1. operational risk this refers to any risk incurred as a result of failure in people internal processes and policies and systems common examples of operational risk in banks include service interruptions and security breaches operational risk is potential sources of losses that result from any sort of operational event for example poorly trained employees a technological breakdown or theft of information 2. market risk this refers to the risk of an investment decreasing in value as a result of market factors such as a recession market risk also known as or systematic risk refers to any losses resulting from changes in the global financial market sources of market loss include economic recessions natural disasters political unrest and changes in interest the basel committee on banking supervision defines market risk as the risk of losses in on-balance or off-balance sheet positions that arise from movement in market prices market risk is the most prominent for banks present in investment banking the four components of market risk one interest risk it causes potential losses due to movements in interest rates this risk arises because a bank's assets usually have a significantly longer maturity than its liabilities in the banking language the management of interest rate risk is also called asset liability management alm interest rate risk occurs when interest rate adjustments influence an institution's net interest margin or market value of equity mve irr can be interpreted in two ways its impact is on the bank's earnings or its effect on the bank's asset liability and off-balance sheet obs positions economic value after deregulation most of the ceilings and restrictions on the interest rates were removed by the regulators and authorities market interest rates are determined by the market dynamics nowadays interest rates are changing based on the supply and demand conditions under these circumstances movements of the interest rates which banks are using for their activities also have effects on the bank's incomes and expenses some of the bank's assets are generating interest revenues such as loans and security investments while on the other hand some liabilities also have expenses like deposits therefore the changing interest rates have had a substantial impact on the bank's profits consequently this is called interest rate risk to equity risk it causes potential losses due to changes in stock prices as banks accept equity against disbursing loans banks can accept equity as collateral for loans and purchase ownership stakes in other companies as investments from their free or investable cash any negative change in stock price either leads to a loss or diminution in investments value three commodity risk it causes potential losses due to change in commodity agricultural industrial energy prices massive fluctuations occur in these prices due to continuous variations in demand and supply banks ma why hold them as part of their investments and hence face losses the commodities values fluctuate a great deal due to changes in demand and supply any bank holding them as part of an investment is exposed to commodity risk for foreign exchange or forex risk is the risk that due to adverse exchange rate changes a bank can suffer losses during a time when it has an open position in an individual foreign currency either spot or forward or a combination of the two it causes potential loss due to a change in the value of the bank's assets or liabilities resulting from exchange rate fluctuations as banks transact with their customers or other stakeholders in multiple currencies banks transact in foreign exchange for their customers or the bank's accounts any adverse movement can diminish the value of the foreign currency and cause a loss to the bank.3 liquidity risk this refers to a bank's inability to meet its obligations thereby jeopardizing its financial standing or even its very existence liquidity risks effectively prevent a bank from being able to convert its assets into cash without sacrificing capital due to insufficient interest with any financial institution there is always the risk that they are unable to pay back their liabilities in a timely manner because of unexpected claims or an obligation to sell long-term assets at an undervalued price 4. compliance risk any risk incurred as a result of failure to comply with federal laws or industry regulations compliance risk can lead to financial forfeiture reputational damage and legal penalties 5. reputational risk as its name implies reputational risk refers to any potential damage to a bank's brand or reputation banks can incur reputational risk for any number of reasons from the actions of a single employee to the actions of the entire institution let us say a news story breaks about a bank having corruption in leadership this may damage their customer relationships cause a drop in share price give competitors an advantage and more reputational risk implies the public's loss of confidence in a bank due to a negative perception or image that could be created with slash without any evidence of wrongdoing by the bank reputational value is often measured in terms of brand value advertisements play a significant role in forming and maintaining the public perception which is the key reason for banks to spend millions in content marketing dollars the reputational risk could stem from the inability of the bank to honor government slash regulatory commitments non-observance of the code of conduct under corporate governance mismanagement slash manipulation of customer records and ineffective customer service slash after sales services 6. credit risk banks often lend out money the chance that a loan recipient does not pay back that money can be measured as credit risk this can result in an interruption of cash flows increased costs for collection and more retail banks take a credit risk any time they lend money to a borrower without a guarantee that the borrower will be able to repay their loan the risk itself is that the bank might incur debt as a result of such an agreement now let us consider the two variations of credit risk counterparty risk and country risk 1. counterparty risk this is a credit risk variant linked to the non-performance of the trading partners due to the dismissal of the counterparty and or failure to perform in general counterparty risk is seen as a temporary financial risk associated with trading rather than average credit risk 2. country risk this is a credit risk variant linked to the non-performance of the trading partners due to the dismissal of the counterparty and or failure to perform in general counterparty risk is seen as a temporary financial risk associated with trading rather than normal credit risk 7. business risk this refers to any risk that stems from a bank's long-term business strategy and affects the bank's profitability common sources of business risk to banks include closures and acquisitions loss of market share and inability to keep up with competitors 8. earning risk earning risk is related to a bank's net income which is the last item on the income statement due to changes in the competition level of the banking sector as well as the law and regulations this could cause a reduction in the bank's net income recent increases in banking competition may narrow the spread between return on bank assets and the cost of funding in bank liability banking authorities are encouraging new banks to enter the local banking market to improve the competition within the banking sector the aim of increasing the competition within acceptable levels is to improve the local services and to reduce the cost of services these improvements are reducing the abnormal returns in banking and therefore this is increasing the probability of earning risk seven tenets of risk management in the banking industry here are the seven tenets of risk management in the banking industry one establish a language system to discuss and categorize risk a risk manager is overheard at a recent intra-departmental meeting the basel two-second pillar requires that we focus on the cap and it is inherent that the board of the bank fulfill their obligations in this respect and that sufficient oversight is provided by this rep at which point many of the participants have no idea what the risk manager is talking about but they are too afraid to ask questions so they nod their heads in polite agreement and hope no one will ask them for their personal opinion 2. develop a big picture view of risk exposure and focus on the most important not all risks are created or end equally banks need to be mindful of credit market and operational risks within the three main areas of risk further stratification is embedded to allow for a comprehensive overall view of risk tools such as value at risk var monte carlo simulations cash flow at risk far stress testing and others are applied to judge the level of risk and subsequently the actions required to contain the risks yet within banks there is often a lack of tools and sophistication to keep pace with a rapidly changing set of products at any point in time one or more risk elements may be more relevant than others but the bank needs to know its risk framework and monitor developments in real time to provide the right level of attention and action 3. centralize ownership of process and decentralize decision making risk management can be most effective when it is applied consistently across the banking organization with policies and procedures developed by risk experts who have the training and experience for their specific country area and client mix it is incumbent upon frontline officers to use the tools and processes to guide their daily interactions with customers interactions are clear answers are given in a timely manner and the responses leave no ambiguity about what the bank is able to do for its customer a good example can be drawn from banks in central europe pre and post-privatization prior to privatization and modernization many banks had a decentralized business model and it was a public secret that the branch managers made up the rules and profited handsomely from insufficiently transparent business practices this led to the failure of many banks in central europe post-privatization the banks focused on centralizing key processes around risk and then decentralizing decision-making down to the branch level with the knowledge that decisions would be made within the centrally developed framework this provided safeguards against unwanted risk 4. drive the process from the top and clearly define roles and responsibilities in the lead-up to the big bust the credit crunch banks were reporting record profits and the leaders were receiving bonuses for relatively short-term results it seemed that everybody wanted in on the big profits and paydays and little heed was given to people calling for curbing the growing risk profiles the clear lesson what the leaders in the organization do not so much what they say is what defines an organization's behavior risk management in a bank is everyone's responsibility not just the risk department leadership must not only espouse a vision but also behave in a manner consistent with it and demonstrate to employees that prudent risk management is a cornerstone to success 5. quantify risk exposure and the costs and benefits of managing risks the warnings were everywhere renowned financial experts were quoted almost every day the risks of credit derivatives are not quantified and nobody really knows how much is out there and w hat will happen when contracts come due we know now at least to this point what has happened had individual organizations been looking appropriately at the risks of purchasing the seemingly too good to be true derivative instruments perhaps they would not have taken them on with such seal and the problem would have been more contained at the original source which was the overheated mortgage market in the united states consistent and rigorous assessment of risk and quantification of the net benefits of appropriately dealing with the risk cannot be replaced with promises of above average returns with no knowledge of the potential downsides 6. embed it systems to facilitate the risk management process the value of it appears to be increasing over time to banking organizations as the environment grows ever more complex so there is no change in this variable in troubled times however the it value will be realized only if it systems development is driven by user needs and not vice versa it systems if properly developed and used can assist the company in risk management by providing control and compliance monitoring technology databases market and industry research and analysis tools and communication tools these are all critical tools that assist in the delivery of the required information to decision makers in the bank this can happen if the it systems are developed with the user's needs in mind.7 embed a risk management culture if a bank is serious about risk management then it will be serious from the top down leadership will espouse a culture of responsible risk management through its behaviors and through the systems and programs it puts into place in the run-up to the financial crisis organizations talked about good risk management however few in leadership positions espoused effective risk management which is evident in the dismal failures in the financial sector a risk management culture can be embedded in the organization through training communications and incentives risk management practices in banks banks must prioritize risk management in order to stay on top and ahead of the various critical risks they face every day risk management in banks also goes far beyond compliance as banks must be on the lookout for strategic operational price liquidity and reputational risk staying on top of these risks demands a powerful and flexible bank risk management program the number of individual regulatory changes that financial institutions and banks must track on a global scale has more than tripled since 2011. there are millions of proposed rules and enforcement actions across multiple jurisdictions that organizations must follow this requires regulatory change management to be a prominent practice within any bank's risk management program regulatory change management can be described in the simplest terms as managing regulatory policy and or procedures applicable to your organization for your industry regulatory compliance can be a burdensome and costly task for financial institutions so it is critical that organizations have the appropriate processes in place to identify changes to existing regulations as well as new regulations that impact the ability of the organization to achieve objectives it is equally important that organizations are informed of any potential consequences or fines should they not meet the regulation once a regulatory change has been made it is essential for organizations to assess how they will implement the respective changes to their current policies processes and training sessions as changes are implemented organizations should begin tracking compliance with the updated regulation going forward risk management process in banking industry having a clear formalized risk management plan brings additional visibility into consideration standardizing risk management makes identifying systemic issues that affect the entire bank simple the ideal risk management plan for a bank serves as a roadmap for improving performance by revealing key dependencies and control effectiveness with proper implementation of a plan banks ultimately should be able to better allocate time and resources towards what matters most size brand market share and many more characteristics all will prescribe a bank's risk management program that being said all plans should be standardized meaningful and actionable the same process for defining the steps within your risk management plan can be applied across the board here are the six stages involved in the risk management process in the banking industry stage 1 identity banks must identify risks across the organization in order to develop a meaningful risk management program note that it is not enough to simply identify what happened the most effective risk identification techniques focus on the root cause this allows for the identification of systemic issues so that controls can be designed to eliminate the cost and time of duplicate effort stage 2 assess assessing risk in a uniform fashion is the hallmark of a healthy risk management system it is important to be able to collect and analyze data to determine the likelihood of any given risk and subsequently prioritize remediation efforts stage 3 mitigate risk mitigation is defined as the process of reducing risk exposure and minimizing the likelihood of an incident top risks and concerns need to be continually addressed to ensure the bank is fully protected stage 4 monitor monitoring risk should be an ongoing and proactive process it involves testing metric collection and incidence remediation to certify that the controls are effective it also allows for addressing emerging trends to determine whether or not progress is being made on various initiatives stage five connect creating relationships between risks business uni ts mitigation activities and more paints a cohesive picture of the bank this allows for the recognition of upstream and downstream dependencies identification of systemic risks and design of centralized controls eliminating silos eliminates the chances of missing critical pieces of information stage 6 report presenting information about how the risk management program is going in a clear and engaging way demonstrates the effectiveness and can rally the support of various stakeholders at the bank develop a risk report that centralizes information and gives a dynamic view of the bank's risk profile it is however worthwhile to emphasize that the best way to begin the process of developing a sound banking risk management plan is by using enterprise risk management software obstacles to risk management in banks 1. regulatory changes the financial services regulatory landscape is in a constant state of flux with new regulations or amendments to existing regulations being handed down every month in response to political turmoil public sentiment emerging technology and more it can be challenging for banks to comply with the ever-changing rules but comply they must lest they expose themselves to compliance risk and the potentially severe consequences that accompany it compliance risk management in banks essentially boils down to three basic steps 1. the bank becomes aware of the regulation 2. the bank works to understand the impact of the regulation on its core business model 3. the bank implements the necessary changes in order to ensure compliance although it might seem simple on its face this process requires banks to expend a significant amount of resources financially and otherwise therefore the best way to conserve resources and achieve compliance that much faster is to automate compliance risk management newer cloud-based developer tools and highly automated devops technologies reduce the adverse impact of applying frequent regulatory changes to operational systems comprehensive cloud-based test systems can be spun up as needed for full-scale regression tests of complex financial systems and then scaled back down to eliminate the carrying cost of idle test systems 2. rising customer expectations today's customer is adept at using their personal device for tasks they would otherwise perform manually including banking this has led mobile banking apps to become ubiquitous that said these apps are often treated as a supplement to a bank's brick and mortar offerings rather than a one-stop shop even for more tech-savvy institutions their mobile app often pales in comparison to that of their online banking platform this is especially frustrating for younger customers who are accustomed to using their phones for just about everything and expect their bank's mobile solution to be just as functional as its online platform or branch operations the desire f or such a solution presents certain challenges mobile devices offer limited screen real estate which can make it difficult to design a user interface that's both aesthetically pleasing and easy to use 3. cyber security breaches as the financial services industry has become increasingly tech based cyber security has become part of the cost of doing business cyber security threats such as malware phishing and denial of service attacks grow more sophisticated with each passing day to the point where legacy systems implemented prior to the rise of big data analytics are incapable of fending them off as a result banks cyber security administrators often find themselves overwhelmed by false positives and spend a significant amount of time investigating things that are not actual problems the good news is that although cyber attacks have become more sophisticated so too has the technology used to combat them banks can now use artificial intelligence to perform rapid pattern recognition analytics across millions of questionable activities and filter out much of the noise this technology can also be used to automate essential cyber security tasks which is a major win given the ever-growing amount of banking data that lives in the cloud and that the existing pool of cyber security professionals is struggling to keep up with demand security information and event management software siem can also help security administrators stay on top of cyber security risk by helping them rapidly identify and resolve problems through the power of machine learning and analytics 4. fraud and identity theft similar to cyber security banks security admins are often overwhelmed by the number of false positives for fraud and identity theft in fact the only real difference between this bank risk and the last is that fraud and identity theft false positives are visible to customers and can interfere with customers ability to complete transactions and in some cases cost them money for this reason false positives are a significant detriment to bank operations and detract from the overall customer experience artificial intelligence ai can help to prevent cyber security breaches and false positives ai can also help with fraud and identity theft using ai banks have the ability to detect potential incidents of fraud and identity theft to a far more refined degree than ever before this has the dual benefit of preventing customers from experiencing the nightmare that is identity theft as well as eliminating false positives again this process can be automated which streamlines security efforts and comes at a huge cost saving to banks similarly ai and automation can be used in conjunction to quickly detect and shut down instances of fraud thereby protecting banks from financial exposure and reputational risk 5. inefficient internal processes every year banks need to look for ways to offset the increasing cost of operations in order to prevent liquidity risk or business risk automation and stringent practices for underwriting servicing and monitoring go a long way not only towards reducing costs but also toward preventing operational risk credit risk and compliance risk automation in particular makes it easier for banks to achieve regulatory compliance for example with custom automation functions configured to meet requirements outlined in such regulations as the beneficial ownership rule another key way banks can save money is by utilizing cloud technology cloud computing can introduce efficiencies that lead to substantial cost savings such as leveraging powerful analytics to cut costs on marketing and time to market for new products 6. increasing competition in today's world traditional banks face increasing competition from internet banks hungry to take market share and tech companies such as apple amazon and google that are breaking into the financial service industry this is especially problematic for local and regional banks which do not have the ability to make up for lost customers by simply expanding their geography in order to counter this encroachment traditional banks need to learn to interact with their customers in the same way that their non-traditional competitors do a shift that often requires them to rethink their customer engagement strategy from the ground up the most efficient way to get started is for banks to refresh their existing offerings and rejuvenate their portals in order to meet rising customer expectations f from there it is in a bank's best interest to partner with a consulting firm and systems integrator that can introduce new technologies that will enable it to meet different challenges and evolve its business conclusion risk management systems in the banking sector have been discussed in this video a bank faces many different types of risks and these need to be managed very carefully the risks in banks arise due to the occurrence of some expected or unexpected events in the economy or the financial markets risks can also arise from staff oversight or mala fide intention which causes erosion in the values of assets thus leading to a reduction in the bank's intrinsic value the risk management process in banking is one of the most effective ways of dealing with the vulnerability of the banking industry these are a few of the different types of risks and their management strategies to deal with the adverse situations of banking functionality with the proper risk management in banking the economy of the world will remain stable without the scenarios of unemployment or recession hope the video is educative and beneficial to you which aspect of risk management systems in the banking sector discussed in this video do you consider to be most crucial in your organization at the moment please post your answer to this question 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