Risk Management In Banks

Introduction

In the history of banking, there are too many instances of bank suffered in loss and failure, especially at the time of recession. Bank failures have a significant impact on the financial system and country’s whole economy. But, what causes those banks failure during recession time? The answer should be the failure of risk control by banks. Banks are highly geared financial risk-takers. They are encountering various risks every day. For example, i) borrowers fail to repay their loan; ii) depositors demand the withdrawals at a faster rate than the banks has reserved for; iii) market interest rate affect the value of loan; and iv) bank securities lose its values. When things go awry the results can be spectacular. Therefore, risk

In banking, the suitable definition of risk is “exposure to uncertainty of outcome”. Exposure refers to a position in the outcome, without which our interest is merely academic. Outcome is the consequence of a particular course of action. Else, uncertainty is defined as the volatility of potential outcomes. The greater the volatility, the higher the risk (Eddie Cade, 1997).

In managing and measuring the risks, banks are actively engaged in risk management to preserve the banks’ position and ensure profitability. Risk management is a comprehensive process, which includes create an appropriate environment, maintain an efficient risk measurement structure, monitor and ease off the risk-taking activities and establishing an adequate framework of internal controls (Claudia Girardone, 2006). Banks usually use the risk management to identify the potential of losses in an investment and then take an appropriate action to tolerate the risk and meet the investment

The consensus is that the overall commercial banks’ financial condition contributes to the several risks that affect bank performance. Anthony M. Santomero (1996), Alina Mihaela Dima and Ivona Orzea (2009) and David H.Pyle (1997) included the market risk, credit risk, operational risk, liquidity risk, interest rate risk and foreign exchange risks as the areas of concern and on-going risk monitoring and management in their papers. Oldfield and Santomero (1995) argued that risks faced by bankers can be divided into three different types. These are (i) risk can be eliminated or avoided if in prospecting, (ii) risk can be liquidated by transfer to another party and (iii) risk that must be accepted and managed at the firm level. Anthony M. Santomero (1996) stated the banking firm relied on the four-step process to implement a risk management system. The sequence of steps started with (i) standards and reports, (ii) position limits or rules, (iii) investment guidelines or strategies and lastly (iv) incentive contracts and