Explain the basics of Risk Management

Due to globalization, the banking sector has been spread to the greater extent. As a result of this our financial services have been exposed to number of changes in the market. As far economy is concerned we need to opt proper guidance towards risk management. Banks acts an intermediator for channelizing the funds through mobilization and funds’ deployment. It results in exposure to different types of the risk like that of credit risk, liquidity risk, interest rate movement risk, foreign exchange risk etc.

Risk can be stated as the a loss that is potential in nature from the banking transaction in the form of the investment in security, loan etc and this can be happen to many kind of reasons. These types of risk takes place because of the uncertainties which in turn take place due to some of the changes in the existing financial, economic, social or political environment and also due to unawareness of the changes that have occurred in the system. If the system is ignorant regarding latest updates then it will be difficult for financial system to be stable. Hence it will result in the risky financial situations. If the risk elimination is not possible, then the risk management deals with the identifying and minimizing the risk factors and hence solving the problem to some extent rather than not at all paying attention towards the risk in the financial management. The main aim of risk management is to stake the value of the holder by enhancing the profit and observing the capital funds to ensure long term solvency of banking sector concerned.

The risk management consists of different functions like that of risk management, risk measurement, risk control and then monitoring and reviewing. The risk identification deals with the making understand the type of the risk, the reason due to which that situation was arisen. The different factors should be kept in mind wile dealing with risk identification process. There are different factors for different types of the risk. Hence different types of risks should be kept in mind while its identification. Various kinds of risk are financial risk and non financial risk. Financial risk consists of credit risk and market risk. Credit risk is further divided into two parts i.e. transaction risk and portfolio risk. Market risk is also subdivided in three parts i.e. interest rate risk, liquidity risk and forex risk. Non financial risk is of only two types. They are operating risk and systematic risk. Then next step is of risk measurement which refers to the degree of risk that is likely to take place due to a particular situation or financial transaction or activity. Normally it is difficult to access the risk and measure its degree. However the same can be determined by the help of the risk rating models. These kinds of models can be developed and also one can get the ready made models and change them according to the need and situation of the organization. It can be done according to the suitability of the situation. The next step being the risk control it is considered as the most important step of the risk management. Risk control includes the risk mitigation and risk aversion. Different tools for risk mitigation are business diversification, hedging and insurance, securitisation and reconstruction, transfer of the risk to other party and fixation of exposure ceiling. Then comes the risk monitoring and risk pricing and risk monitoring bankers fix the parameters on which risk is monitored so that there is no chance of risk in viable existence. The fundamental basic of risk management is fixation of the price on the basis of degree of risk. Prices are fixed in such a way that loss could be taken care of without putting burden on capitals. Basically risk management is very important factor that needs to be kept in mind when it comes to the financial state of an organization. The risk management not only helps us to maintain the stability in the economy of the organization but it also helps us to reduce the risk factors that are dangerous to put the organization in the state of bankruptcy.

The risk covering factors of the financial system should be kept in mind before hand only. It is rightly said that the prevention is better than cure. It means that risk management should be taken care of before hand only. Reserve Bank of India issued some guidelines to avoid risk and also related to the risk management of credit market and operational risk. Risk rating system should be set up by the banks for the counter parties. Definite time period should be fixed for the banks to move over to the Value at Risks (VaR). Banks need to create methodology for maintaining the capital of the economy. Investment proposals should also be subjected to the credit risk analysis. Potential credit exposure should be measured on the daily basis. Limits should be placed on inter banking borrowing in order to manage the liquidity risk. Contingency plans should be provided by the banks in order to meet the adverse problems in the liquidity conditions. Organization that is suffering from risk should integrate the activities of ALCO and credit policy committee. Portfolio quality should be evaluated on the ongoing basis rather than maintaining it on near the date of balance sheet. It will be difficult to take care of the risky factors in less span of time. So it is mandatory to fix it well on the time before it is too late to mend the ways. Call funding, core deposits to core assets, purchased funds, swapped funds, off balance sheet commitments are some of the methods included in the management of the liquidity risk. The proposals of investment should be included in total risk evaluation. These guidelines were issued by the Reserve Bank of India on Oct 20, 1999 broadly covering the management of credit, market and operational risks in a organization. Although exact measurement of risk is not possible but I could be controlled to a extent by keeping few things in the mind.