risk management

Running Head : Risk Management

Risk Management in Banking Sector , Interest Rate Risk , Liquidity Risk Operational Risk , Most Important Area of Risk Management

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Risk Management

Introduction

Risk Management is the process in which the financial supervisors identify the key risks in front of them , acquire coherent and logical measures to cope up with the risks , make decisions to point out the risk area , select tools to minimise the risk and design methods in to monitor the resulting risk position (David H . Pyle 1997

) The financial markets are encountering several risks in the modern and futuristic world of today . The increased risk factor has changed the economic scenario due to which many financial institutions are also suffering from financial instability . It is also predicted that financial risks will become more challenging and exigent in coming years (FSA , 2007

The current situation highlights the management in the financial sector because the ongoing changes in the sector are raising the risk level at alarming rate . Banks are making structural changes (Jill L .Wetmore , 1994 ) in their balance sheets and risk-based capital requirements (John R . Brick , 1994 ) In addition banks are now eager to implement day-to-day accounting (Wetmore , 1996 ) for maintaining their transactions . These changing trends are inviting the risk factors into the financial sector and hence the need for risk management goes to its peak

The banking sector is heading the risk factors in many areas . These include market risk , operational risk , performance risk , liquidity risk credit risk and interest rate risk (H . Pyle , 1997 ) Our discussion about the risk management with reference to banking sector will emphasis upon the three major risk areas which are Interest Rate Risk (IRR Liquidity Risk and Operational Risk . All of these three areas are very critical and there is substantial requirement of sound risk management practice in these areas . Issues related with these risk areas and proposed methods to deal with them are described below

a ) Interest Rate Risk and BIS method

The banking sector is going through a phase of sensitivity related to the interest rate risk (Flannery and James , 1984 ) The background for the interest rate risk is prepared when the banks engage themselves in activities like taking loan , purchasing securities and taking deposits with different securities so that they can execute their business and offer different products and services to customers to meet their demands (Comptroller 's Handbook , 1998 ) These activities often lead the bank to a situation where their earning and the capital get exposure and they start facing the Interest Rate Risk or IRR . The investment securities that have been assessed through the market-to-market valuation (Gilkeson and Smith , 1992 ) accelerate the level of interest rate risk and bank can not conceal the assets value decline resulting from the increase in the interest rates (Wetmore , 1994

The interest rate risk level also effect and influence the activities and performance of the bank (A .S . Ahmed , Anne Beatty , 2004 ) however this assumption has been criticized...