Types of Risk in Banking Sector

By | November 5, 2021

With banking sector, many types of risks are associated that provides bad effect on banking businesses. So banks are more obliged to implement a strong and reliable risk management system because it is bank where people keep their hardly earned money with a believe of safety. Today, let’s see different types of risk in banking sector.

Types of Risk in Banking Sector

Generally, risk is the possibility of happening something bad that may cause losses and damages. It is uncertainty about consequences and happenings in future. And, risk management is the process of identifying and analyzing all the possible risks and future uncertainties in order to be pre-ready to overcome it’s bad effect and consequences.

Types of Risk in Banking Sector

  • Credit Risk
  • Market Risk
  • Operational Risk
  • Liquidity Risk
  • Reputational Risk
  • Business Risk
  • Systemic Risk
  • Moral Hazard

These types of risk in banking sector are explained in detail as follows:

1. Credit Risk

It is the possibility of loss that a bank may face when a borrower fails to repay the loan amount because of death, business loss, inadequate income, unemployment, unwillingness etc. Credit risk is associated with loans, credit card, swaps, bonds, trade financing, equities, options etc.

As we all know that major source of income of any bank is loan. Bank accepts deposit from people and provide loan in order to make profit. But all loan that banks provides not get recovered rather some result in bad debts. So, credit risk arises when a borrower fails to meet the terms and conditions as agreed with the bank.

2. Market Risk

Market risk is defined as the risk of loss that a bank may face due to changes in the value of public market indicators. It is the potential loss that can occur due to fluctuations in interest rate, stock price, foreign currency exchange rate, commodity price etc.

3. Operational Risk

Operational risk is the risk of loss that may occur due to human error, system failures and programming errors, improper information processing, leaking or hacking of information and inaccuracy of data processing. This type of risk is mainly occurred due to human errors and failure of internal processes.

4. Liquidity Risk

If a bank is unable to meet it’s short term financial obligations due to shortage of cash and other assets then it is called liquidity risk. Lack of marketability of an investment that can not be bought or sold quickly enough may also cause liquidity risk. This badly effect the day to day cash transactions of the bank.

5. Reputational Risk

Just like any other businesses, a bank also have it’s own reputation, goodwill, brand image in the market. Anything that a bank does is judged by its customers, investors and other stakeholders that directly or indirectly effects on it’s reputation. So, reputational risk is the possible loss of the bank’s reputational capital, goodwill and image. Reputational risk depends on many things such as bank’s daily activities, rumors about the bank, customer service etc.

6. Business Risk

As we all know that the final target of any business is to make profit. And business risk is directly related to the profitability of the bank. If a bank is experiencing lower profit than expected or experiencing loss rather than profit then this is called business risk for the bank. Business risk arises when a bank is unable to adapt market conditions and changes due to failure of bank’s strategies, plans and policies.

7. Systemic Risk

Systemic risk is the risk that doesn’t affect a single bank or financial institution rather it affects the whole industry. It arises due to failure of entire system that all follows. It is related with the cascading failures where the failure of a big entity can cause the failure of entire industry. There are many factors that may cause systemic risk such as inflation, climate change, wars, currency rates etc.

8. Moral Hazard

This kind of risk is faced by the bank due to mistakes of other big bank or large financial institutions. If a big bank or financial institution takes risk knowing that someone else will have to face burden of the risk if things go badly then this is called moral hazard.

How Banks Can Deal With Different Types of Risks?

Banks are required to manage different types of risks and to do so, they need to be able to identify the risk and assess its probability and impact.

The banking industry is going through a lot of changes and it is not just the banks that are changing. The customer base, technology, competition, regulation, etc. are all constantly evolving. Banks need to be prepared for these changes and be able to deal with them in order to stay relevant in the market.

  • The best way to deal with different types of risk is by taking a risk-based approach. Banks should identify the type of risk they’re dealing with and then take appropriate measures to mitigate it.

Banks are responsible for managing risks. They are well aware of the fact that there are many types of risks. It is important to understand these risks and how to deal with them.

What are the Most Increasing Risks For Banks in 21st Century?

Banks are always looking for new ways to expand their services. With the rise of fintechs and other financial institutions, banks are looking for ways to stay competitive. One way they can do this is by investing in cyber security. There are many different types of risks that banks face, but they all have a common thread: cyber security.

3 Most Common and Highly Increasing Risks for Banks are:

  1. The first type of risk that banks face is a cyber attack from hackers, which could lead to stolen money or data.
  2. The second type of risk is fraud from customers, which could happen when the customer falsifies information on a credit card application.
  3. The third type of risk is fraud from employees within the bank itself. This can happen when an employee takes money or data without authorization or when an employee uses their privileges to commit fraud outside the bank as well as inside it (e.g., a teller who also sells drugs).

So, these are the types of risks in banking sector. If you have any confusion regarding anything, request you to post it in the following comment section. Thank You!

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