Literature review of Risk Management in Banking

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

The current economic situations caused by financial shifts, the output of businesses in large numbers are sinking. Poor conditions, deficiency of resources, choice of incorrect techniques, impracticable schedules and lack of expertise are involved in the majority of collapses. To secure the banking sector from the unfavorable effects of the global ¬nancial disaster, the rations need to be dealt with risk assessment and controlling actions. Risks are typically identified by the adverse impact on effectiveness of a number of discrete sources of ambiguity. Financial risk in banking is likelihood that the outcome of an action or incident could initiate discouraging impacts. Such results could either bring up a direct loss of income/investment or may induce imposition of restrictions on bank's capacity to meet its business targets. Such restrictions proffer a risk as these could obstruct a bank's capability to perform its evolving business or to make use of favorable circumstances to expand its business.

Risk management represents the background, approaches and plans that are indicating towards the successful administration of buried opportunities as well as hazards. Determinative risk managing optimizes the persistence between threats and control. Risk management agenda can be accepted as a "path" which will assist the bank owners to effectively and expertly administer the resources, program, and quality of core actions. The magnitude of risk management cannot be underrated at any stage. Though banks might have reasons to consciously perform an unsatisfactory job so as to meet cost reduction targets, a surplus of calamities have revealed that these attempts rush at great risk. Even the potential of some mega players has been in danger: some carried on; while the others were put under close watch and/or were disowned. The course of financial risk management consists of policies that allow an organization to control the risks linked with financial markets. It engages and effects many divisions of an organization including depository, retail sectors, advertising, legal, tax, property, and corporate finance.

It seems correct for any debate regarding risk management procedures to start on with why the firms deal with risk. As stated by standard economic theory, directors of cost maximizing firms should magnify projected profit without observing the changeability around its estimated value. Hancock (1991), Avery and Berger (1991) and Marshall and Siegel (1996) are a few names to mention who put their outstanding contributions for providing an emergent literature on the explanations for active risk management. In fact, the latest analysis of risk management documented in Bhattacharya and Thakor (1993) enrolls dozens of offerings to the area and at least 4 distinctive justifications presented for active risk management. These contain supervisory self interest, the non-linearity of the tax composition, the overheads of financial desolation and the existence of capital market fallibilities.

The risk management procedure entails both interior and outer analysis. The opening part of the process entails determining and prioritizing the financial risks facing by an organization and comprehending their consequence. Risk identification covers observing and documenting risks that will liable to have a damaging effect on the business. The detection and related scrutiny is a usual practice that should be done constantly. Both internal and external risks should be distinguished. Internal risks are those that can be easily manipulated within the bank environment. There are various methods available to assist in recognizing risk areas that comprise historical facts, work breakdown structure, risk record and business policies. It may be crucial to check the organization and its products, supervision, clients, providers, opponents, pricing, industry movements, balance sheet configuration, and position in the business. It is also obligatory to think about stakeholders and their aims and sensitivity for risk. Once a genuine understanding of the risks comes forward, proper strategies can be executed together with risk management policy. For instance, it might be the likelihood to adjust where and how business is performed, in so doing dropping the organization's exposure and threat. A different strategy for coping with risk is to welcome every risks and the option of losses silently.

There are three open substitutes for managing hazard:

1. Do nothing and aggressively, or inactively by default, receive all risks.

2. Hedge a section of vulnerabilities by finding out which vulnerabilities can and must be hedged.

3. Hedge all potential weak spots.

Assessment and reporting of risks facilitates conclusion makers with data to perform decisions and observe outcomes, both before and after approaches are taken to lessen them. As the risk management process is unending, reporting and remarks can be used to improve the system by amending or refining strategies. A dynamic decision-making process is an imperative constituent of risk management. Decisions on probable loss and risk mitigation provide an opportunity for discussion of central issues and the unfixed standpoints of stakeholders.

Risk management is performed centrally employing policies designed by the General Management. Such guidelines classify the categories of risk and identify the procedures and operating limits for each form of business deal and/or mechanism. Financial risk management is integrated at the Treasuries Zone which has the chore of measuring the risks and locating into place the respective hedges under the synchronization of Group Treasury. The Treasuries Zone manages directly in the market for the Operating Units and, where they cannot control directly because of external limitations, they attune the actions of Local Treasury Sectors. One more way of detecting risk, again highly important for risk management and risk perception chiefly in our perspective of public procurement, is to consider demand and supply as foundations for risk.

Jorion (1997), after evaluating the position in the toy industry, examines that the order for fad-driven goods can swing from moderate to boiling at once and then abruptly evaporate as the next hot product launches in the market. Considering supply, supply chain risk designates a vagueness or unpredictable incident affecting several bands within the supply chain, which can harshly impact the success of business goals. As the supply chain grows to be at large-scale, risk management and risk lessening has to be element of the supplying policy. Supply risks involve e.g. those that potentially obstruct or postponed operations like political insecurity and unstable labor market; possible hazards that an opponent will take over a broker and potentially freeze supplies, risks interconnected with delays and unsatisfactory quality. Inbound supply risk has been described as 'the likely happening of an event linked with inbound supply from individual brokers or the supply bazaar, in which its results cause the failure of the purchasing organization to accomplish customer request or result in threats to customer life and wellbeing.

What can be executed to alleviate such insecurity and risk? Best organizations are reviewing their supply chain and are modifying the talents, methods, and tools required to struggle in these days unstable global market. They are raising themselves robust questions and analyzing their supply chain from various aspects. These consist of:

How do we calculable identify risk, and are we aligned and unvarying in our definition?

Are our providers meeting our targets on value, cost, deliverance, scale and protection?

Is our used contemplation by category, geography or supplier producing additional risks? Do we consider more than spend relating to risk (i.e., quality, consistency, business stability, etc.)?

How do we mitigate risk from lower-tier service providers?

Do we have to upgrade the abilities and potentials of our supply chain and procurement team to meet the multifaceted demands of our recent setting?

Do other sectors realize their responsibility in sponsoring a top-in-class supply chain?

Have we documented and trained every single supplier against conditions for a range of regulatory actions and do they meet inspection prerequisites?

Until any party can answer these questions in the positive, the risk of crash exists there. Through a practical, fair evaluation of all attachments in the supply chain, the risks can be totally recognized and minimized. Basically, the purpose of any supply chain risk management plan should be to observe, control and figure out supply chain risk, which will serve to maintain stability and magnify productivity. The product of not executing these key steps could bring about a serious collapse in supply chain functioning further trimming down your competency to optimize the continuation of product to the client. Valuable supply chain risk management offers the facility to predict and respond quickly to external developments and activities. It sets an emphasis on perplexities and the unforeseen. This in turn, will help organizations to resist with the existing economic hurricane and remain a workable business unit.

In 1993 Froot attaches a vital property of risk. For him, risk occupies not simply the doubtfulness, but the fact that should an incident take place (in other words, should something go awry) as well. The banking sector is constantly procure tougher challenges in meeting different risk management provisions, and regardless of how tough it is, the existing operations forces the risk managers to be attentive, and extraordinarily sharp towards the causes of defending the interest of the people involved. If the outcomes do not change the cost-benefit estimations, we may face ambiguity that something goes on and transforms things, but there is no threat, as there are no discouraging outcomes. As said previously, risks in public acquirement can only be appraised if they are balanced and related against the benefits connected with a definite procurement. For example, the possibility of failure to distribute a public service or to deliver it behind time or much high-priced, must be evaluated against the comparative benefit outside this productive service for the organization and the private stakeholders plus against the expenses of evading threatening events to occur and - if they take place - to curtail their disadvantageous results. In Froot's justification, the risk would alter the effectiveness of an action, but if this effectiveness is still high, if the cost‐profit considerations are still encouraging even though the incident of the risk to take place, the function may still be performed. Similarly, if the service without the risk to happen is tremendously high, and the possibility of the risk to take place is esteemed to be pretty low or the unconstructive consequences of failure are reasonably priced, there is no hesitation to accept risk. As Hancock, Avery and Berger (1991) indicated that risks involved in drastic improvement normally have been designed according to three aspects, the level of ambiguity, the extent of manageability and the relative weight (in other words: profit). If the chances of a shocking result is high, the talent and resources offered to manipulate and tackle outcomes are limited, and the likelihoods of collapse is high, a project should be tagged 'hazardous'. Efforts to determine risk sensitivity and risk horror made through inspecting behavior of game show contestants create risk aversion within folks.

It has been asserted that risks facing all financial institutions can be divided into three independent types, from a management standpoint. These are:

(i) Risks that can be removed or hedged by plain business practices,

(ii) Risks that can be assigned to other contributors, and,

(iii) Risks that must be passionately handled at the firm level.

The risks enclosed in the bank's major activities, i.e., those concerning its own financial statement and its central business of lending and borrowing, are not totally entertained by the bank alone. In various cases the institution will remove or lessen the financial risk linked with a transaction by suitable business doings; in others, it will transfer the risk to other delegates through a blend of pricing and product design. The banking sector identifies that an institution need not participate in business with an approach that without reason enforces risk upon it; nor should it take up risk that can be resourcefully handed over to other participants. Rather, it should merely deal with risks at the organizational level that are more easily handled there than by the market itself or by their holders in their own groups. To sum up, it should readily undertake those risks that are completely a feature of the bank's range of services.

In banking, the core attraction is primarily on risk factors contained within traded financial mechanisms. In meeting the necessary attributes in banking sectors, there is a need to supply human and financial resources everywhere in the firm, an ample amount to meet the objective of an effective risk management structure. In proving these funds, it is required to assign proper command and liberty in the working process. There needs to be a responsibility of 'possessorship' in the fulfillment function, with the aim that the organization can maintain itself allied with its compliance risk management duty. A complete database should be prepared, together with screening and evaluating of the risks occupied in any sort of incidents, which collectively, may provide purposeful reports based on the acts and conventions directing compliance risks, coupled with on hand or new products, and upcoming business movements. The banking divisions need to comprehend operational risk at the organizational level, where the involved risk factors are compacted into one, making it a bit obvious to have an authentication of operational risk engrossed.

A British bank is run skillfully. Tradition, obedience, and set of laws must be the driving engines, excluding them - disorganization! Hostility! Moral breakdown! To be brief, we have a horrible mess! When investors are allowed to be revolting, then we have a ghastly disorder. And that is just what we have right now: a horrible unruliness. This ghastly anarchy is to reproach on the bankers' moral extent losing its track and not having strong bindings to obtain it back.

Even though most dominant financial institutions in the UK have deteriorated due to the banking disaster, the degree to which they have been affected fluctuated extensively. In assessing how the failure of British Banks had an impact on the associations which are now partially or totally publicly owned, it becomes noticeable that numerous factors caused different banks to stop working. Thousands of employments in the financial zone have been depleted. Joblessness rate is growing high day by day. Land prices have descended sharply and loans are much difficult to achieve. It is not simple to compute approximately what will be the overall expenditure to public funds of the banking crisis but the detriment will be massive.

Consider the example of Royal Bank of Scotland (RBS). One of the two British Bank giants: The Royal Bank of Scotland (RBS) engaged in retail banking in the UK, largely in Scotland and northern England. In 2005, RBS was reorganized and a Global Banking division was formed which is a dominant banking collaborator to prime corporations and financial associations all through the globe, providing a wide collection of debt financing, risk control and loan services to its clients.

Here we mention a few explanations that led RBS near crackup. RBS led a cartel which paid 71.1 billion Euros (£64.7 billion) for the Dutch bank, and later divulged that they had overpriced by between £15 and £20 billion and additionally the transaction was finally approved in October 2007 at a time when the fiscal markets started to decline. This designates that RBS disbursed the faulty price for ABN Amro and at the inoperative occasion.

As mentioned in Wall Street Journal (2008) one more reason detected for RBS collapse was the existence of incompetent risk management plans, which required a lot of modifications. Actually, there had not been a lawlessness of merchandising decisions, but that the controls themselves were formulated in an incorrect manner, which means - there was a concern not regarding risk identification but about how the risk was fixed … The risk was detected but in the risk systems it was computed as being negligible: it eventually became sizeable and it was wrong. Chief executive of the bank verified that there had been no alarm bells from the risk management division within the bank that had been ignored. It is unbelievable that Boards of Directors and even high-ranking executives have the basic level of capability required to drive the budding system. To conclude, handling such a multifaceted system requires a vast awareness of the risks considered and the techniques exploited to assess them. 

Moreover, we have the role of electronic components. Telecommunications formed a world where screen-based merchants working in high frequency trading chambers could achieve or lose billions instantly. So there are numerous big discrepancies between this devastation and prior ones: First, industrial science has dissociated trading from realism; second, the disaster is on a large-scale, not just associated to a particular geography or land, as all countries are united through technology and trade this time all over; third, that risk models and risk management were gravely inconsistent; and in conclusion, "that the opportunities to express voracity have grown very much". The outward appearance now is same as casino capitalism, where bankers carried out their barter via screens of integers. In real life, we can perceive the actual importance of our goods and services, finances and maneuvers; in a pure play domain of computer-assisted trading using investment mediums that are one time, two times or three times separated from the real belongings they connect into, it is not easy to distinguish the risks involved or the veracities.

Although at present, bankers have still been dutiful for the public. They have allowed the access of trade and exchange to switch from provinces to networked industries; they have encouraged work and standards of living for many to benefit from an unmatched period of permanence in the world's economies with luxury and contentment for many; whilst also considering producing new techniques of working completely through the globalized economy; and the amalgamation of advancements in technology and financial markets has indicated that we can witness massive expansions in attaining avenue to capital and liquidity when obligatory. But banker's these days have also been dreadful for the community. They have waste their decent compass and become voracious to the point of inflaming civil disturbances; they have behaved foolishly without any awareness of the risks they are accepting; they have rely upon world markets with capital and resources that are the property of others; and they have demolished companies, lives and markets through unwise trading with risks that are out of control.

Banks exploit a choice of sources to recognize, examine, and calculate risks to understand their probable profits or losses on banking dealings. This is why banks check credit information, employment record, earnings, and other sources to find out the risk level of every consumer. Banks deemed they were curtailing risks and rewarding their combating behavior by selling their mortgages to others and gambled on the incessant generation of interest revenue. As the markets deflated, the amount of wealth spent openhandedly in lending activity blocked unexpectedly. The Federal Reserve restored this condition by offering lines of credit and promises of liquidity to leading banks, assisting them to start again lending to smaller banks immediately.

If a bank is passionate to carry on business with a customer who has not a stimulating financial set up, they will normally reduce their risks by charging high prices or interest rates or even involve a subscriber. Additionally, interest rates also cause a risk to the banking industry. Generally it is noticed that as interest rates boosts, lending activity falls down as numerous borrowers are not prepared to finance supplies or services at a higher expense. When interest rates drop, a raise in lending activity is observed primarily. In general, risk is a conception not exclusively properly covered in the literature. Our perceptive for the rest of this report is that risk is measureable ambiguity for something to take place that lets missions stop working, cuts their efficacy or magnifies their overheads and time period. Motivate, strengthen and modernize extraordinary operations in risk management. Risks can almost never be fully eliminated; however they can be narrowed down.


Methodology is the method a research is conducted. The methodology is the tool to tackle the research while using different sources. It can also be narrated as a conducting way of research. It defines how research should be carried out including the theories and philosophies on which the research is being made. (Saunders et al - 2003). Research Methodology supports in coming to a decision that how work is done in addition to the styles and techniques used for carrying out the research (Swetnam - 2004). To fulfil the objectives of this report, it is necessary to carry out primary and secondary research coupled with the theories and matter discussed in literature review. So this section will identify the methods that will be used to justify and answer the research topic. Research is a systematic way of collecting data from reliable and suitable sources. A research lacking of any clear purpose will be unrelated to the readers.

Saunders (2003) writes that a quality research has to possess two key variables.

It should have clear purpose to fining out things

Data for research should be accumulated and represented in a systematic manner.

So with a very clear topic of digging out the factors of motivation in McJobs we will accumulate data from reliable sources. It will further be experimented on our hypotheses and will conclude our results in a systematic way. Ghauri & Gronhaug (2002) argued that it is vital to collect and interpret data in a systematic way. It will make a sense that research will be predictably based on logical relationships rather than depending on assumptions or beliefs.