Comprehensive Analysis of Banking Risks and Regulations Report

This report provides an in-depth analysis of various banking risks and the regulatory framework that governs the financial sector. It begins with an introduction to credit risk, market risk, and operational risk, highlighting their significance and impact on the banking industry. The report delves into different types of banking risks, including business risk, systematic risk, moral hazard, reputational risk, and cybersecurity risk, offering insights into their causes and consequences. Furthermore, it evaluates credit risk in detail, examining the Basel Committee on Banking Supervision's perspective and the importance of risk management departments. The report also explores the impact of market risk, including interest rate risk, equity risk, commodity risk, and foreign exchange risk. Operational risk is another key area of focus, covering human, system, and process risks. The report also touches on liquidity risk, business risk, moral hazard, and reputational risk, providing a comprehensive overview of the challenges faced by banks. Finally, the report includes a conclusion summarizing the key findings and a reference list for further study.

Running head: BANKING RISKS AND REGULATIONS
Banking risks and regulations
Name of the student
Name of the University
Author Note

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TABLE OF CONTENTS
Introduction................................................................................................................................2
Significance of various forms of risk.........................................................................................3
Evaluation on Credit risk.........................................................................................................10
Conclusion................................................................................................................................12
Reference list.......................................................................................................................................14

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Introduction
The probable risk of loss which usually results from the failure of the borrower to repay
loans or meet any contractual obligations is termed as credit risk. Credit risk also refers to
that risk that lenders might not receive the owed interest or the principal amount which can
lead to an interruption of the cash flows and increased cost for collection. Over the past few
decades the financial service industry went through manty significant transformation as a
result of both external and internal factors. Transformation of the business model, adoption of
advanced technologies along which changes the regulatory environments are the reason
behind transformation of the financial sectors (Shahriar, Schwarz and Newman 2016). A
bank faces different kind of risks which must be managed carefully. When the bank is not
able to take its money back from the company, then the stake of the bank will be going down
and therefore the bank will be in a financially weak position. On the other hand the regulation
in banking is a kind of government regulation which are generally subjected to banks which
are also designed in order to create the transparency in the market. The objectives of
regulations comprises of reduction of systemic risks, prudential and avoiding misuse of
banks.
This will also make the depositor to withdraw money from the bank. The risks that the
bank faces can be divided into here categories which are unrelated risks, significant risks and
unrelated risks. The eight types of major risks that the bank faces are:
 Credit risk
 Market risk
 Operational risk
 Liquidity risk
 Business risk

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 Systematic risk
 Moral hazard
 Reputational risk
 Cybersecurity risk
Significance of various forms of risk
The three major kinds of risks of the banks comprised of market risk, operational risk and
the credit risk. Banks are known for setting up departments which includes risk management.
Department of the management of risks help the management of banks by measuring
different portfolio of the assets, loans, deposits along with liabilities.
Business risk: the risk that arises from the business strategy in the long term is known as
the business risk. In few cases when the banks cannot adapt to the changing environment
compared to the competitors, the bank then faces the risk of losing the share of the market
and they have to shut down (Stulz 2015). As the technology is transforming the banking
industry at fast pace, it therefore needs to develop the banking interface. Business hazards are
affected by various components which includes deals volume, per unit value, rivalry and
government controls. The banking industry in the recent decade is diversified and quite
advanced. In today’s world bank have a huge variety of strategies from which they can
choose and when one such type of strategies is chosen, banks are needed to focus their
resources for obtaining the strategic goals in the long run (Bonner, Van Lelyveld and Zymek
2015). Therefore, there can be presence of risk that a bank may tend to choose the wrong
strategy and this can result for the banks to suffer losses and end up being collapsed.
Therefore, there will be absence of any possible ways to mitigate the risks for the banks
which are generated by not following appropriate business objectives. Banks like DBS and

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BBVA makes strides in the innovation of technology in order to make the changes in the
demands for consumers either with the strategic partnerships or with the in house
developments. Players which are non-financial includes Amazon and Tencent invests the in
house development of technologies of the new age so that financial services are offered.
Some of the factors which affects the business risk comprises of variability in demand and
selling price, uncertainty in input costs, speed of the changes in technology and the ability to
adjust the price. This kind of risk is generally influenced by the sales volume, per unit price
and the government regulation.
Credit risk: the Basel Committee on Banking Supervision states that the people who
borrows from the bank does not meet the obligations of payment regarding the terms which
are agreed with the banks. It consists of the uncertainty involvement in the repayment of the
dues of the bank along with the repayment of dues on time. As a result of incorrect evaluation
the national as well as the global banks suffered huge losses (Ndungo, Tobiasand Florence
2017). The financial institutions also face huge losses due to inappropriate monitoring of the
default on the payments of the mortgage by the subprime borrows which resulted to damages
in billions of dollars and can result to loss of millions of jobs. Credit risk results to failure of
the business of the borrowers, inadequate income and also due to underwriting frameworks.
The credit risk is a kind of risk which takes place as a result non-payment of loans by the
borrowers. This is a type of risk which usually takes place due to non-repayment of loans
from the borrowers. The unpaid loans are the by-product of conducting the business of
banking, as a result of this the modern banks have prepared to handle the situations in order
to avoid any loss. The bank’s profitability is very sensitive to the credit risks. Therefore, even
there is a rise in the credit risk by a minute amount it will impact the profitability of the bank.
Therefore, in order to avoid such risks banks have come up with various measures. The

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financial institutions holds those funds which are usually kept in the reserves so that risks are
mitigated.
Market risk: According to The Basel Committee on Banking Supervision, market risk is
stated as the risk of losses in on or off-balance sheet which rises from the market price
movement. The market risks comprised of different kinds of risk which includes interest risk,
equity risk, commodity risk and foreign exchange risk. Commodity risk results from the
potential losses which results as a change in the price of the commodity. As a result of
continuous variations in both supply and demand there is a fluctuation in the prices. The
foreign exchange risk is the loss which results because of change in the value of the assets of
the bank. It also results from the fluctuation of the exchange rates. The losses which occurs
due to change in the prices of the stocks as a result of banks accepting equity against
disbursing loans. Market risks takes place when the factors affects the overall performance of
the financial market which can also be referred as systematic risk ( Mengze and Wei 2015).
Banks usually market risks in different forms. Banks hold huge proportion of securities apart
from making loans. As a result of treasury operations of banks in the short term, some of the
securities are held. Securities are usually held as collateral where banks needs to provide
loans to the customers. The business of banking is intertwined with the business of capital
markets. Therefore, for mitigating such risks, hedging contracts are used by the banks. With
the help of using contracts such as forwards, options and swaps, banks can remove market
risks from the balance sheet. This kind of risk is the possibility of the investor who
experiences losses as a result of factors affecting the overall the overall performance level of
the financial markets. They are also sometimes referred to as the systematic risk.
Operational risks: banks need to conduct huge operations to make it profitable.
Operational risk results due to failed business process in the day to day activities of the bank.
Some of the examples of the operational risk includes payment credited to the wrong account.

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Maintaining a large scale internal process is quite a difficult task. Operational risks also
results mainly due to hiring of the wrong people. This risk which remain after determining
financing risk which results from breakdowns in the internal procedures (Aoki. and Nikolov
2015). According to the Bank of International Settlements, operational risks can also be
termed as risk of loss which results from failed internal process, people and the systems.
Operational management results due to human risks, system risks and processes risk. Human
risk is the loss as a result of human error which may be done willingly. Losses caused as a
result of improper information and leaking of information is termed as processes risk. System
risk results due to failure of systems and failure of software. These kind of risks results from
the human intervention or human error, internal software failure and failure in case of internal
processes so that perfect data and information are transmitted. The Basel Committee on
Banking Supervision states that the risk of operation as the risk of loss which results due to
failed internal process. All the banks face operational risks every day across all the
departments which includes credit, treasury, investment and information technology.
Liquidity risk; this kind of risks takes place due to lack of marketing of any kind of
investment that cannot be bought. The inability of the bank to provide cash is known as
liquidity risk. Liquidity risks takes place when bank cannot function the daily operations.
Failure to manage the risks leads severe consequences for reputations of the of the bank as
well as bond pricing which consists of ratings of the bank in the money market. Liquidity
risk is a kind of risk which is present in the business of the banking. Liquidity risks are also
those risks which the banks will fail to meet the obligations when depositors come in to take
back their money. Liquidity risk is also inherent in the fractional reserve banking system. In
the banking sector small amount of deposits are kept as reserves and the rest are kept for
creating loans.

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Business risk: the possibility where a company have lower than anticipated profit can be
termed as business risk. It is also influenced by many factors which includes sales volume,
per unit price, competition, economic climate and government regulations. Business risk
takes place in many ways which includes compliance risk, strategic risk, operational risk and
reputational risk. Strategic risk takes place when the business does not work according to the
model of the business or any plan. With time the strategy of the company becomes less
effective over time and struggles to reach its defined goals. Compliance risk is another form
of business risk which takes place in the industries and in those sectors, which are highly
regulated with laws.
Moral hazard: moral hazard is that risk when a party has not entered contract in any kind
of good faith have provided wrong information about the assets, credit capacity or liabilities.
Moral hazards occur when someone has the opportunity for taking advantage of the situations
by taking risks that the other people will pay for. Moral hazards usually comes from the
insurance industry. Moral hazard is that risk when a party without entering into the contract
will be providing any kind of misleading information about the assets or liabilities. It
generally takes place under the information asymmetry. It also takes place under the problem
of principle agent in those cases where a single party is known as an agent which generally
works on account of another party which is also termed as the principle. Moral hazards takes
place when two parties will be coming into agreement with each other. The existence of
moral hazard take place when the insurance is available which may decrease in order to
protect the property.
Reputational risk: reputational risk can be a threat which can hamper the good name of a
business. Reputational risk can take place in a number of ways which occurs directly as the
result of the actions made by the company which results due to the actions of the worker. In
order to avoid any reputational risks the companies need to be socially responsible and also

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environmentally conscious. Reputational risks are the major hidden risks that can act as a
threat for the survival of large companies which results due to the actions of errant
employees. This kind of risk implies that the loss of confidence of the public in a bank as a
result of negative perception which is also treatable. Reputational value can be measured in
terms of the brand value. As advertisements plays an important role in maintaining the
perception of the public, banks had to spend millions for content marketing dollars.
Reputation of a bank acts as an intangible asset in the issues of banking. The reputations help
the banks to generate business more profitably. Customers will usually want to deposit their
money in those banks where they believe it follows a safe and sound business practice.
Therefore, when any news in the media portrays a bank in the negative light, it has a bad
influence in the business of the banks. In order to save the reputation banks should ensure
that they are not participating in any kind of unfair or manipulative business practices. Banks
also need to make sure that the public relations efforts projects them as a friendly and honest
bank.
Reputational risk can take place due to
 The inability of the financial institutions in order to honour regulatory commitments.
 Customer records mismanagement
 Customer service or the after sales service is ineffective.
 Non-observance of the code of conduct under the corporate governance.
Compliance risk: according to the definition made by the Bank of International
Settlement, compliance risk is risk of legal or regulatory sanctions and the financial loss.
Compliance risk also means that the banks may suffer due to the failure of compliance with
laws, regulations, rules, self-regulatory organization standards which are related and all the
codes of conduct which are applicable in the activities of banking. This kind of risk includes

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risk exposed to legal penalties, financial forfeiture and the loss of material that an
organization faces when it fails to act according to the industrial regulations and laws,
internal policies. This kind of risk is also known as the integrity risk because man y
compliance regulations are enacted to make sure that the organizations are working fairly and
ethically. The compliance risk management is the chunk of collective governance and risk
management. When a particular bank participates in some kind of transactions which are
made by the customers in order to avoid any regulatory reporting requirements, evading tax
liabilities or even facilitating illegal conducts will be exposing the bank to the compliance
risk. A bank should always be organizing its own compliance function along with setting
priorities for the managing the compliance risk which is consistent with its own risk
management strategy and the structures. As there is a close relationship present between the
compliance risk and the operational risk, banks might organize the functions of operational
risk along with the compliance functions. Usually the board of directors of the bank are
responsible for overseeing the management of the compliance risk of the bank. The senior
management of the bank are also responsible for the effective management of the compliance
risk of the bank. The senior most management of the banking sector are also in charge for
establishment and communicate the compliance policy which consists of the basic principles
which needs to be followed by the management and the staffs along with explaining the
processes by which compliance risks are needed to be identified and managed with all levels
of the organization. . The risk management in the banking activity includes:
 Identification and analysis of risk.
 Elimination and risk control
 Risk taking and evaluation
 Financing risk through risk transfer.

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Cybersecurity risk: this type of risk is mostly present in the industry of financial services.
Cybersecurity risks are those risks which are usually accepted by the banking sectors so that
they can keep secure any electronic information and keep them safe from any theft, misuse
and damage. Cybersecurity risks harms people as s much a technology risks does.
Cybersecurity risks takes place from a huge range of both external and internal factors which
includes lack of segregation of the user privilege, missing transactions of the business
controls along with shortcomings in personal checking. In order to mitigate the risks of
cybersecurity, the controls should be applied across all divisions along with the business units
so that no permission for accessing are granted without any prior knowledge. Cyber-attacks
are mainly the exploitation of the computer systems, enterprises which are technology
dependent and the networks. Banking, financial services and the insurance sectors are one of
the critical domains which are highly prone to the cyber-attacks. Financial institutions like
Citibank, JPMorgan Chase, PwC and Global Payments have been the victims of the
cybercrimes before. The financial and the banking services sectors have faced almost three
times more cyber-attacks than any other industry. As banks possess data of millions of users
who keeps money, therefore the risk of cybersecurity in banks is not surprising. Data
breaches generally takes place due to improper encryption. Malicious codes and software’s
are often used by hackers for alteration of the computer codes which leads to disruptive
consequences that can compromise data leading to cybercrimes which includes monetary
information’s, healthcare records and system infiltration or identity threats. Due to all these
reasons the banking and financial services are known to have face three times more cyber
attacks than any other industry.
Evaluation on Credit risk
The Basel Committee on Banking Supervision states that credit risk includes both
uncertainties involved in repayment of the dues of the banks and repayment of dues over

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time. Most of the banks including Wells Fargo, Goldman Sachs, Morgan Stanley JPMorgan
and the other financials faces credit risk. The default results due to the inadequate income or
failure of business. Credit risk can also be wilful when the borrower is not willing to meet its
obligations in spite of having adequate incomes (Calomiris and Carlson 2016). Credit risk
also signifies the volatility of losses on credit exposures mainly in the two forms which
includes the loss in the value of the credit assets and the loss in the current and future
earnings from the credit. Managing credit risk is the focus of intense regulatory scrutiny.
There are various challenges that a bank faces while credit risk management. These consists
of:
 Inefficiency in data management: managing credit risk needs the ability of securely
storing, categorizing and searching of data based on variety of criteria. Database are
needed to be updated in real time in order to avoid easy location of information.
 Group wide risk modelling infrastructure should be limited: rousting tress testing
capabilities along with the model management which spans the entire modelling of
life cycle ensures accurate risk management.
 Lacking of the risk tools: identifying the portfolio concentrations or the re grade
portfolios is very essential. A comprehensive risk assessment will be able to clearly
identify strengths and the weaknesses associated with the loans.
Credit risk signifies reduction in credit assets values before any default which may take
place as a result of deterioration in the portfolio or credit quality of any individual (Mengze
and Wei 2015). Majority of the serious banking problems results due to the poor portfolio
risk management, not giving enough attention for changes in economic that can lead to a
deterioration in the credit standing of the bank’s counterparties. The credit risk can also be
defined when the borrower of the bank cannot meet the obligations with respect to the agreed
terms. The aim of the credit risk management is maximization of the risk of bank’s adjusted

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rate of return. The rate of return can be adjusted by maintaining exposure of credit risk within
acceptable parameters. Banks are required for managing the credit risks in the portfolio along
with the risks present in the individual credits or transactions. For a long-term success of the
banking organization an effective management of credit risk is essential. In order to
overcome the challenges faced during managing the credit risk the banks need to establish an
appropriate environment of credit risk, operate under a sound crediting process, maintain an
accurate administration of credit along with proper measurement and monitoring process and
also to ensure proper control over the credit risk (Calomiris and Carlson 2016). Some of the
principles needs that relates to the assessment of the management bank of credit risk:
 Initiate a proper environment for the credit risk: the board of the directors should
approve and review the strategy of credit risk and other important risks of credit
policies related to bank. The senior management should also be responsible for the
implementation of the credit risk strategy which is usually approved by the board of
directors (DeAngelo and Stulz 2015). The policies and procedures will address the
credit risk of all the activities of the banks at individual credit levels. Banks should
also identify credit risks and manage them in all activities.
 Operating under a credit granting process: banks should be operating in a well-defined
credit granting criteria. The credit granting criteria should consist of clear indication
of the target market of the banks along with the thorough understanding of the
borrower. there should be establishment of the credit limits by the banks at the levels
of individual borrowers and counterparties. Banks should also have a clear established
process for the approval of new credits along with the amendment, renewal and
financing of the existing credits. The extensions of the credits should be made on the
basis of the arm’s length.

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 Preserving the credit administration, monitoring and measurement process: the banks
must include in place a system of monitoring for the condition of individual credits.
Banks are also encouraged for developing an internal risk rating system for managing
the credit risk. The rating system should also be consistent with the nature and the
complexities of the activities of the bank. Banks should also have information systems
and analytical techniques which enables management to calculate the credit risk
which is present in all on and off activities of the balance sheet. Banks should also
have in place a system for monitoring the composition along with the quality of the
credit portfolio. It should also take into consideration the potential future changes in
the economic conditions while assessing credits of the individuals (Bonner, Van
Lelyveld and Zymek 2015).
 Ensuring proper controls over the credit risk: Banks should make sure that the credits
should be managed properly and also that the exposures of credit are within the
consistent level.
Conclusion
Regulation of banks is a form of government regulations which subjects to the
requirements, restrictions and guidelines of the banks. Financial risk management is a kind of
practice of economic value in banks by using financial instruments in order to manage the
exposure of different kinds of risk which includes volatility risk, market risk, inflation risk
and many more. Risk management can be both qualitative and quantitative. In the worldwide
banking sector, the international banks adopt the Basel Accords so that they can track and
expose both market and operational risks
Banking activity is formed by multitude of risks affecting the performance of banks.
Both risks and performance are interrelated to each other. Risk management can be defined
as helping in achieving objectives of bank. Risks usually emerges as a result of actions such

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as deregulation or due to increase in the consumption. The risk management strategy of the
banks includes determining important risk resulting in the normal course of business in credit
institution. Management of risks is one of the important sources in crating excess value at the
bank. The aim of the management of the banking is to achieve profit for higher banking
performance. The growth of profit is one of the indicators of the banking performance which
includes the entire banking system. It can be said that there is a presence of fifteen sources of
risk in the banking activity which can be grouped as credit risk, market risk, liquidity risk,
legal risk and the strategic risks. As a result of financial instability the central banks have
become concerned for understanding vulnerabilities in the banking system. Therefore, in
order to manage the systematic risks standardization and international cooperation is needed.

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