UNIVERSITY OF TECHNOLOGY SARAWAK

Semester 1, 2021/2022

RISK MANAGEMENT
Assignment 2

Prepared By:
Ngiam Li Jie (BTM21090001)

Lecturer:
Dr Sim Siew Ling

1
Introduction

Profit is typically described as the return for taking risks. This is truer elsewhere than in
banking industry. Banks are exposed to several forms of dangers. A good banker is one who can
regularly create high returns for shareholders while mitigating these risks. Risk mitigation begins
with the accurate identification of the risk, its probability of occurrence, and its potential impact
on the organization.

Credit Risk

Credit risk is the biggest risk faced by the banking industry. This is the failure of the borrower
or counterparty to fulfill its contractual commitments. An example would be a borrower's failure
to pay the principal or interest on a loan. Mortgages, credit cards and fixed income instruments
may default. Breach of contract can also arise in areas such as derivatives and guarantees
provided. Due to the nature of their business models, banks are not completely immune to credit
risk, but they can reduce their exposure in a number of ways. As industry or issuer degradation is
often unexpected, banks limit risk through diversification. If credit risk occurs, the impact is it
will cause economic depression and bank collapse owing to the danger of client default, which
has a detrimental impact on the economic growth of many nations throughout the globe.

However, there are some strategies that can mitigate this risk happen. The credit team
analyses the creditworthiness of organizations seeking to borrow money. This entails evaluating
both business and financial risks. The structuring of a loan can decrease risk. It consists of data
such as who the bank is lending to, if the borrower has a complicated corporate structure,
matching the borrower's anticipated cash flow and payback schedule. In addition, we can write
credit notes. It comprises information such as the borrower's debt capacity, clarification on the
risks involved, and risk mitigating variables.

2
Market Risk

Market risk arise mostly from the capital market activity of the bank. The possibilities of this
risk occur is because stock markets, commodities prices, interest rates, and credit spreads are
unpredictable. If banks are actively involved in capital market investments or sales and
transactions, they are exposed to additional risks. Banks are exposed to many types of market
risk. For instance, if they possess a significant amount of equity, they are susceptible to equity
risk. Moreover, banks are compelled by definition to keep foreign currency, exposing them to
foreign exchange risk. Likewise, banks expose themselves to commodity risk by lending against
commodities such as gold, silver, and real estate. If this risk occurs, the impact is it will bring
about a market depreciation for the company. Customers will not choose to continue to invest in
this company but will look for a better banking company.

The strategies to mitigate this risk to occur are we need just utilize hedging contracts. We can
utilize financial derivatives that are freely tradeable on all financial markets. Using instruments
like as futures, options, and swaps, banks may eliminate market risk from their balance sheets to
an almost complete degree. Investment diversification is also crucial. Banks may also minimize
their investments by hedging them with investments that are inversely linked.

Liquidity risk

Liquidity risk is another fundamental banking risk. Liquidity risk refers to the possibility that
a bank may not be able to meet its obligations if depositors withdraw their funds. This danger is
inherent in a financial system with fractional reserves. In this method, only a small portion of
deposits is kept as a reserve while the rest is used to generate loans. Therefore, if all depositors
withdraw at the same time, the bank will not have enough funds, which called as bank run. This
has happened several times in contemporary financial history. A drop in deposits or an increase
in withdrawals, which are liabilities for the bank, are examples of liquidity risk. Consequently,
banks cannot create sufficient funds to pay these obligations. The 2008-2009 global financial
crisis clearly emphasized this fact. The impact of this risk is if the bank is short on cash,
consumers lose trust and try to obtain additional funds. Then, liquidity risk increases again.

3
 The strategies to mitigate this risk are a good balance sheet management is one of the most
effective strategies for banks to decrease their exposure to liquidity risk. We must invest in more
modern methods of balance sheet management. This allows them to employ software with more
robust analytical and budgeting skills in order to occasionally maintain a positive balance sheet.
We can manage the bank's cash flow effectively. Banks should strive for the most accurate cash
flow projections and take prompt action to increase payments and uphold their commitments. We
must also develop stronger stress management skills. As a financial institution, it is essential to
be candid about the prospect of severe circumstances, especially given the current unstable
financial climate.

Cyber Threat

As the financial services business grows increasingly dependent on technology, cybersecurity

has become one of the most crucial challenges in the banking industry. Cybersecurity threats like
as malware, phishing, and denial-of-service assaults have become so complex that legacy
systems constructed before to the emergence of big data analytics are incapable of defending
against them. It is possible that the bank's security system is not particularly robust, or that
hackers have created a website that is identical to the bank's official website in order to deceive
consumers into falling victim to a scam. The impact is it gives the corporation the reputation of
not having a flawless security system or of being unfairly accused, which eroded the public's
faith in this bank and may result in legal action.

For example, Wells Fargo stated that workers fraudulently established over 2 million client
accounts without their knowledge or approval. Customers of Wells Fargo took note when they
began receiving charges they hadn't anticipated, including credit or debit card charges. Initially,
individual Wells Fargo branch employees and supervisors were held accountable. Later, the
obligation for opening several accounts for consumers through cross-selling transferred from
management to employees. This bank scam was orchestrated by a certain manager in
collaboration with other bank personnel. By establishing these accounts, Fargo workers were
able to unlawfully get credit. Due to the deception, the Consumer Financial Protection
Bureau fined the banks around $100 million, which, when added to the remaining losses and

4
fines, totals roughly $3 billion. In addition to exposing the bank to civil and criminal charges, the
illicit activities eroded client confidence.

The strategies to mitigate this risk happen are by engaging with other businesses and security
partners who offer managed services to aid with protection, we can overcome skill gaps. In
addition, we may establish continuing security awareness training programmes or assess existing
programmes to ensure that they are current and relevant to the current threat scenario. In
addition, we may acquire detection and response systems that assist prevent assaults proactively.
We may also implement consumer education initiatives to prevent clients from disclosing critical
information to cybercriminals.

Operational Risk

Risk associated with the failure of people, internal procedures and rules, and systems is
known as operational risk. This risk is caused by the breakdown of business procedures in the
bank's regular operations. Examples of operational risk include payments being credited to the
incorrect account or the execution of incorrect orders during market trading. No division of the
bank is exempt from operational risk. The possibilities of this risk occur is when information
technology systems fail or when the incorrect individuals are employed. Errors in the internal
procedures followed might potentially result in catastrophic errors. For instance, Barings filed for
bankruptcy because it failed to adopt adequate internal controls. A trader was able to put wagers
on the derivatives market that were so huge that Barings' equity was wiped out and the bank
ceased to exist. When an operational risk occurs, the impact is it can have profound and long-
lasting repercussions. For instance, mistakes or fraud in a bank's credit underwriting procedure
might result in increased credit charges.

The strategies to mitigate this risk happen are when recruiting employees, it is necessary to
require employees to have stable academic qualifications and knowledge in terms of operations.
When interviewing employees, they need to meet company-specific criteria in order to be hired.
Companies can also provide courses to employees to gain a deeper understanding of the working
environment and improve their work efficiency. Before each piece of information and data is
submitted, it must be reviewed by professionals to avoid negative impacts caused by data errors.

5
Conclusion

Risk management is really important to a company's management. Because it can analyze the
risks that the company will face so that we can avoid these risks from happening and cause
losses to the company.

APA Reference

Wingard, L. (2022, June 24). The top 6 challenges banks face with risk management. Hitachi
Solutions. Retrieved November 30, 2022, from
https://global.hitachi-solutions.com/blog/risk-management-in-banks/

Major risks for Banks. Corporate Finance Institute. (2022, November 28). Retrieved November
30, 2022, from https://corporatefinanceinstitute.com/resources/risk-management/major-
risks-for-banks/

Srivastav, A. K. (2022, September 15). Credit risks in banks. WallStreetMojo. Retrieved

November 30, 2022, from https://www.wallstreetmojo.com/credit-risks-in-banks/

Risks faced by banks. (n.d.). Retrieved November 30, 2022, from

https://www.managementstudyguide.com/risks-faced-by-banks.htm

Eliyahu, T. (2022, October 27). Financial cyber threats: 10 cases of Insider Bank attacks.
SentinelOne. Retrieved November 30, 2022, from
https://www.sentinelone.com/blog/financial-cyber-threats-10-cases-of-insider-bank-
attacks/

Credit risk mitigation. Financial Edge. (2022, June 27). Retrieved November 30, 2022, from
https://www.fe.training/free-resources/credit/credit-risk-mitigation/

Strategies banks use to manage liquidity risk. Finance Digest. (2021, February 2). Retrieved
November 30, 2022, from https://www.financedigest.com/strategies-banks-use-to-manage-
liquidity-risk.html

Duncan, C. (2022, September 8). 5 biggest threats to cyber security in the banking industry in
2022. DeskAlerts. Retrieved November 30, 2022, from
https://www.alert-software.com/blog/cybersecurity-in-banking

6
7