INTRODUCTION TO THE

RISK

Chapter-1 Module-1
INDEX
 Introduction to Risk:
 Meaning of Risk and Uncertainty, loss, perils,
hazards
 Types of Risks
Financial and Non-Financial Risks, Individual and
Group Risks, Pure and Speculative Risk, Static
and
Dynamic Risk, Quantifiable and non-quantifiable
Risk
 Risks for Financial Institutions
 Classifying Pure risks
RISK
 Risk is the possibility of losing something of
value.
 Risk refers to the possibility that something

unpleasant or dangerous might happen.

 Risk is a condition in which there is
possibility of an adverse deviation from a
desired outcome that is expected.
Meaning of Uncertainty
 It is the condition of being unsure about
some one or something
 Uncertainty refers to a state of mind
characterised by doubt, based on lack of
knowledge about what will or will not happen
in the future.
Meaning of Loss
 The fact that you no longer have something
or have less of something.
 A disadvantage caused by someone leaving or

by something being taken away.

 The action or state of not maintaining or
having control over something any more.
 A situation in which a business or
an organization spends more money than
it earns, or loses money in another way.
Meaning of Perils

 Peril means a great danger, or something that

is very dangerous.
 A peril refers to the cause of loss. It means

the serious and immediate danger.

 Example:They faced the peril of falling rocks.

something that causes or may cause injury,

loss, or destruction.
 Examples include falling, crashing your car,

fire, lightning, water, volcanic eruptions or

falling objects.
Meaning of Hazards

 Hazards are the conditions that increase the

severity of loss or the condition affecting
perils.
 Hazard is any agent that can cause harm or

damage to humans, property or environment.

 Hazards are classified as:

1. Physical hazards
2. Intangible hazards
◦ Moral hazard
◦ Morale hazard
◦ Societal hazard
 Risk, peril, and hazard are terms used to
indicate the possibility of loss, and are often
used interchangeably, but the insurance industry
distinguishes these terms.
 A risk is simply the possibility of a loss, but
a peril is a cause of loss. A hazard is a condition
that increases the possibility of loss.
 For instance, fire is a peril because it causes
losses, while a fireplace is a hazard because it
increases the probability of loss from fire.
 Some things can be both a peril and a hazard.
Smoking, for instance, causes cancer and other
health ailments, while also increasing the
probability of such ailments.
Types of Risks
1. Financial and Non-Financial Risks
 Financial risk is any of various types
of risk associated with financing, including
financial transactions that include company loans
in risk of default. ... In modern portfolio theory, the
variance (or standard deviation) of a portfolio is
used as the definition of risk.
 The study defines non-financial risks broadly as
events or actions, other than financial transactions,
that can negatively impact the operations or assets
of a company.
2. Individual and Group Risks
 Individual risk (particular risk) is the
probability for an individual or small groups
to suffer ill effects at a specific point. Eg-
theft, robbery, fire, etc.
 A risk refers to a Group risk (fundamental

risk) if is affects the economy or its

participants on a macro basis.
3. Pure and Speculative Risk
 Pure risk is a risk in which there is only a
possibility of loss or no loss—there is no
possibility of gain. Pure risk can be
categorized as personal, property, or liability
risk.
 Speculative risk is a category of risk that can

be taken on voluntarily and will either result

in a profit or loss. All speculative risks are
undertaken as a result of a conscious choice.
4. Static and Dynamic Risk
 Static and dynamic risks are distinguished by their
temporality.
 The possibility of loss is uniform over an extended
period of time for static risks, so static risks are
more predictable, and, therefore, more insurable.
 Dynamic risks change with time, making them less
predictable and less insurable
 Example of static risk include theft, where as
Changes in price level, income, tastes of
consumers, technology etc (which is examples of
dynamic risk) can bring about financial losses to
members of the economy
Difference between dynamic risk and
static risk
Dynamic risk Static risk

Losses are not easily predictable Losses can be predictable

It results from changes in It occurs even if there is no change

environment in economic environment

These risk are not covered by These risk can be covered by

insurance insurance

These risks may benefit the These risks don’t benefit the
society society
5. Quantifiable and non-quantifiable
Risk
Quantifiable risks are those that can be
measured. Eg financial risk
 while non-quantifiable risks are those that

are not measured. For e.g risks which leads

to tension or loss of peace etc.
Risks for Financial Institutions

 Over the decades, the financial services

industry has undergone significant
transformation due to internal and external
factors, including business model
transformation, adoption of advanced
technologies, changing regulatory
environments, etc.
 Modern banking sector is a highly complex

where stakeholders of different background

play an increasingly influential role.
Business/Strategic risk

Compliance risk

Credit risk

Cyber security Risk

Liquidity risk

Market risk

Operational risk

Reputational risk
1. Business/Strategic risk
 Business risk is the risk arising from a bank’s business

strategy in the long term. When a bank fails to adapt to the

changing environment as quickly as their competitors, it
faces the risk of losing market share, getting acquired, or
shutting shop.
2. Compliance Risk
 compliance risk is defined as the risk of legal or regulatory

sanctions, material financial loss, or loss to reputation a bank

may suffer as a result of its failure to comply with laws,
regulations, rules, related self-regulatory organization
standards, and codes of conduct applicable to its banking
activities
3. Credit risk
 Both global and national banks suffered heavy losses due to

incorrect evaluation and monitoring of potential default rates

on mortgage payments
4. Cyber security risk
 It refers to the risk undertaken by a financial institution to

keep electronic information private and safe from damage,

misuse or theft.
5. Liquidity risk
 It can be defined as the risk of a bank not being able to

finance its day to day operations

6. Market risk
 Market risk can be defined as the risk that arises from

changes in economic factors like interest rates, exchange

rates, stock prises, commodity prices.
7. Operational risk
 All banks face operational risks in their day to day

transactions across all their departments including treasury,

credit, investment, information technology.
8. Reputational risk
 Reputational risk implies the public’s loss of confidence in a

bank due to a negative perception or image that could be

created with/without any evidence of wrongdoing by the
bank.
Classifying Pure risks

 Pure risks are types of risk where no profit or

gain is possible and only full loss or no loss is
possible.
 There are three types of pure risk.
 1. Personal risks.
 2. Property risks.
 3. Liability risks
1. Personal Risks
 These are the risks that directly affect the individual’s

capability to earn income. Personal risks can be

classified into the following types:

• Premature Death: Death of the bread earner with

unfulfilled financial obligations.
• Old Age: It refers to the risk of not having sufficient
income at the age of retirement or the age becoming so
that mere is a possibility that the individual may not be
able to earn the livelihood.
• Sickness or Disability: The risk of poor health or
disability of a person to earn the means of survival. E.g.
the possibility of damage to limbs of a driver due to an
accident.
• Unemployment: The risk of unemployment due to
socio-economic factors resulting in financial insecurity.
 2. Property Risk

 These are the risks to the persons in possession of the

property being damaged or lost.
 The immovables like land and building being damaged due to
flood, earthquake or fire, the movables like appliances and
personal assets being destroyed due to the fire or stolen.
 The losses may be direct or indirect/consequential.
 A direct loss implies the visible financial loss to the property
due to mishappening.
 Whereas, the indirect ones are the losses arising from the
occurrence of an incident resulting in direct/physical
damages or loss.
 The loss to crops due to flood is a direct loss – the
destruction of the growing power is a consequential one.
 3. Liability Risks
 These are the risks arising out of the intentional
or unintentional injury to the persons or
damages to their properties through negligence
or carelessness.
 Liability risks generally arise from the law. E.g.
liability of the employer under the workmen’s
compensation law or other labor laws in India.
 In addition to the above categories, risks may
also arise due to the failure of others.
 For example,the financial loss arising from the
non-performance or non-standard
performance in a contract – in engineering/
construction contracts.