Explain the concept of risk in Banks. Discuss the various measures undertaken by Reserve Bank of India while designing the regulatory framework for Banks.
The risks to which a bank is particularly exposed in its operations are: liquidity risk, credit risk, market risks (interest rate risk, foreign exchange risk and risk from change in market price of securities, financial derivatives and commodities), exposure risks, investment risks, risks relating to the country of origin of the entity to which a bank is exposed, operational risk, legal risk, reputational risk and strategic risk.
Liquidity risk is the risk of negative effects on the financial result and capital of the bank caused by the bank’s inability to meet all its due obligations.
Credit risk is the risk of negative effects on the financial result and capital of the bank caused by borrower’s default on its obligations to the bank.
Market risk includes interest rate and foreign exchange risk.
Interest rate risk is the risk of negative effects on the financial result and capital of the bank caused by changes in interest rates.
Foreign exchange risk is the risk of negative effects on the financial result and capital of the bank caused by changes in exchange rates.
A special type of market risk is the risk of change in the market price of securities, financial derivatives or commodities traded or tradable in the market.
Exposure risks include the risks of bank’s exposure to a single entity or to a group of related entities.
Investment risks include the risks of bank’s investment in non-financial sector entities, fixed assets and investment real estate.
Risks relating to the country of origin of the entity to which a bank is exposed (country risk) is the risk of negative effects on the financial result and capital of the bank due to bank’s inability to collect claims from such entity for reasons arising from political, economic or social conditions in such entity’s country of origin. Country risk includes political and economic risk, and transfer risk.
Operational risk is the risk of negative effects on the financial result and capital of the bank caused by omissions in the work of employees, inadequate internal procedures and processes, inadequate management of information and other systems,
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