Risk is exposure to uncertainty. Business risks are those inherent in bank activities and include capital risk, market risk, liquidity risk, and more. Foreign exchange risk arises from foreign currency exposure and can cause losses from adverse exchange rate movements. Transaction exposure is the risk of currency fluctuation during the life of a transaction, while translation exposure is the conversion risk on the balance sheet date. Credit risk is the failure of a borrower to repay money, and country risk is specific to a particular country.

1. Chapter -1
Various Risks in Banking

2. Structure of the chapter -
Understanding the risks in banking
sector.
Understanding risks in international
banking.
Components of risks and meanings
thereof.

3. What is risk in banking ?
Risk is exposure to uncertainty
There are two aspects of risks viz.
uncertainty and exposure to that
uncertainty
Risk in banking may lead to losses in
transactions, loss of customer
confidence etc.

4. Business risk -
Business Risk are those risks that are
considered inherent in the activities
undertaken by a bank irrespective of
whether the controls are in place.
These can be, broadly further
classified into different categories
like, Capital risk, Market risk,
Liquidity risk etc.

5. Types of business risks -
Capital Risk Risk of insolvency
Market risk Trading risk –
quality of portfolio,
interest rate /
forex risk
Risk related to
Earnings risk quality of earnings
and threat

6. Types of business risks -
Liquidity risk Asset liability
mismatch
Operation risk – Risk arising out of
operations, people
& process risk
Control risk
Inadequacy /
failure / absence of
controls

7. Risk in international banking -
Risks in international banking are
unexpected loss from operations that
can result from international banking
transactions turn adverse due to
foreign currency exposures.
It can be foreign exchange risk,
country risk, legal risk etc.

8. Foreign exchange risk -
Foreign exchange risk means a risk arising
from a foreign currency exposure. E.g.
losses due to adverse exchange rate
movements during a period in which it has
open position in spot or forward.
Exchange risks, related to currency
exposure are commonly connected to
transaction and translation exposures.

9. Transaction exposure -
The risk that the base currency value
of a foreign currency denominated
transaction will vary with the change
in exchange rates during the life of
the transaction.
This arises when business has
foreign currency denominated
receipts or payments.

10. Translation Exposure -
It may also be called as accounting
exposure.
It arises when there is need to
translate foreign currency assets and
liabilities in to the home currency for
the purpose of finalizing the
accounts.

11. Economic Exposure -
It is a change in future earning
power and cash flow as a result of
adjustment of the currencies.
It represents a change in competitive
position.

12. Exchange risk in open & mismatch
positions -
Banks dealing in the foreign exchange market, in
the course of their dealing with exporters,
importers and others, buy and sell currencies and
build up open positions in various currencies in
which these transactions are denominated, an
open position arises when a bank buys or sells
currency outright and does not square it up by
undertaking an offsetting opposite transaction.
When the assets exceeds the liabilities a long or
overbought position is created in that currency
and when the liabilities exceed the assets, a short
or oversold position is created in that currency.

13. Gap risks -
Gap risks arising out of open gaps be
contained within manageable limits
by fixing suitable gaps.
Usually two types of gaps limits are
fixed – individual gap limit (IGL) and
aggregate gap limit (AGL)
IGL defines net overbought or
oversold position for a particular
month, while AGL is aggregate of IGL

14. Value at risk (VaR)
VaR is the popular risk measurement
concept for forex risk.
It is defined as the estimate of potential
loss in a position or asset, portfolio of
assets over a given holding period at a
given level of certainty.
VaR is based on statistical concepts like
standard deviation, normal distribution,
mean etc.

15. Credit risk -
Credit Risk is the failure on the part of borrower
while performing an obligation. It means non-
payment of debt in timely manner.
If parties of different countries transact with each
other credit risk is high.
To avoid this risk Proper selection of borrowers,
adoption of sound credit granting policies, using
effective loan review mechanism process for
controlling risks, fixing inter-bank and country
exposure limits etc. is being done

16. Country Risk -
If one party deals in foreign currency with
bank situated outside its country then it
involves country risk. Change in the
government or the policies of the
government are factors responsible for
making the contract invalid.
By fixing the country risk limits, such risk
can be minimised.

17. Operational Risk -
Loss due to lack of internal control,
breakdown in information
processing, settlement or legal
compliance systems are factors
responsible for operational risks.
Thus failure in operation controls
which results in financial loss is the
main factor in operational risk.

18. Legal Risk -
Due to legal enforceability of
contracts such risks arise.
To avoid such legal risks and get
protected from it will be better to
make internationally accepted Master
Agreements.

19. Summary -
Risk is exposure to uncertainty
Business Risk are those risks that are
considered inherent in the activities
undertaken by a bank irrespective of
whether the controls are in place.
Foreign exchange risk means a risk arising
from a foreign currency exposure. E.g.
losses due to adverse exchange rate
movements during a period in which it has
open position in spot or forward.

20. Summary -
The transaction risk is that arising
due to variations in exchange rates
during the life of the transaction.
Translation risk is conversion risk on
balance sheet date.
Credit risk is failure of borrower to
pay the money.
County risk is country specific.

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