Risk management in the investment banking industry involves proactive risk management strategies and other mitigation systems to avoid surprises in the business. Learn more here.

1. Managing Risks in
Investment Banking
Mar 05, 2021 | Editorial Team
The primary component of the investment bank’s risk management strategy
is the risk appetite based on the current and future risk profile, as determined
by the Investment Bank’s Council.
Risk management involves the identification, analysis, and response to risk factors
that are part of a business life cycle. A good risk management structure involves
the calculation of the uncertainties and prediction of their influence on the
business.
A perfect risk management structure supports proactive risk
management and other risk mitigation systems too, such as
planning, budgeting, and cost control. As a result, the business will
not face many surprises.
At investment banks, the risk management strategy is approved by
the Council, revised, and evaluated on an annual basis.
Risk classification
Investment banks engage in different types of businesses and as such, each type
is associated with a specific set of risks. Depending on their sources and impact,
they are grouped as follows.
Simple tips to managing risks at investment banks
This is how investment banks can manage risks at different levels.
Market risk management:
Monitor, measure, and manage - liquidity, interest rate, foreign exchange, and
commodity price risks through an all-inclusive dynamic framework.
Assess potential problems through stress testing.
Credit risk management:
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2. Maintain credit exposure within the acceptable parameters.
Make lending decisions based on the credit score.
Gauge how much a bank stands to lose on credit portfolio.
Operational risk management:
Establish internal audit systems.
Assess and eliminate weak control procedures.
Train the staff at all levels
Legal risk management:
Conduct all activities within the regulatory frameworks
Liquidity risk:
Diversify
Secure back-up funding
Limit cash flow gaps
Reputational risk:
Demonstrate business integrity
Manage social media, feedbacks, and reviews
Secure data and data integrity
Foster a productive workplace
Key takeaways
Though the above principles and information are helpful, they may not fully
address an investor’s concerns. The risk equation is dependent on how people
view gains and losses.
Tversky and Kahneman documents that, “investors would put twice the weight
on the pain associated with a loss than the good feeling associated with a
profit”.
Risk occurs everywhere!
While we think of risk in negative terms, the investment world has a
different note as risks are inseparable from the desirable
performance.
If the investors believe they can tolerate the risk, both at an
emotional and financial level, they invest!
Another behavioral tendency is the ‘drawdown’. The magnitude, duration, and
frequency of a negative period are considered while measuring drawdown.
Drawdown is the period during which the asset’s return is negative in relation to
the previous high mark.
Risk management is closely associated with psychology too!
What is your risk equation? Share with us.
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