What Are the Main Risks Faced by Banks and How Does a Bank Attempt to Manage These Risks?

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What are the main risks faced by banks and how does a bank attempt to manage these risks?

A Bank is a financial intermediary that acts as an economic firm producing goods and services. With this view in mind it’s easy to see that a bank exists to make a profit. In order for a bank to be successful and make a profit, it has to take risk. A bank that is averse to risk will be a stagnant institution unable to adequately serve its customers effectively and produce a profit. However, a banking institution that takes excessive or unnecessary risk is also likely to run into trouble. All risk is uncertain but with bounds the probability of an outcome can be predicted using expectation. A bank can also run into trouble if it decides to take a
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They can also reduce the risk that consumers who are approved a loan default by taking out security in the consumers. For example in the case of most mortgages and larger personal loans this is taken in the form of the consumers’ home. Doing this provides the consumer with a much greater incentive to keep up to date with repayments and not default.

Another type of risk faced by banks is Liquidity Risk. The liquidity risk faced by the bank is that it has to have the ability to meet any financial obligations it has, using its available equity, when they are called upon, without suffering heavy or crippling losses. If a bank were unable to satisfy its depositors’ demands a ‘bank run’ may occur. This occurs when depositors lose confidence in the bank and rush to withdraw their deposits. An example of this recently was with Northern Rock who lost their consumers’ confidence and triggered the first run on a British bank in over a hundred years. The resulting bank run caused a severe liquidity crisis, which then transformed into a solvency crisis for the bank. It was at this point the government had to intervene and bail the bank out to safeguard Northern Rocks customers’ savings. To make sure that a bank is able to come good on its liabilities it must constantly make sure that adequate liquidity is maintained, that is to maintain a balance between its primary liabilities (clients deposits at the bank), that could be called upon to be paid on demand, and
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