Banks are in the business of managing risk
Risk is a fundamental element that drives financial behavior. Without risk, the financial system would be vastly simplified. However, the risk is omnipresent in the real world. Financial Institutions, therefore, should manage the risk efficiently to survive in this highly uncertain world. The future of banking will undoubtedly rest on risk management dynamics. Only those banks that have efficient risk management system will survive in the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for the long-term success of a banking institution. Credit risk is the oldest and biggest risk that a bank, by virtue of its very nature of the business, inherits. This has, however, acquired a greater significance in the recent past for various reasons. Foremost among them is the wind of economic liberalization that is blowing across the globe. India is no exception to this swing towards a market-driven economy.
The future of banking will undoubtedly rest on risk management dynamics. Only those banks that have efficient risk management system will survive in the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for the long-term success of a banking institution. Credit risk is the oldest and biggest risk that a bank, by virtue of its very nature of the business, inherits. This has, however, acquired a greater significance in the recent past for various reasons. Foremost among them is the wind of economic liberalization that is blowing across the globe. A precursor to successful management of credit risk is a clear understanding of risks involved in lending, quantifications of risks within each item of the portfolio, and reaching a conclusion as to the likely composite credit risk profile of a bank. The cornerstone of credit risk management is the establishment of a framework that defines corporate priorities, loan approval process, credit risk rating system, risk-adjusted pricing system, loan-review mechanism, and comprehensive reporting system.
The world over, credit risk has proved to be the most critical of all risks faced by a banking institution. A study of bank failures in New England found that of the 62 banks in existence before 1984, which failed from 1989 to 1992, in 58 cases it was observed that loans and advances were not being repaid in time. This signifies the role of credit risk management and therefore it forms the basis of the present research analysis. Researchers and risk management practitioners have constantly tried to improve on current techniques and in recent years, enormous strides have been made in the art and science of credit risk measurement and management. Much of the progress in this field has resulted in the form of the limitations of traditional approaches to credit risk management and with the current Bank for International Settlement’ (BIS) regulatory model. Even in banks that regularly fine-tune credit policies and streamline credit processes, it is a real challenge for credit risk managers to correctly identify pockets of risk concentration, quantify the extent of risk carried, identify opportunities for diversification, and balance the risk-return trade-off in their credit portfolio. The two distinct dimensions of credit risk management can readily be identified as preventive measures and curative measures. Preventive measures include risk assessment, risk measurement, and risk pricing, an early warning system to pick early signals of future defaults, and better credit portfolio diversification.
Questions:
1) Based on what you have read in the case what can you deduce about the ability of banks to manage risk in the market? Explain.
2) Are the regulations and standards generated by the New Basel Capital Accord and other Accords beneficial for banks? Explain
Step by step
Solved in 2 steps
