10 Major Risks Faced By Banks In 2020

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Over quite some time, the finance industry witnessed many significant transformations due to advancements in technologies, business model transformations, changing regulatory standards, and many other external and internal factors. Today, the banking industry has been tremendously changing the lives of ordinary people. The banks have become much more advanced, and the security aspect has been improved to a large extent.

However, with the increase in growth of the banks, the banking operations have become much more complicated. The risks involved with the adoption of disruptive technologies called for the change in regulatory environments and business procedures. Even if we talk about history, banks have suffered significant losses due to the shift in customer’s behavior patterns, the introduction of new technologies, changes in international policies, and so on. Hence, it’s vital to discuss the significant risks involved in the finance industry that are majorly faced by all the banks.

Risks Involved in Banking Industry

1. Credit Risk

One of the most significant threats faced by banks is credit risk. In simpler words, credit risk is defined as the inability of a borrower or a counter party to meet the contractual obligations. In other words, when a borrower fails to pay the appropriate amount to the lender due to any financial crisis. The banks have suffered huge losses in the past from credit risks, and are still prone to such losses.

Although credit losses are primarily defined by the inability of the borrower to repay loans to the lenders, it also includes the delay in payments of the borrower. That means if any borrower does not make timely payments, then such types of cases also come under credit risks.

What Can Be Done?

Such types of losses commonly occur due to borrower insolvency. Hence, banks should conduct proper research before granting the loans and should only sanction loans to individuals and businesses that are not likely to run out of their income during the payment period.

2. Market Risk

Market risks are defined as the risks involved in the fall of a company’s share or decrease in the value of the stock of third-party companies where the bank has invested. We all know that apart from sanctioning loans, the banks also hold a certain amount of shares in the market. In that case, if by any means, the share price of the banks decreases, then they will suffer huge losses, and these types of losses generally come under market risk.

The market risks can vary depending upon the type of commodity a bank holds. For instance, if a bank holds foreign exchange then they’re exposed to a Forex risk, in the case of gold, silver, or real estate, they are exposed to commodity risks, etc. similar is the case with equity risk.

What Can Be Done?

To mitigate market risks, banks usually leverage hedging contracts. They use contracts like forwards, options and swaps, and many more, to completely eliminate the various market risks.

3. Business Risk

Business risks are a significant result of credit risk. To put it simply, when a bank fails to generate profits during a specific period, then it is called business risk. Many times, a business takes a loan from a bank and then fails to repay it. In such a scenario, the banks face losses due to business risk.

The result of business loss is either being acquired by some other banks, or collapse in big banks. Examples of such banks that suffered huge losses due to the wrong business strategy are Washington Mutual and Lehman Brothers.

What Can Be Done? 

Although there are no sure-shot methods of eliminating the business risk, the adoption of the right strategy might do the work.

4. Compliance Risk

When a bank does not follow proper regulatory standards put down by the financial institutions, then such type of risk is known as Compliance risk. These are usually a not much greater risk but surely have some significant outcomes. When a bank does not comply with proper regulation formed by the banking institutions in their certain branch, then they face financial and legal losses.

The banks get severely affected by these losses and suffer loss in their daily banking targets. They had to bear legal penalties and might face significant challenges by the regulatory committee.

What Can Be Done?

To mitigate such types of risks, the banks should formulate, regulate, and manage all the regulations and compliance policies across all their branches.

5. Security Risk

Now that’s a considerable risk that has been on the top of the list for the global market, irrespective of their domains. Cybersecurity has been impacting the financial industry for quite a few years, and the problem is still prevalent in the banking sector. We witnessed many cases where hackers penetrated the security layers of some big banks and stole a large sum out of it.

Banking institutions are still making considerable investments in the security aspect to make their customer’s data and their systems more secure than ever. The industry is leveraging the latest technological advancements of AI, ML, Blockchain, big data, etc. to yield positive results in terms of security.

What Can Be Done?

The banks need to invest in top-notch fintech software and mobile apps that are way more secure and impenetrable. They should keep their private information safe using a technologically advanced electronic medium.

6. Operational Risk

When there is a failure in the internal processes of the bank due to inefficient systems, then it is termed as operational risk. We all know that banks have to perform a wide array of banking operations like daily transactions, cross-border transfers, cash deposits, and much more. However, there are times when the internal systems or the central system slows down.

In such a scenario, the bank faces losses due to operational risk. Not only that, when there are some other mistakes like payment transfer in the wrong account, or execution of an incorrect order, etc. also falls under operational risk. It is noteworthy here that banks do not directly get affected because of the operational risks.

What Can Be Done?

The operational risks can be minimized by automating the workflows so that the human interventions reduce. Also, the banks should use software from a trustworthy development company to ensure smooth operations.

7. Reputational Risk

Reputational risk is a significant result of the operational risk and, to some extent, the security risk. In other words, when a company fails to provide security to their customers, or when they perform inefficiently in processing their requests, then they suffer loss in users. People began spreading rumors about the bank, and the bank’s image gets spoiled.

The news channels interrogate the people and make false perspectives about the banks. In such a scenario, the daily revenue of the bank drastically reduces, and hence they suffer huge losses. They lose their stellar reputation in the global market, and their profits decrease.

What Can Be Done?

The banks should ensure smooth functioning and should provide safety and security to all of its customers. They should never participate in any unfair practices and should ensure customer satisfaction in every possible way.

8. Liquidity Risk

Liquidity risks arise because of the increase in the non-profitable assets in the bank. That is, if there is an increase in the credit losses and losses due to business risk, then liquidity risk arises. Due to the rise in the liquidity risk, the bank becomes insufficient to meet the obligations if any depositor comes to withdraw its money.

Looking back in history, the losses due to liquidity risk was a significant concern of all the banks at that time. However, the present-day scenario has been completely changed. Now the banks have new regulations of keeping a minimum amount of reserved cash to mitigate liquidity risk. That implies that the depositors can be paid even during the time of credit for business loss.

What Can Be Done?

The banks should follow proper regulations of the central banks and should keep a minimum requisite amount in the banks to eliminate the chances of losses due to liquidity risk.

9. Systematic Risk

Whenever there are some external issues involved with the bank like employee’s strike, market fluctuation, non-stability of the government, and so on, then it is termed as Systematic risk. The systematic uncertainty is beyond the control of management since it entirely depends on the various external factors.

The losses due to systematic risks are unpredictable and cannot be wholly avoided. Banks suffer huge losses due to systematic risk and may have to write off certain assets to compensate for their losses.

What Can Be Done?

The systematic risks are entirely unpredictable, and so they cannot be eliminated. However, with smart skills, they can be minimized up to a certain extent.

10. Moral Hazard

Moral hazard is an entirely new type of risk when compared to the other mentioned risks. It came to light recently in the global market. The moral hazard occurs when a bank takes some risk, even when they know that someone else has to bear the losses. In other words, when a bank invests in a risky business, and it backfires, then it is the taxpayers who have to bear all the losses.

Although the central bank has been tracking the banks and their operations very carefully, some of them still take dreadful risks when not under the regulatory oversight. They get to indulge in the illegal practices and create an imbalance on the taxpayers when their planning fails.

What Can Be Done?

The central bank should pay more attention to the activities of the banks to eliminate the losses caused by moral hazards. The banks should also not indulge in risky businesses and should follow the proper path.

To Conclude

In this article, we discussed the top ten risks faced by the banking industry with the growing digitalization. Not to say, all these risks are faced by every bank of the world at some time or the other. And the best way to combat all these mentioned risks and losses due to these risks is to opt for a more secure financial solution.

We, at Matellio, always provide efficient and secure software applications to all our clients. Our expert developers, and certified QA Engineers make sure that your product remains secure and safe and world hassle-free to achieve your business goals. So, if you have any idea for the product development or wanted to build a secure financial solution, then always feel free to contact us.