Non-Financial Risks of Banks

What is credit risk?

The risk that when a bank makes a loan, there is a possibility that it may not be repaid and the bank will incur a loss. The risk will be informed materially by three things:

• Probability of default - driven by the underlying creditworthiness of the borrower
• The duration of the loan - the longer the loan period, the higher the risk
• Collateral - the rights of the bank when a loan defaults.  This drives the loss given default position

What is Counterparty credit risk?

Counterparty credit risk is a specific form of credit risk that arises mainly from derivatives & securities financing (such as reverse repo). 

What is operational risk?

It arises in the course of doing business. The risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events, where the root cause is not due to credit or market risks.

What are the types of Operational risk?

• Treasury risk
• Systems risk
• Model risk

What is Net interest income?

Net interest income is the difference between interest earned on assets and the interest paid on liabilities and is usually the largest component of most banks’ income and therefore the basis of profitability.

What is a Gap risk ?

The risk in Net interest income arises from mismatches in the timing of repricing of assets and liabilities within the banking book, which is normally called gap risk.

What is Net interest margin?

Net interest income in a bank can also be compared to the average interest earning assets the bank has and this metric is called Net Interest Margin (NIM).

What is Market risk?

Market risk is the risk of losses arising from adverse changes in market prices or rates. These types of prices/rates could include:

• Interest rates
• Equity
• FX
• Credit
• Commodities

Explain the importance of good internal governance in controlling and managing risks.

• A board is the highest level governance meeting in a bank and its responsibilities are to set the strategy and define the bank’s risk appetite in pursuit of that strategy.
• From a treasury perspective the most important parts of the risk appetite will be capital, liquidity and funding metrics and these must be coherent with any strategic and business plans.
• A board will also put in place a risk framework which defines who is accountable and responsible for identifying risks and assessing (measuring), monitoring and controlling them.
• The Chief Executive Officer (CEO) is ultimately accountable and responsible for the day-to-day running of the business and control of risks within the Board’s risk appetite.
• The CEO will likely be supported by an Executive Committee (Exco) and by other committees that focus on specific risks. Most relevant to treasury and ALM is the ALCO and the Risk committee.
• ALCO is chaired by the Chief Financial Officer and is responsible for ensuring the bank remains within its risk appetite and most effectively uses its financial resources which we take to mean, materially, in this respect, capital, liquidity, funding, leverage and interest rate risk.