Financial risks in the banking sector are usually related to bonds, loans, stocks, commodities and interest rates. These risks are encountered by financial institutions, multinational companies or joint stock companies.
When a financial institution is unable to meet its liability or equities, then it has not managed its financial risks effectively. For example, banks suffer loss when they issue loans to consumers who are unable to pay back the loans. When this happens, the credit risk management team would have created certain risk management strategies before providing the loans — the bad debt expense account is an example of a risk management strategy.
Best Practices For Managing Financial Risk
In today’s financial institutions, risk is gradually evolving and is not seen as a mechanism to be controlled, but as critical business drivers that manage revenue and loss — striking a balance between both. With a strategic risk management practice, banks can grow even when the economy is recessive, or when internal factors such as IT failure occurs. Below are some best practices used to manage risk in financial institutions:
Management should speak a common language
Risk issues should be translated to one language so that all management staff and departments can understand the problem and work together as a team to resolve it. Different departments have different lingo that work for inter-departmental processes, but when taken out of context will make no sense to staff in other departments. This is why management has to speak a common language, so that their teams will do the same.
Outline your risk exposure and prioritize it
Some risks are more detrimental to an organizations’ health than others. This is why risk should be categorized and given a scale of preference within every organization. For example banks need to be more cautious of credit, operational and market risks. Tools like Value at Risk, Monte Carlo simulations, Cash Flow at Risk and others should be applied to test the level of risk and subsequent actions to help contain the risk.
Hire experts to create risk management policies
There are some risk experts who have the specific training and experience in handling risk in certain geo-locations. Banking practices have to be transparent so centralizing risk management decisions is key to keeping your banking doors open.
Create the tools to manage risks
IT systems and processes should be laid out to manage risk. The value of IT to the banking sector is becoming more and more apparent. This also applies to managing risk as these IT systems can help in monitoring risk, analysis and compliance.
There are so many best practices that are used to manage risk in the financial sector today. What works for one bank may not work for another, hence the need for qualified risk assessors and IT tools that can help gather data and implement strategies.
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