Describe the steps of risk management process in a bank

Risk Management Process is a systematic approach that aligns strategy, people, technology, processes, and knowledge with the purpose of assessing, evaluating, and managing the risk that an organization/bank faces.

Risk Management Process is a combination of the following five (05) steps:

Risk Identification

Nearly all the transactions of a bank create one or more of the major risks, i.e., Liquidity Risk, Interest Rate Risk, Market Risk, Default or Credit Risk, and Operational Risk.

Risk Measurement:

The risk measurement seeks to capture variations in earnings, market value, losses due to default, etc., arising from uncertainties associated with various risk elements. Risk can be measured in three ways:

Based on Sensitivity

Sensitivity captures the change in a target variable resulting from a unit change in a single market parameter. For example, a change in market value due to 1% change in interest rate is a sensitivity measure.

Based on Volatility

Volatility measures the stability or instability of any random variable, such as earnings, market value, losses due to default, etc. It is a common statistical measure of dispersion around the average of the mentioned variables.

Based on downside potential

While volatility measures both upside and downside deviations, downside potential measures only losses, ignoring profit potential.

Risk Mitigation

Risk Mitigation is the process of reducing risk by eliminating uncertain elements. A lot of alternatives are available to banks to mitigate risks, like:

Collateral, Credit derivatives: for credit risk mitigation.

Interest rate swap, forward rate agreement: for mitigating interest rate risks.

Forex forward contracts, forex options, or financial futures: for mitigating forex risk.

Risk Pricing

Risk pricing is the process of setting prices or determining the interest rate on loans based on the level of risk involved.

For example, borrowers with poor creditworthiness are usually charged higher interest rates than borrowers with good credit scores because they are considered riskier. Risk pricing should also consider:

• Cost of deployable funds
• Operating expenses
• Loss probabilities
• Capital charge

Risk Monitoring and Control

Risk Monitoring and Control means continuously observing, measuring, and managing risks so that they remain within acceptable limits and do not negatively affect the organization or bank.

Senior management and the board should regularly:

• Monitor and report risk exposure
• Evaluate major risks and their impact on capital
• Review assumptions and risk trends
• Adjust strategic plans according to the bank’s risk profile 96th BPE, 2(a), 6th BPE 4(a)