Explain How Risk Can be Categorized?

Risk in banking comes in many shapes and sizes. Categorizing it properly helps banks to decide which risks to avoid, which to transfer, and which to manage actively.

There are two broad ways to look at banking risks.

From a Managerial Perspective:

(a) Risks that need to be avoided: where the potential loss far outweighs any benefit.

(b) Risks that should be transferred: handed off to a third party through insurance, derivatives, or guarantees.

(c) Risks to be actively managed: accepted and controlled through proper risk management systems.

From a Functional Perspective

Financial Risks

These are risks that directly affect the bank’s financial position, like earnings, market value, and capital. The main financial risks are: Credit Risk, Liquidity Risk, Interest Rate Risk, and Market Risk.

Non-Financial Risks

These risks do not arise directly from financial transactions but can cause serious financial damage. Operational Risk is the main one — covering people, process, and system failures, as well as external events.

Also included are Strategic Risk (poor business decisions) and Reputation Risk (negative public opinion causing loss of customers and business).