Explain the ‘Risk’ considering activities of a financial institution

Risk is the possibility of financial loss or an adverse outcome arising from a financial institution’s activities and decisions. Risks associated with different activities of a financial institution:

(1) Lending activities expose a bank mainly to credit risk, as borrowers may fail to repay their loans.

(2) Financial market activities expose a bank to market risk, as interest rates, exchange rates, and security prices may change.

(3) Funding and payment activities expose a bank to liquidity risk, as the bank may not have enough funds to meet its obligations on time.

(4) Day-to-day operations expose a bank to operational risk, which may arise from problems with people, processes, systems, or technology.

This activity-based approach is consistent with the source material’s point that banks’ actual activities and exposures determine the risks they face.