Risks in Banking & The Prevention - Assignment Example

 Risk management refers to the procedure of recognizing, analyzing and either mitigating or accepting any uncertainty in an investment. Mainly, organizations use risk avoidance, risk assumption, risk transfer, and risk retention in the management of future events. When an organization, for instance, an international bank decided to take a large potential private banking client there are risks involved. The risks involved with this client may cause the fall of the bank especially if the client is from a country associated with drug money such as Mexico. Therefore, this paper will describe some of the risks involved when the bank decides to take this client. The first risk is credit risk. Credit risk refers to the risk involved if a borrower defaults on any type of debt given by failing to provide the required payments (Greuning, Brajovic & Johnson-Calari, 2003). This may occur if the client borrows large sum of money from the bank to finance his or her businesses and is unable to repay. Additionally, if the client is a drug cartel, the bank may incur loss if the government is involved since the client will no longer be in a position to repay the debt. The bank can face Interest Rate Risk. Interest rate risk refers to the risk that an investment’s value will change as a result of the absolute level of interest rates. Interest rate risk dissembles the value of bonds (Apostolik, Donohue & Went, 2009). As the interest rate rise, the price of bonds falls. The bank may face this risk since the client will frequently make international wires where the bank will use bonds. Therefore, if the interest rate increases, the price of the bonds will fall hence the bank will suffer. The bank can face Market Risk. Market risk refers to the risk of losses of position that arise from movement in the market price (Greuning, Brajovic & Johnson-Calari, 2003). The client will be involved in frequent international wires. These wires may be a risk to the bank if the stock indices or if the interest rate validity changes. The bank can face Currency Risk. Currency risk refers to the risk that develops from the change in the price of a certain currency against the other (Pelzer, 2013). The bank may face this risk since the client id involved in international wire transfer which means that the bank will constantly be involved in currency change. If the currency exchange rate drops as the bank is selling, the bank may incur a loss. The bank can face Counterpartal Risk. Counterpartal risk refers to the risk where a party of a contract may not live up to the contractual obligations (Pelzer, 2013). When the back acquires this client, both parties will sign a contract where both parties are expected to abide by it. However, the bank may face this risk if for instance it leads the client a certain amount of money which they has agreed upon, and the client is unable or does not pay the borrowed funds back. The client may failure to pay on the loan resulting to losses to the bank. The bank can face Operational Risk. Operation risk refers to the risk that an organization of the bank undertakes when it tries to operate within a given industry or field (Pelzer, 2013). Additionally, the risk results from the breakdown in internal procedures, systems, and people. The bank may face this type of risk since it will be involved in numerous human interactions when dealing with the frequent international wires from the client. If an error occurs during some of the business operations between the client and the bank, the bank may incur losses. The bank can face Regulatory Risk. This risk occurs when there is a change in the laws and regulations in a given country (Greuning, Brajovic & Johnson-Calari, 2003). The bank may face a substantial amount of regulations in the way they operate when it comes to the amount of money the client can change. The client will be involved in frequent international wires making the bank face this type of risk due to a change in the fees it can exchange in different nations. This will intern make it difficult for the bank to operate due to some regulatory laws and regulations. The bank can face Compliance Risk. Compliance risk is the danger posed to an organization’s capital or earning as a result of non-conformance or violation with regulations, prescribed practices or laws (Apostolik, Donohue & Went, 2009). Since the bank will be dealing with international wires for the client, the bank may sometimes find itself not complying with some of the necessary standards which will result to fines, voided contracts and payment of damages. This risk may cause the bank to lose some of its current clients due to diminishing reputation that will be a result of this risk. The bank can face Litigation/Legal Risk. Litigation/legal Risk refers to the risk where legal actions may be engaged due to the corporation’s or an individual’s inactions, actions or services (Apostolik, Donohue & Went, 2009). The client is from Mexico where the biggest drug lords and money laundering occurs. Therefore, if the client is laundering drug money, the bank will suffer numerous legal actions. Apart from this, since the bank has deep pockets, it is prone to litigation risks since the client can conceive the rewards associated with any plaintiffs. The bank can face Criminal Risk. Criminal risk refers to the risk of getting involved in a criminal activity which is against the laws and regulations (Greuning, Brajovic & Johnson-Calari, 2003). By acquiring the client, the bank may face this type of risk. If the client is involved in money laundering, the bank may face legal actions for helping the client in laundering the money even if the bank officials were not aware. The bank can face Systematic Risk. Systematic risk refers to the risk that affects the overall market and not a particular segment of the market (Apostolik, Donohue & Went, 2009). Since the bank is dealing with a large potential client, the client may decide to put some of his/her assets in bonds. If there is any instance of recession, inflation, war, or interest change, both the client and the bank will suffer from systematic risk. This can result to the bank making losses due to this client. The bank can face Reputational Risk. Reputational risk refers to the danger or threats to standing or a good name of a corporation (Greuning, Brajovic & Johnson-Calari, 2003). There are many ways in which reputation risk can occur. For this case, the bank can face reputation risk from acquiring the client. If the bank acquires this client who is from Mexico, its reputation may be damaged since most of the clients who transfer a large amount of money in Mexico are thought to be associated with drug money. This may result to loss of some of the current permanent clients who do not want to be associated with drug money. The bank can face Jurisdictional Risk. Jurisdiction risk occurs when a corporation is operating in a foreign jurisdiction (Apostolik, Donohue & Went, 2009). When the bank acquires the client, it will be operating in a foreign jurisdiction. Therefore, this will cause the bank to face jurisdictional risk since Mexico is well known for money laundering. This can result to the bank facing punitive penalties and fines if it the client is involved in money laundering. Lastly, the bank can face Interface Risk. Interface risk refers to the risk that may result as a result of the boundaries formed between adjacent bodies, phases, regions or substances (Greuning, Brajovic & Johnson-Calari, 2003). Interface risk may occur where there is the interface between the bank and crime. This risk may face the bank since the boundaries that are formed between the bank, and the client may fail hence facing loss or fines. References Apostolik, R., Donohue, C., & Went, P. (2009). Foundations of banking risk: An overview of banking, banking risks, and risk based banking regulation. Jersey City, NJ etc.: Global Association of Risk Professionals (GARP) [etc.. Greuning, H. ., Brajovic, B. S., & Johnson-Calari, J. (2003). Analyzing and managing banking risk: A framework for assessing corporate governance and financial risk. Washington, D.C: The World Bank. Pelzer, P. (2013). Risk, risk management and regulation in the banking industry: The risk to come. New York: Routledge. Read More