Risk Management Overview - Essay Example

A business may not be able to run without all these basic activities and it is also likely to collapse. Business risks are usually categorized into two groups; systematic and unsystematic business risks. Systematic risk is where the economy generally experiences a downfall due to natural calamities floods and drought, political instability, recessions, inflation or even fluctuation in currencies. Any business operating under the same economy is bound to fail or make more losses than profits (Akhter, 2010).

Unsystematic risk is where a specific section of the economy or industry fails unlike systematic where it’s the overall market (Sensarma and Jayadev, 2009). The common way of counter attacking this is to employ diversification. Business risks are further categorized into strategic, compliance, financial and operational. Strategic is where there is new competition in the market, compliance is where a certain business is responding to new terms and regulations that have been newly put in place to run businesses.

Additionally financial business risk is where for instance several customers are unable to pay back to the business and operational business risk is when for example there is burglary to the business (Akhter, 2010). The banking as an industry has risks associated with it. One of them is aggressive and almost philanthropic lending of loans to clients and selling the loans to other financial institutions and hoping to run entirely on the interest generated from it, usually with an aim of maximizing profit (Akhter, 2010).

This becomes a risk when the economy collapses, experiences inflation or recession because with that, comes an automatic delay in loan servicing and sometimes the money given out looses its value with time because of currency fluctuation. Most banks are involved in lending. This involves a bank client giving a security pledge to a bank that they are able to pay back or service their loans fully. It is usually called collateral. It can be land, car or a house (Sensarma and Jayadev, 2009). In order to maximize their profit and returns, banks have increased their interest rates.

This poses such a risk to the banking system because with increased interest rates comes with an exponential reduction in lending activities. This is because not so many clients are wiling or able to pay for a higher than normal interest rates, so they don’t take loans all the same. This creates a financial confusion which the bank has to solve lest it collapses completely (Devine, 2006). To solve this, banks have to lower their lending standards and attracting more clients by using new in the market methods.

Liquidity risk is a type of risk that results from the unavailability of a proper market for an investment that cannot be sold fast enough in order to counter attack a foreseen loss (Akhter, 2010). Banks have severally taken houses or antiques as collateral from clients. When the clients are not able to service these loans on time the banks decide to sell these collateral. Antique is one of the hardest items to sell in the markets because not so many people know their value and there is never ready market for them (Breeden and Whisker, 2010).

Many banks suffer loss before recovery before selling such products and may never sell it completely leading a major loss. Liquidity risk therefore leads to a situation where the banking institution is unable to meet it objectives or profit