Risk Management

The following series of articles will focus on risk management.  The concept of risk taking is essential for any bank to generate profits.  There is a saying, “the greater the risk, the greater the reward”.  While this statement holds true most of the time, there is a fine balance that must be achieved to ensure that a bank is taking the appropriate levels of risk.  Taking prudent risks means taking risks that can be absorbed if business conditions turn sour.  Additionally, organizations need to understand risk to the extent that they can allocate their limited source of capital to projects or initiatives which generate the greatest return on investment with the least amount of risk. 

At a high level, a retail banking organization consists of five key segments; retail banking, asset management, corporate banking, insurance, and operations support. 

The retail banking function generates profits by accepting customer deposits and using those funds for lending activity.  The idea here is buy low, sell high; meaning, pay low interest rates on deposits and charge higher interest rates on issued loans. 

Corporate banking is a very important function within a bank.  The key functions within this area are trading and underwriting.  Banks help corporations by underwriting securities and bonds and issuing them to the market.  The trading desk is the group which actually sells these securities or bonds to the market through their sales channels.  The traders also are involved in the day to day management of the banks assets and liabilities through the issuance and purchase of securities.

The asset management group serves in a custodial capacity by managing non-bank assets that investors can buy into.  Mutual funds are a great example of this.  Risk within AMG is limited to the loss of potential servicing fees in the case that the assets decrease in value. 

Operations’ is behind the scenes but these are the folks which make everything work internally.  They are responsible for accounting, auditing & compliance, money transfer, risk management, and reporting financial results to the market. 

Finally, some banks will have an insurance arm which deals in providing individuals/businesses’ with different forms of guarantees if certain events occur; such as, death or fire damage to your home. 

In the rest of this series, we will cover some of the various risk measurement techniques which help banks answer some key questions:  What is the potential loss?  Is the reward to risk ratio high enough?  How can we increase our reward to risk ratio?  To answer these questions, we will dig into concepts such as RAROC, economic capital, VaR, asset liability management, market risk management, credit risk management, and more.

Types of Risk >>
Economic Capital >>
RAROC >>
Value at Risk (VAR) >>
Shareholder Value Added >>
Tim Ord
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