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How can you identify potential risks in banking with risk management tools?

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Banking is a complex and dynamic industry that faces various types of risks, such as credit, market, operational, liquidity, and reputational. Identifying and managing these risks is crucial for the stability and profitability of banks, as well as the financial system as a whole. In this article, you will learn how to use some of the most common and effective risk management tools and techniques to assess and mitigate potential risks in banking.

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Rajul Jain

Director Risk - Head of Supervisory Risk Services at Visa India and South Asia
Matheus Nascimento

Equity Analyst | Economics | Data Science

1 Risk identification

The first step in risk management is to identify the sources and types of risks that may affect your bank's activities, objectives, and performance. You can use various methods to collect and analyze information about the internal and external environment, such as interviews, surveys, audits, reports, historical data, scenarios, and SWOT analysis. You should also consider the interdependencies and correlations among different risks, as well as the potential impact and likelihood of each risk.

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Rajul Jain

Director Risk - Head of Supervisory Risk Services at Visa India and South Asia
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One simple way of looking at Risk is to identify factors which prevent me/my organisation from meeting its objectives. Identification of these factors, is identification of risks

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Cathal Rabbitte

The next crash. Actuary - Risk, Capital, Inflation and Volatility Modelling
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Run macro consistent stress tests to identify the risks with greatest impact which may be hidden by conventional analysis. Quantify total exposure and compare against any mitigants. Instead of assessing risk using capital factors, assess by individual asset class for the 3 inflation scenarios, namely Higher for longer, Soft Landing and Recession. Produce 3 separate projections to represent the 3 inflation scenarios to replace each single default projection. This can help raise awareness of unmodelled risk issues.

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Matheus Nascimento

Equity Analyst | Economics | Data Science
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In my perspective, the process involves gathering market data to establish the risk exposure parameters for a bank or financial institution.

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2 Risk measurement

The next step is to quantify and evaluate the risks that you have identified, using appropriate metrics and models. For example, you can use credit ratings, credit scoring, and credit value at risk (CVaR) to measure the credit risk of your borrowers and counterparties. You can use value at risk (VaR), stress testing, and sensitivity analysis to measure the market risk of your assets and liabilities. You can use key risk indicators (KRIs), loss data, and risk control self-assessment (RCSA) to measure the operational risk of your processes and systems.

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Matheus Nascimento

Equity Analyst | Economics | Data Science
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From my perspective as an equity analyst specializing in financial institutions and deeply engaged with the economic environment, the initial step involves assessing the quality of the credit portfolio, solvency, and key risk indicators such as leverage ratio, Basel ratio, and RWA. Following this, the subsequent step entails conducting stress tests, utilizing metrics like VaR, CVaR, and sensitivity tests to evaluate the resilience of the capital structure across economic cycles.

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3 Risk mitigation

The third step is to implement strategies and actions to reduce or transfer the risks that you have measured, according to your risk appetite and tolerance. You can use various techniques to mitigate risks, such as diversification, hedging, collateral, insurance, securitization, and outsourcing. You should also establish policies and procedures to monitor and control the risks, such as limits, triggers, reporting, and escalation.

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Matheus Nascimento

Equity Analyst | Economics | Data Science
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I could offer a perspective rooted in the Brazilian market, which contends with high structural credit costs stemming from elevated default rates, along with longstanding fiscal challenges faced by the government over the past decades. Considering these factors, integrating Treasury Structure, TVM portfolios, and proactive hedging policies could emerge as a robust strategy for cultivating high-quality balance sheets.

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4 Risk reporting

The fourth step is to communicate and disclose the risks and their mitigation to the relevant stakeholders, such as senior management, board of directors, regulators, auditors, and investors. You can use various formats and tools to report risks, such as dashboards, scorecards, heat maps, risk registers, and risk reports. You should also ensure that the risk reporting is timely, accurate, consistent, and comprehensive.

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Matheus Nascimento

Equity Analyst | Economics | Data Science
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To construct a comprehensive Risk report for stakeholders and market analysts, a meticulous analysis of the institutional structure is imperative. This entails elucidating metrics for risk assessment such as Basel levels, RWAs, exposures, coverage, and leverage ratios, offering a clear perspective on credit quality. Following this, delving into detailed information regarding each segment in which the institution operates further enhances transparency and understanding.

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5 Risk review

The fifth step is to review and update the risk management process and tools on a regular basis, to reflect the changes in the risk environment, the bank's strategy, and the best practices. You can use various methods to review risks, such as audits, feedback, benchmarking, and lessons learned. You should also identify and address any gaps, weaknesses, or issues in the risk management process and tools, and implement continuous improvement actions.

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Matheus Nascimento

Equity Analyst | Economics | Data Science
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I believe that establishing an analysis process geared towards identifying the primary vulnerabilities within an institution's portfolio, particularly when viewed through the lens of economic cycles, is essential for estimating potential impacts. Conducting audits and deriving lessons learned from thorough data analysis can be immensely beneficial. This approach aids in predicting, at the very least, the key risks associated with timing and the pace of balance sheet expansion, as well as controlling exposure and leverage.

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6 Risk culture

The sixth step is to foster a positive and proactive risk culture within your bank, that supports and aligns with the risk management process and tools. You can use various elements to promote a risk culture, such as vision, values, leadership, incentives, training, awareness, and accountability. You should also encourage and reward a risk-aware and risk-responsible behavior among your employees, customers, and partners.

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Rajul Jain

Director Risk - Head of Supervisory Risk Services at Visa India and South Asia
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To add on, risk is not one person or one function job. Maintaining a strong culture can increase productivity by streamlining energies on key activities while avoiding others!

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you identify potential risks in banking with risk management tools?

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1 Risk identification

2 Risk measurement

3 Risk mitigation

4 Risk reporting

5 Risk review

6 Risk culture

7 Here’s what else to consider

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