Banking Risk

Overview

As a firm, a bank is subject to of the risks common to other firms, which are detailed in enterprise risk corner. However, the leveraged nature of banking makes risk a primary concern, not just to managers, but to regulators as well.

Bank Risks

• Asset specific risks are risks that can be measured on the asset level, specifically, risks that affect the value of a bank asset.
  
  
  • Market Risk: refers to the risk that market prices move. In the context of banking, this generally means that interest rates change.
  • Credit Risk: represents the risk that bank assets will default.
  • Optionality Risk:
  The income that bank assets generate can effectively be attributed to the three risks using PNL Attribution
• Bank specific risks are risks that can only be seen at the bank level.
  
  
  • Liquidity Risk: is the risk that a liability (cash payment) will come due, or a customer withdraws their money at a time when the bank does not have enough (liquid) cash to cover the payment or withdrawal. Liquidity as a risk arises from the liquidity of the individual assets in the portfolio. (that is, bank liquidity risk arises from but is to be distinguished from the liquidity profile of the banks assets)

Measuring Total Risk

• Economic Capital: is a standard model for measuring total bank risk, utilzing the tools of Value at Risk.
• Stress Testing - a form of testing where the bank is forecast in a handful of bad but specific scenarios.

Regulatory Framework

• Basel Framework: is an internationally agreed upon framework which does not have the force of law, except to the extent that countries decide to adhere to its accords and enforce its standards on its own banks. The framework was agreed upon in order to create a level playing field for banks while enforcing prudential standards.
• US Legal Framework: