Question

Q4) Describe the six major risks of financial institutions? And also the methods that can be used in order to reduce interest rate risk and credit risk?

Answer 1

Six Major Risks of Financial Institutions are

1)Credit Risk : Credit risk is the major risk facing by the financial institutions in present financial environment ,credit risk is the risk to a financial institution when there is possibility of default by the borrower to meet it's obligation.Credit Risk is prevalent in case of loans.

2)Liquidity Risk: This is the risk arising from funding of long term assets by short term, liabilities or funding short term assets by long term liabilities. Liquidity risk be better explained by following terms

Funding liquidity risk: It is the inability to obtain funds to meet cash flow obligation when these arise.

Funding risk : The risk arises from need to replace net outflows due to unanticipated withdrawal or non-renewal of deposits.

Time risk : This risk arises from need to compensate for non-receipts of expected inflows of funds i.e. performing assets turning into non-performing assets due to which recovery has not come and deposit that funded that loan is to be returned.

3)Asset Backed Risk: Asset backed security Risk is defined by pooling of assets and liabilities of the pooled assets which are offered as collateral

4) Equity Risk : It's a risk based on the capital returns of the financial institutions i.e., the amount of the capital invested in the market.

5) Currency Risk: It is purely based on exchange value of the currency due to market fluctuations globally

6) Foreign Investment Risk: When rate of different currencies fluctuate and lead to possible loss to the bank, this is called a forex risk.