How Financial Organizations Defend Themselves from Indebtedness

October 27, 2021
Bank Risk Management

Every business or enterprise has an inherent risk with it. This also includes the financial institutions and a bank is one of the most exposed ventures and it has the highest level of risk associated when it comes to its day-to-day functioning.

Thus, the threat management department is one of the core parts of any bank and its internal process. 

The banking and financial industry is modernizing and updating its operations for a long time by digitizing the systems and integrating the disparate systems.

They are also allowing external access to the data through open banking. Therefore, the complexity and importance of threats are increasing exponentially. 

As a result, these financial bodies develop many risk management techniques that reduce the risk as deeply as possible without affecting the growth of such bodies.

Many components are a part of the software tools for risk management in this industry and they play a major role in the compliance process of a bank and also affect its decision-making strategy.

Categories of Risk Management

As there are multiple varieties of threats that are inherent to this industry, many facets are present when it comes to risk management and it needs personal focus with attention.

The two fundamental threat types include – the risks that are taken by financial institutions by taking upon themselves and this is essentially taken care of while lending or when making investments; the other types of threats are the ones that occur due to the forces or events outside of the financial body. 

All these financial risks should be assessed collectively and they should be mitigated and monitored continuously.

Thus, risk management is a critical aspect of the financial sector. Below are the types of threats in this industry.

Credit Default Risk – This is a type of financial risk that is core to the business model of the bank and it is a key part of the revenue stream. It is the biggest danger for any bank.

The risk arises when the customers or organizations that borrow from them do not repay the amount. 

But credit-issuing is an important revenue stream with higher interest rates thus it can’t be ignored by the financial bodies.

The management of credit threats involves the assessment of the lending health of a body to ensure that such risk is reduced. 

Liquidity Risk – Another major risk category for a bank is liquidity risk. It includes the risks associated with a bank’s ability to pay back debts.

The threats in terms of banking debt are also about the cash flows that it has in hand at any time and its ability to raise money through asset sell-off. 

The management of liquidity risk is extremely complex and it involves financial factors that compound or convolute any issue.

The banks need to accomplish stress tests regularly which enables them to ensure that the bank can meet short-term debts in case this becomes a necessity for raising liquid funds to manage the banking operations.

Market Associated Risk – The uncertainties that a bank faces in the short or long term and are about the sudden unexpected changes that occur in the market are market risks and they impact the finances of a bank negatively. Many events affect the exposure of a bank to such risks.

It is an integral part of the job of a risk manager and they assess the overall risk for the bank as per the market condition at regular time intervals.

It also helps to diversify the bank’s resources to reduce exposure to such events.

Operational Risk – Operational threat covers the vulnerabilities which are associated with a bank’s inner workings.

Such threats can occur from the incidents including accidental human faults during any type of transactions related to banking. It can also occur due to deliberate fraud actions.

It covers all types of cyber crimes which are becoming a threat that is growing rapidly with tools like ransomware and phishing. 

The management of operational threats is relatively new and it includes risk governance within the laws of banking supervision. 

Risk Management Procedures

While dealing with the huge threat spectrum of the banking and financial sector, all types of banks embrace various threat management procedures.

Risk Management Procedures

This is essential for doing business and there are some basic techniques that banks use to reduce the exposure and damage that is associated with the various threat categories. 

These techniques include: 

  • Evasion – This is the basic technique that involves evading from engaging in any type of risky venture for a bank. For instance, a bank not lending money to borrowers who have a history of bad credit is an example of evasion.
  • Retention – This is the process of risk acceptance and a certain degree of hazard is unavoidable for the banking sector and it is necessary for the lasting growth of a bank.
  • Control – In case of a bad loan or other unforeseen events, the bank needs to mitigate damages as per its capacity. The liquidity hazard also comes into play in such a scenario.
  • Transfer – This type of hazard is about the third party and the banking and insurance department is insured by the investor deposit. 

Approaches towards Risk Management

The art of hazard management involves the combination of robust financial data with the human instinct that ensures good financial decisions for the industry.

The threat management does not have a perfect way and it is based on future events hence it has an unknown element. There are different strategies that managers use while executing the daily routine. 

The first step in this approach is to identify various types of threats banks face.

The approach is to make a decision as per the internal decisions of the organizations. The approach involves not lending to the unworthy borrowers and other unexpected events in the market. 

Managers have to visualize all these potential problems, outcomes, and scenarios through the use of tools like decision trees, process mapping, and SWOT analysis. The multiple types of risks indicate a threat level. 

A disaster manager has to employ a wide variety of such tools that help them to tap the pulse of a bank and such strategies ensure that the bank or organization are ready and healthy for reacting or rebounding in case something goes wrong.

Software for Risk Management in Banking Industry

All banks need to use some type of threat management software to manage their internal and external risks.

The legislation and development of artificial intelligence and machine learning tools are providing a wide range of choices around the world for banking and financial institutions. 

The digital threat management programs use the huge data available and they process this data to help the managers in making better decisions for their organizations.

This allows the people who are in charge to understand the big picture for their institution too in real-time.

The multiple common features of such software areas are as under:

  1. Obedience – This is a feature that includes compliance and it essentially includes the consumer protection laws, the board oversight, and the ability for a bank to self-audit to ensure that the measures are in place and work well for its objectives. The software should be up to date as per the national or international requirements. They help a bank to stay afloat by the regulations while also eliminating the potential fines that may be stamped upon them in case of non-regulation. 
  2. Digital Repository – This is an important feature, which is to serve as a digital repository for the multiple risks faced by a bank, collecting data and visualizing the data in charts. The digital dashboard presents the insights in a great fashion.
  3. Robust Monitoring and Sorting – The software is for assessing everything from IT to internal fraud and employee lawsuits. It helps a risk manager to tag and sort hazard levels and creates strong workflows which help banks to deal in a better manner.
  4. Generation of Report – Report generates and shares with executives quickly. Such reports enable a team to see the potential outcomes of different scenarios and to make informed decisions.

Synopsis

The process of bank threat management is core to the bank’s internal processes and no bank can survive without it.

The job of a manager is to understand the threats before them and keep them in check. There are many threats including internal and external risks that make a bank fail.

But the right threat management tools can be beneficial in visualizing and organizing the risks so that everybody can have information about the overall health of a bank.  

All product and company names are trademarks™, registered® or copyright© trademarks of their respective holders. Use of them does not imply any affiliation with or endorsement by them.

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