Risk is a very common word liberally used in the news media, especially financial journalism, heavy academic journals, professional magazines and most often by the regulators.  Risk may be thought of as a concept that describes uncertainty in achieving goals and drivers of uncertainty include lack of information, knowledge, judgment and care to maintain a few.  Risk is the most fundamental factor that influences financial behaviour and it would be fairly a simple job to allocate and manage resources in the absence of risk.

Managing risk has acquired greater dimensions in the wake of the Structural changes that has come about the international financial world.  Mergers and alliances, coupled with growth in size, competition deregulation, product innovation, new business initiatives have substantially altered the behaviour of this world. 

The environment in which we operate is a complete set of relationships and interactions amongst many an element and the very purpose of the existence of an organization is to create value by interacting with its environment.  Resources such as human, financial, intangible assets are converted into services to create value that cater to the needs of the constituents and society at large.  In such a scenario, risk traces its origin to the uncertainty of an unexpected change in the environment.  Managing risk in short means managing the organization.  An organization can be termed risk fit if it has sensitivity to detect risk, has flexibility to respond to risk and the capability to mitigate risk in terms of resources.

Globalization and technology have brought about mind-boggling changes in both domestic and international markets.  In the past, the single key recognized risk was credit risk.  The customers do want to bear the credit risk even for a price.  The changes embracing the financial world have resulted in many more new risks being added to the galaxy of risks.  Listed below are risks, which can generally be generally understood by common sense and many not need mathematical sophistication.  Experience shows that often in most of the downfalls, people seldom thought about them and have not planned for them in advance.

The first salvo was fired in 1971, with the break up of fixed exchange rate mechanism.  The oil price shocks of 1973 followed by the event of Black Monday - 19th Oct. 1987 and many successive events have brought risk management under microscopic view.  The latest event to be added to the list is the bombing of WTC on 11th Sept. 2001.

Management of Market risk has received increasing attention world over from managers and supervisors with the risk in trading activities.  It is the risk that changes in financial market prices and rates will alter the value of bank’s positions.  The sub-class of market includes interest rate risk, currency risk, basis risk, commodity risk and equity risk.  Measuring of market risk in trading portfolios is done through a summary measure, Value at Risk (VaR) and Value at Risk (VaR) models, where these models are designed to estimate for a given trading portfolio, the maximum loss that a bank could incur, over a specific time period with a given probability.  A comprehensive risk management approach requires supplementing by a stress-testing programme to evaluate the impact of extreme market events.  Ultimately, it is these violent large price movements that cast great risks to the bank, which are not captured by VaR models.

The non-traded interest rate risk is often a greater source of market risk for banks; bank has a wide mix of fixed-rate and floating rate assets and liabilities, which are sensitive to repricing when interest rates change.  Here comes Asset-Liability Management (ALM) process which banks keeps in determination of interest rate sensitivity of the balance sheet and the implementation of Risk Management practices to hedge the potential efforts of such interest rate charges.

Liquidity risk comprises both funding liquidity risk and trading related liquidity risk, though the two have a closer relationship.  While the former relates to the ability of a bank to raise funds to roll over debt obligations, meet statutory requirement, Cash margin and collateral requirements of counter parties, the latter is that risk that a bank will be unable to execute a market transaction at a prevailing market price and this may also reduce the bank’s ability to manage and hedge market risk.  History is replete with financial institutions and banks crashing down on account of poor liquidity management.

Credit risk is the risk that a shift in the credit quality of a counter party will affect the value of the bank’s position.  Since risk management came into being credit risk has been recognized as a key risk.  It encompasses a class of risks viz. default risk, spread risk, downgrade risk and concentration risk.  Credit migration approach is employed to assess credit risk.  There are also other methods like contingent claim, actualized approaches to measure credit risk.  The assessment involves sophisticated statistical tools and computational facilities.

Operational risk refers to potential losses causing from inadequate systems, failure of management, defective controls, frauds and human errors.  It has been observed that derivatives are more prone to operational risk through cash transactions as they by their very nature are leveraged transactions.  The guiding principles of operational risk include factors like objectivity, consistency, relevance, transparency etc.  Operational risk poses a great challenge to the top management in terms of bringing about harmonization in the business units, corporate governance, internal audit and risk management.

The major impetus on implementation of risk management in banks has been the Basle Committee on Banking Supervision (BCBS). The new capital accord envisages capital allocation, based on more comprehensive approach to risks.  It can be undoubtedly said that risk management is becoming increasingly complex and banks in India are at their infancy in regard to risk management.  Risk management is a more skilled activity than in the past.  An efficient bank in future will be the one with a single analytical engine that draws data from a single data source and supply information enterprise wide risk.  Reusable, robust risk software and sophisticated analytics will constitute the risk systems.

A year from now is going to be somewhat changed from today and one hundred years now will be certainly different.  If each tomorrow would exactly be like each today, there would be no need for the study and practice of risk management!!!