Risks in Banking and Financial Institutions Due to Changing Environment

Factor Affecting Financial Intermediaries

General business and economic risk factors exist for many industries; however, increased competition among banks and savings institutions has resulted in the industry’s aggressive pursuit of profitable activities. 

Techniques for managing assets and liabilities and financial risks have been enhanced in order to maximize income levels. 

Technological advances have accommodated increasingly complex transactions such as the sale of securities backed by cash flows from other financial assets.

Regulatory policy has radically changed the business environment for banks, savings, and other financial institutions. Additionally, there are other risk factors common to most banks and savings institutions, based on their business activities. 

The other primary risk factors are described next.

 (i) Interest-Rate Risk.

This is the risk that adverse movements in interest rates may result in loss of profits since banks and savings institutions routinely earn on assets at one rate and pay on liabilities at another rate. Techniques used to minimize interest-rate risk are a part of asset/liability management. 

(ii) Liquidity Risk

This is the risk that an institution may be unable to meet its obligations as they become due. An institution may acquire funds short term and lend funds long term to obtain favorable interest rate spreads, thus creating liquidity risk if depositors or creditors demand repayment. 

(iii) Asset-Quality Risk.

This is the risk that the loss of expected cash flows due to, for example, loan defaults and inadequate collateral will result in significant losses. 

Examples include credit losses from loans and declines in the economic value of mortgage servicing rights, resulting from prepayments of principal during periods of falling interest rates. 

(iv) Fiduciary Risk.

This is the risk of loss arising from failure to properly process transactions or handle the custody, management, or both, of financial related assets on behalf of third parties. 

Examples include administering trusts, managing mutual funds, and servicing the collateral behind asset-backed securities.

 (v) Processing Risk. 

This is the risk that transactions will not be processed accurately or timely, due to large volumes, short periods of time, unauthorized access of computerized records, or the demands placed on both computerized and manual sy