Analysis of Risk Management and Mitigation Strategies in Banking Organizations
Abstract
Thebankingindustryisanessentialaspectofanyeconomy. The sector playsvitalroles such as; employment opportunities, ensure steady capitalaccessforboth small and medium enterprises,cushion established industries against financial problems, facilitate expansion and development of businesses, and provide auxiliary services to government, among many other.As a vital part of development, businessorganizationsneedbanking servicestomaintainfavorableinventorylevels,increasetheiroutput,expandtheiroperations, and investinnoveltechnologies.Therefore,astableandconfidentbankingsectoris essentialfortheindustry’sindependenceandoverall economic growth.However,this sector facesnumerouschallengesthatthreatenefficiency in how it dispenses its mandate.Globalizationandtechnologicaladvancementsare among the factors that have incessantly steered the bank industry into a quagmire of risks. External and internal banking transactionsare the primary sources of bank industry risks. Global supervisoryandregulatoryorganizationshave continuously voiced their concerns on how the banks should realign their systems to avoid such risks or develop mitigation strategies that will be used in case of risk emergency. Thus, thispaperseekstoevaluateriskmanagementandmitigationpracticesinthebankingsector.
Keywords:
AnalysisofRiskManagementandMitigationStrategiesinBankingOrganizations
The business world is made of many risks, and actors assume them to make profits on the investments. Bankingorganizationsas a component of business alsoassumesriskslike any other enterprise torealizegainsontheirinvestments.However, Banks face risks that could potentially deny their profits and causesignificantlosses to their finances.
Traditionally banks hold reserves of their investment in anticipation of future uncertainties. Althoughcertainrisksareanticipated,othersare not.In the event of unpredictable threats such as; fallinginterestratesandfinancialcrises,plunges many banks into a financial crisis where they are forcedto re-inject their capital in the system to cushion the losses.Globalization, ever-advancing technologies, and competition continue posing dynamic and unpredictable risks to the banking industry. These unpredictability calls for activeriskmanagementstructurestoenablethemtosurvive.
Effectiveriskmanagementpractices form the frontline strategies that can be used in the management of such risks.When well-fashioned, the art of risk management is a tool that can be utilized by bankingorganizationsto continually expand their niche alongside remainingcompetentthrough optimization ofrisk-returntrade-offs.Furthermore,thefieldofriskmanagementhasexperiencedconsiderableandrapidgrowthover thelastthreedecades,andthishasresultedinseveraldifferentperspectiveson risk management. Through study models performance of some of the risk management techniques has been impressive and recommendable.
The new risk management techniques indicate how the banking sectors are becoming aware and acknowledging dynamics in the recentglobalfinancialcrisis. Financialsectorplayers unanimously concur on the need forcomprehensiveand holistic riskmanagementreformsinthe bankingandfinancialmanagementsector.Regardlessofthediverse solutionsbeing offered,expertsagreethatthe scarcityofappropriate,effectiveriskmanagementsystemsisacriticalfactorinthefailureofbankingorganizations. They mayevenhavecontributedtotheongoing financialcrisis.
LiteratureReview
Risk management in the banking sector
The banking industry is among the sectors that are dynamic and also faces exponential number of risks in their daily operations. Hence, risk management practices are vital to theircontinuity and safeguard of their asset values (Megeid, 2017).Effective risk management in the banking industry demands that banking and other financial organizations incorporate various management and mitigation strategies into their risk management approaches.
Koch(2014)statesthatineffectiveriskmanagementstrategiesposes negative impacts on basic operations which include inappropriateauditingofbothfinancialstatementsandauditexpensesandsubsequentlyresultsinincreasinglyunreliablereports.Forexample,the2008–2009globalfinancialcrisissawseveralorganizations,includingbanks,becomeliquidatedasaresultofweakcontrolsystemsandthelackofeffective riskmanagementstrategiesandpractices(Jobst,2014).Asaresult,betterriskmanagementpracticesandpoliciesarenowconsideredvitaltobankingorganizationsinAustraliaandotherpartsoftheglobe.
Risk management strategies
Bankingorganizationsemployvariousriskmanagementstrategiestodealwiththerisksintheirinternalandexternalenvironments.Many business scholars including, Jobst(2014), affirmsthatstress-testingstrategiesareamongthemostnotableandeffectiveriskmanagementstrategiesbankingorganizations use.“Stresstesting”isthegeneraltermusedtodescribethedifferentmethodologiesthatbankingandfinancialorganizationsusetoestimatetheirprobablevulnerabilitytovariousuniquebutpossibleriskevents.Onenotableadvantageofstress-testingriskmanagementstrategiesistheuseofstatisticaldataanalysisin predicting, interpretation,andthecontrolofunfavorableriskoutcomes. Theseincreasetheprecisionwithwhichrisksareidentifiedandmanaged(Cucinelli&Patarnello,2017).
Stresstestingis alsoconsideredausefultoolforenhancingtheclarityofthebank’s balancesheetstatements.Moreover,stresstestingisaneffectivetoolforriskmanagementbecause ofitsflexibilityandthemannerinwhichitexplicitlycorrelatesprobableimpactstocertainevents(Schmitt,2018).The capability provided by the stress testing strategies have aided the banks in determining the trend of their activities and further forecast their expectations. Such information is key to theorganizationalriskmanagementprocessforbothcapitalandfinancialriskmanagementaswellasforstrategicandoperationalexcellence(Schmitt,2018).
AstrongexampleofaneffectivestresstestingriskmanagementstrategyisthatusedbyJPMorganChaseBank,whichsuccessfullyintegratesdifferentstress-testingtoolstomanageandanalyzesourcesofpossiblebanking-basedrisks;itssuccessrateisclearinitsimplementationoftestsonthebank’sportfoliovalues,riskprofileevaluation,andanalysisofprobablenegativefutureconsequences.
Through stress-testing risk management strategies can ensure that banking and financial institutions assume measures to prevent failure, particularly failure associated with economic crises (Wu and Chen., 2014)). As such, stress-testing strategies aim to safeguard clients who deposit their finances with their banks and keep fiscal crises from becoming worse. AccordingtoJobst(2014),effectiveriskmanagementstrategies,stress-testingprojects,andqualifiedbankingstaffareessentialfortacklingeconomicandstatisticalstress-testingfundamentalsusingdatameasurementtools.
Buston(2016)claimthatoneofthenotableadvantagesofstress-testingstrategiesisthattheyconcentratemainlyoncriticalrisks,includingmarketrisks,liquidityrisks,andcreditrisks,andtheyanalyzethebank’sability towithstandcrisesinhypotheticalscenarios.Suchscenarioshavealsobeensimulatedusingintricatecomputermodels,withanincreasedfocusonthebankinginstitution’sbalancesheet.Toascertainefficiency,stress-testingriskmanagementstrategiesstudythebank’ssensitivitywhenit is facingunfavorableeconomicconditions,andtheyusestressesthatarescalablefromlighttoextremeand enablethegenerationofdynamicresultsthatindicateallthepossiblewaysthebankingorganizationwillperforminsuchunfavorableconditions.
Anotherremarkableriskmanagementstrategythatbankingorganizationsemploy istheBaselIIstrategy.AccordingtoMegeid(2017),BaselIIisasetofglobalbusinessstandardsthatrequirefiscalinstitutionstomaintainadequatecashreservestoeffectivelycoveranyrisksthatareincurredasaresultofabank’soperations.Thus,BaselIIrequiresbankstomaintaintheleastcapitalratioinrelationtotherisk-weightedassets.CucinelliandPatarnello(2017)maintainedthatBaselIIoffersbankingorganizationsthechancetoimproveboththeirregulatorycapitalsandcreditriskweightsbyalteringtheirportfoliosandconducting activemanagementofexistingrisks.
AccordingtoMegeid(2017),BaselIItakesanessentialstepwithregardtoestablishinganincreasinglyreliablerisk-sensitivestructureandpromotingthedevelopmentofrobustriskmanagementstrategiesforbankingorganizations.TheothernotableadvantageoftheBaselIIriskmanagementstrategyisthat,inadditiontopromotingincreasedbankingsupervision,thestrategyemphasizestheneedforcapitaltosafeguardbanksagainstpotentiallossesassociatedwithvariousoperations-relatedrisks.
Additionally,thestrategymakesuseofvariousquantitativeandqualitativetoolsinthesupervisionofexistingriskmitigationandmanagementstrategieswhilealsomeasuringadherencetoexistingregulationsandstrengtheningthecorporategovernance framework.Inthisregard,risk-basedmonitoringenablessupervisorstofocusontheprobablecausesofbankingrisks.TheBaselIIstrategyrestsonindividualpillars.Pillar1consistsofthecapitalrequiredforthemanagementofmarketrisks,creditrisks,andoperationalrisks.Koch(2014)assertedthat,tomanagetheaboveriskseffectively,banksundertheirpresentregimesmusthavean8%capitaladequacyratio.Pillar2,usescomputationmethodsforthecapitalchargetoevaluatecreditandoperationalrisks.BaselIIalsomakesuseofthebasicindicatorapproach,whichentailsanestimationofcapitalneedsandthesizeofoperationalrisksasfixedpercentagesofnetinterestearningsandnoninterestincomeofbankingorganizations,averagedoverthepast3financialyears.
Furthermore,theadvancedmeasurementapproach (BaselIIpillar2)entailsthecomputationofmarketandcreditrisksandcapitalneedsbasedonbanks’internalsystems. This enables theevaluationandmanagementofbanks’operationalrisks.Finally,theinternalratings-basedsystemassertsthatcapitalneedsmustbebasedonquantitativeandqualitativeassessmentsofcreditrisks,andtheseassessmentsmustbeutilizedfor thedifferent bankunits.Thisapproachmeansthatbiggerbanksmustcomputethepossibilityofdefaultlinkedtotheratingoftheborrowertodeterminetheamountofcapitalneeded.Inagreementwiththeaboveobservations,Abuzarqa(2019)asserted thatBaselIIstipulatesthe minimumcapitalreservesaimedatsafeguardingcreditorsfromoperationalandcreditmarketrisksevenasitincorporatesanassetweightingsystemtoenablepreciseriskmeasurement.Moreover,inadditiontoofferingmoresignificantsupervisoryfunctionstocentralbanks,theBaselIIriskmanagementstrategynotonlyallowsaccountingtransparencyinfinancialinstitutionsandbanksbutalsoenablestheapplicationofmarketpressurestobankingorganizations.
The other notablekeyriskmanagementstrategiesthat Iwilldiscussinthis paperare riskmitigation—orriskreduction—andriskbalancing.Inbanking,mitigationofbusinessrisksaimstoreduceanyprobableadverseoutcomesofaknownrisk,andbanksmainlyapplyitininstanceswhererisksareunavoidable.WuandChen(2014)describedriskbalancingofriskfailuresindiversemostmodesagainsteachotherinamannerthatminimizesthetotalrisk,tomaintaintotalriskequilibrium.Riskbalancingtheorists argue thatbankshaveparticularequilibriumlevelsofrisks.
HypothesisandResearchMethodology
Bankingorganizationsfacedifferenttypesofrisksdaily,andtheriskratingforeachthreattendstodifferdependingonthelossesthatarelikelytoaccrueasaresultofitsoccurrence.Asaresult,forthepresentstudy,Ihypothesizethatbankingorganizationsmakeuseofdifferentriskmanagementstrategiesdependingonthethreatsandriskstotheiroperations.Giventhehighvolumeofexistingdataandresearchonthetopic,Iwillusethedeskresearchmethodology.AccordingtoHelmsetal.(2018),deskresearchisasecondaryresearchmethodologythatinvolvesthecollectionofdatafromvariousexistingsourcesandis,therefore,alow-costresearchmethodologycomparedtofieldresearch.Thecostsinvolvedincludeonlythetimetakenandthecostofacquiringanyresourcesandresearch materials.
Althoughthedeskresearchmethodtypicallyinvolvesthecollectionofdatafrompublishedstatisticsandreports,inthepresentstudy,Iwillalsocollectdatafromprimary sourcessuch as field surveys(Chu&Ke,2017).Iwillcollectthedatafromsearchesconductedinlibrariesandthe internet, and I will conductinterviewswithprofessionalsengagedinbankingriskmanagement.
The study will utilize diversedatasourceswhich willinclude;internaldatafrombankingcompanies,such as datafrombanks’financialreports, whichindicatetheirriskmanagementstrategies.Furthermore,Iwillacquireinformationfromold interviewsconductedwithbankingprofessionals(Chu&Ke,2017).Othersourcesofdataforthepresentstudywillincludelibrariesandonlinedatabases,includingEbscoHostandDialogDataStar.Iwillalso searchvariousdatabasesandonlinelibrariesforpertinentarticlesinpeer-reviewedacademicjournals and usetheseonlinelibrariesto collectdatafromreports,organizationalandindustrialstatistics,educationalmaterialsonriskmanagementandmitigationpracticesinthebankingsector,andgovernmentreportsandstatistics.Iwillacquireadditionalinformationonriskmanagementandmitigationpracticesfromtheinternet,particularlybankingorganizations’websites.Toanalyzeandclarifythedata,Iwill usequalitativedataanalysis. This willensureeffectivecomprehensionoftherelevantriskmanagementandmitigationstrategiesusedbybanks.
References
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