Risk management tools and techniques in banking and their regulation

Abstract

In this dissertation, the core risks taken by banks are identified, and the tools and techniques in the management of such risks assessed. The regulatory aspect is looked into. The core financial risks to the business of banking are credit risk and liquidity risk, market price risk, currency risk and interest rate risk. The objective of banking is not to minimise such risks but to manage them effectively. Accurate and timely measurement of risk is essential to effective risk management systems since it enable banks to control and monitor risk levels. In attaining such objectives, banks adopt tools for measuring the magnitude of their financial risk and based upon the risk management policies established by the Board of Directors, apply the necessary techniques to control financial risks. Whilst internal controls can be considered as a set of techniques directed at controlling operational risk, the importance of high-level controls in managing the broad aspect of credit, liquidity and market risk management cannot be overlooked. Management oversight through internal controls ensures that the efforts in measuring and managing financial risks are not obscured by operational ineffectiveness. Major international banks are continuously developing new risk management tools and techniques due to their high risk exposures. Notwithstanding, smaller deposit money banks still attain comfort through the application of traditional risk management practices. By refraining from implementing sophisticated risk management practices however, can drive banks relying solely on traditional practices into a competitive disadvantage on the effective allocation of regulatory capital following the developments of Basel Accord II towards a risk based capital approach. Whilst the ultimate goal of supervisory authorities is that financial risks arising out of the business of banking are maintained under control, proposed risk management practices and reporting requirements do have a bearing on the choice of risk management tools and techniques selected by banking institutions.