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  • 19Oct

    What can cause a crisis in the banking system?

    In times of deregulation and strong competition, the banks are fighting for survival on the financial markets. To make a profit, they have to deal with many risks which might cause the performance of the banks to go down, even leading to their bankruptcy. There are three basic risks which every bank needs to consider if it wants to avoid serious consequences. Those are: credit risk, market risk, and operational risk.




    Credit risk

    The credit risk has to be evaluated for every commitment and for every business transaction before the bank gets into the credit transaction. According to the Basel II recommendations, there are four components of risk:

    • Probability of default – refers to obligors which are evaluated by their credit capability;
    • Loss given default – the amount of loss if it comes to non-committing of obligations;
    • Exposure at default – estimation of the extent to which a bank may be exposed in case of the counter party’s default; and,
    • Maturity – the longer the maturity means that the credit risk is higher.

    Market risk

    World of banking

    World of banking

    The market risks are risks that may be caused by the negative trends on the market such as changes on the stock market, fluctuations of interest rates, and currency changes. Volatility of prices on financial markets and changes in currencies are influencing the growing risks for the banks involved in these activities. The bank needs to estimate possible fluctuations on the market to predict if they might have impact on its financial situation. The banks are controlling financial risks by holding short term bonds, shares and others currencies. They permanently estimate and control their value in the market based on their current prices. There are two kinds of market risk – general market risk and specific market risk.The general market risk refers to possible loss caused by the general unfavorable trends on the market. The specific risk is determined by fluctuations in certain sectors of the financial market such as negative trends of certain bonds or stocks. Also, it is worthwhile to mention that the national central banks are in charge of managing the financial risk on the markets so they prevent big fluctuations and bring commercial banks into more safe positions to avoid bankruptcy.

    Operational risk

    The operational risks are defined as the risk of loss caused by irrelevant internal processes, such as the mistakes of the employees or the systemic errors. Also, it can be caused by some external factors such as, for example, the legal risk or inadequate representations. The commercial banks are managing the operational risk by holding a certain amount of capital that will cover the extra loss. That part of capital is not considered in the operational planning. However, the best way to prevent operational risk is to have good management and good a team of trusted and qualified employees that understand all  the technical parts of any financial operation they are performing.

     

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