10 Major Risks Faced By Banks

Over the past few years, the finance industry has undergone many significant transformations due to technological advancements, business model transformations, changing regulatory standards, and enterprise software development practices. Today, the banking industry is changing the lives of ordinary people tremendously. Banks across the globe have become much more advanced with the help of enterprise solutions and have strategically addressed the security concerns that have plagued online banking solutions in the past. 

However, due to the accelerated growth of the banking sector, banking operations have become much more complicated. The risks involved with adopting disruptive technologies call for a change in the regulatory business procedures. Even with the power of cutting-edge hardware and sophisticated banking enterprise solutions, the industry is facing some major concerns.  

Read More: Digital Transformation in Banking Industry

Even if we talk about history, banks have suffered significant losses due to the shift in customer behavior patterns, the introduction of new technologies, changes in international policies, and so on. Hence, it’s vital to discuss the risks involved in the finance industry that are majorly faced by all the banks.

Risks Involved in Banking Industry

Credit Risk

One of the most significant threats faced by banks is credit risk. In simpler words, credit risk is defined as the inability of a borrower or a counterparty to meet the contractual obligations. In other words, when a borrower fails to pay the appropriate amount to the lender due to any financial crisis. The banks have suffered huge losses in the past from credit risks, and are still prone to such losses. 

Although credit losses are primarily defined by the inability of the borrower to repay loans to the lenders, it also includes the delay in payments of the borrower. That means if any borrower does not make timely payments, such cases also come under credit risks.

What Can Be Done?

Such type of losses commonly occurs due to borrower insolvency. Hence, banks should conduct proper research before granting the loans and only sanction loans to individuals and businesses that are not likely to run out of their income during the payment period. Banks can employ enterprise solutions to evaluate the applier’s financial history and then deduce whether they will be able to pay off their loan.

Market Risk

Market risks are defined as the risks involved in the fall of a company’s share or decrease in the value of the stock of third-party companies where the bank has invested. Apart from sanctioning loans, the banks also hold a certain number of shares in the market. And if for any reason, the banks’ share prices dwindle, then the banks will suffer huge losses. Such losses generally come under market risk. 

The market risks can vary depending on the commodity a bank holds. For instance, if a bank holds foreign exchange, they’re exposed to a Forex risk; in the case of gold, silver, or real estate, they are exposed to commodity risks, etc., similar is the case with equity risk.

What Can Be Done?

To mitigate market risks, banks usually leverage hedging contracts. They use contracts like forwards, options and swaps, and many more to completely eliminate the various market risks. To reduce the probability of such risks, banks employ AI-based banking enterprise solutions that study the market trends and provide an optimal course of action.

Business Risk

Business risks are a direct result of credit risk. Simply put, when a bank fails to generate profits during a specific period, it is considered to be under business risk. Many times, a business takes a loan from a bank and then fails to repay it. In such a scenario, the banks face losses due to business risk. 

The result of a business loss is either being acquired by some other banks or a collapse in big banks. Examples of banks that suffered huge losses due to the wrong business strategy are Washington Mutual and Lehman Brothers.

What Can Be Done?

Although there are no sure-shot methods of eliminating the business risk, the adoption of the right strategy might do the work. Being vigilant and monitoring business health using automated banking software and enterprise solutions might help banks prevent major losses.  

Read More: Financial Software Development: A Complete Guide

Security Risk

One of the biggest concerns for all finance-based businesses is their cybersecurity. . Cybersecurity concerns are also the reason why many customers are against the idea of online banking. History is littered with bank cyber-attacks that resulted in billions of dollars vanishing.   

It is a common misconception that anything that is digital is theoretically hackable. But while that may be true for systems with outdated security measures and tools, for updated systems, nothing can be farther from the truth. As technology evolves, hackers keep finding new ways to hack banks. And it falls on the banks to evolve with the times and ensure that their enterprise solutions are secure against the latest threats.  

Banking institutions are still making considerable investments in security to make their customer’s data and systems more secure than ever. The industry is leveraging the latest technological advancements of AI, ML, Blockchain, big data, etc., to yield positive results in terms of security.

What Can Be Done?

The banks need to invest in top-notch fintech software development that is way more secure and impenetrable. They need a skilled and detail-oriented technology and cybersecurity partner who provides top-tier software development services. Investing in the latest cybersecurity tools can also help banks keep their data secure and people’s money safe.

Compliance Risk

When a bank does not follow proper regulatory standards put down by the financial institutions, such risk is known as a Compliance risk. These are usually not as concerning as the other risks on this list, but they are still quite significant. 

When a bank does not comply with proper regulations formed by the banking institutions in their branch, they face financial and legal losses. 

The banks get severely affected by such risks and suffer losses in their daily banking targets. They have to bear legal penalties and might face significant challenges from the regulatory committees.

What Can Be Done?

To mitigate such types of risks, the banks should formulate, regulate, and manage all the regulations and compliance policies across all their branches. Hiring a banking enterprise software development company to create solutions that can help you keep track of various compliance requirements is also a great way to avoid getting in such legal quagmires.

Operational Risk

When there is a failure in the bank’s internal processes due to inefficient systems, it is termed an operational risk. Banks have to perform various operations like daily transactions, cross-border transfers, cash deposits, and much more. However, there are times when the internal or central systems slow down. 

In such a scenario, the bank faces losses due to operational risk. Not only that, when there are some other mistakes like payment transfer in the wrong account, execution of an incorrect order, etc. also falls under operational risk. It is worth noting that the banks do not directly get affected because of the operational risks but can be held responsible by those who are affected.

What Can Be Done?

The operational risks can be minimized by automating the workflows using enterprise solutions to reduce human intervention. Also, banks should use software from a trustworthy development company to ensure smooth operations.

Reputational Risk

Reputational risk results from the operational risk and, to some extent, the security risk. In other words, when a bank fails to provide quality services to their customers, or when they perform inefficiently in processing their requests, then they suffer a loss in user perception. The news channels interrogate the people and make false perspectives about the banks. In such a scenario, the daily revenue of the bank drastically reduces, and hence they suffer huge losses. They lose their stellar reputation in the global market, and their profits decrease.

What Can Be Done?

The banks should ensure smooth functioning and should provide safety and security to all of its customers. They should never participate in unfair practices and ensure customer satisfaction in every possible way.

Liquidity Risk

Liquidity risks arise because of the increase in the non-profitable assets in the bank. That is, if there is an increase in the credit losses and losses due to business risk, then liquidity risk arises. Due to the rise in the liquidity risk, the bank cannot meet the obligations if any depositor comes to withdraw its money. 

Historically, the losses due to liquidity risk have been significant and multi-faceted. However, the present-day scenario has been completely changed. Now the banks have new regulations of keeping a minimum amount of reserved cash to mitigate liquidity risk. That implies that the depositors can be paid even during credit time for business loss.

What Can Be Done?

The banks should follow proper regulations of the central banks and should keep a minimum requisite amount in the banks to eliminate the chances of losses due to liquidity risk. Furthermore, by using strict flags and automated tasks governed by AI-based enterprise solutions, banks can further decrease the chances of running into any liquidity risks.

Systematic Risk

Whenever there are some external issues involved with the bank like employee strikes, market fluctuation, unstable government, and so on, then it is termed a Systematic risk. A systematic risk usually arises from uncertainties beyond the control of the bank management since it entirely depends on various external factors. 

The losses due to systematic risks are unpredictable and cannot be wholly avoided. Banks suffer huge losses due to systematic risk and may have to write off certain assets to compensate for their losses.

What Can Be Done?

The systematic risks are entirely unpredictable, so they cannot be eliminated. However, with smart skills, they can be minimized up to a certain extent.

Moral Hazard

A moral hazard is a relatively new kind of risk in the financial market as compared to all the others on this list/ It came to light recently in the global market. The moral hazard occurs when a bank takes some risk, even when they know that someone else has to bear the losses. In other words, when a bank invests in a risky business, and it backfires, then it is the taxpayers who have to bear all the losses. 

Although the central bank has been tracking the banks and their operations very carefully, some of them still take dreadful risks when not under the regulatory oversight. They get to indulge in the illegal practices and create an imbalance on the taxpayers when their planning fails.

What Can Be Done?

The central bank should pay more attention to the activities of the banks to eliminate the losses caused by moral hazards. The banks should also not indulge in risky businesses and should follow the proper path. Furthermore, by using AI-driven enterprise solutions that operate on market data and other such parameters, banks can get business action predictions that convince them not to make risky decisions.

To Conclude

In this article, we discussed the top ten risks faced by the banking industry with the growing digitalization. That is not to say that all these risks are faced by every bank in the world. But the best way to combat all these mentioned risks and losses due to these risks is to opt for more secure financial enterprise solutions. 

At Matellio, we provide cost-effective and scalable software development services for finance businesses of all sizes. We develop efficient and secure software applications to all our clients. Our expert developers and certified QA engineers ensure that your enterprise solution provides value to your business and meets all the compliance requirements. At the same time, we strive to develop solutions that are easy to use and understand.  

If you want to learn more about our enterprise software development offerings, contact us!