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Understanding How Your Bank Manages Risk


When you open a checking account or a savings account, you might not be too concerned about the possibility of losing money. After all, bank failures are largely a rarity and when one does occur, the FDIC is there to protect your deposits. Risk management in banks also plays a role in ensuring that consumers can place their trust in the financial institutions that they use. If you’re interested in creating a personal risk management strategy for your money, you can talk to a financial advisor.

What Is Risk Management?

Risk management is simply the process of identifying potential risks and developing strategies to minimize or eliminate them. Businesses engage in risk management across a wide range of industries, which includes financial services.

Why is risk management important? Without it, businesses may be vulnerable to risks that could threaten their financial security or position in the marketplace. By proactively managing risk, organizations are better positioned to control outcomes to a degree and mitigate or offset potentially negative business impacts.

What Does Risk Management in Banking Mean?

Banks and other financial services institutions apply risk management principles to understand what risks they face and how to insulate against them. One of the ways that banks manage risk is by using an if/then approach.

What does that mean? Simply put, if “A” happens, then we can expect “B” as a result. Whether that result is positive or negative is a key consideration for risk management in banking.

Banks are concerned with risks that affect them at an individual level, but risk management also encompasses the financial services industry and economy as a whole. Risk management in banking is about connecting the dots to identify any and every potential threat.

Is risk management foolproof for banks? Not necessarily, as there are always risks that may slip under the radar. However, a solid risk management strategy can make it easier for banks to see threats coming and proactively deal with them before a seemingly small issue becomes a larger one.

Categories of Risk In Banking

risk management in banks

Banks deal with many different layers of risk, both financial and non-financial. Some of the main types of risk include:

  • Credit risk
  • Market risk
  • Operational risk
  • Reputational risk
  • Liquidity risk

Credit risk is the risk that the bank will not get back the money that it lent out. That can happen when individuals or businesses take out loans, then default on them. Managing credit risk is vital for banks, as widespread defaults can threaten the bank’s ability to maintain cash flow and operations.

Market risk or systematic risk refers to the risk of losing money as a result of fluctuating volatility or prices. In banking, one of the most significant drivers of market risk has to do with interest rates. Rate hikes (or rate cuts) can directly affect a bank’s earnings and overall capital.

Operational risk is another way of referring to the internal risk and it can be triggered by different factors. For example, a bank may be subject to operational risk if it’s lax in applying cybersecurity measures to prevent hacking or fraud. This type of risk is problematic because it can result in interruptions to normal operations and lost earnings for the bank.

Reputational risk has to do with how the bank is perceived by the industry and consumers. For instance, if a bank is fined for engaging in deceptive business practices that could drive customers away. That could lead to financial losses if the bank is unable to repair its reputation or is eclipsed in the marketplace by competitors.

Liquidity risk measures a bank’s ability to convert assets to cash in order to pay its financial obligations. If a bank runs short of cash and can’t pay its creditors or make interest payments to depositors, that could threaten its overall stability.

What Other Risks Do Banks Face?

Banks also face risks on fronts that can be more challenging to define. For example, with technology constantly evolving financial institutions run the risk of being left behind if they don’t adapt fast enough. There’s also the risk that banks will invest in upgrading to the latest trendy tech only to see it fizzle out or be replaced by something new.

Then there’s the risk of running afoul of regulatory guidelines. The federal government is continually updating banking guidelines. If banks aren’t paying attention, they risk being out of compliance with the latest rules.

As mentioned, cybersecurity is a growing risk factor for banks and financial companies. Along with the threat of being hacked, banks also have to deal with other risks such as identity theft and fraud. Banking fraud can be costly and banks have to figure out a strategy for managing those added costs. If that involves passing them on to consumers that could result in a shrinking business footprint if customers decide to go elsewhere.

Then there’s the changing banking landscape. The traditional banking model is increasingly sharing space with digital banks and non-bank fintech companies, all of whom are competing for customers. Banks face the risk of losing customers if they’re unable to remain competitive when it comes to things like product selection, online and digital banking, interest rates and fees.

Risk Management Strategies in Banking

How do banks manage risk? There’s no single answer, as managing different types of risk may require different approaches.

A good risk management strategy in banking typically includes:

  • Systems that allow banks to identify risks
  • Methods for collecting and analyzing information regarding specific types of risk or risk factors
  • Processes for mitigating or eliminating risks where possible
  • Ongoing monitoring of risks that have been identified
  • Evaluating the effectiveness of risk management solutions as they’re implemented

Banks can use internal teams to manage risk or outsource that need to a risk management firm.

You can do some risk management of your own when it comes to your bank account. For example, choosing a secure user ID and password or setting up multi-factor authentication are two effective ways to protect your banking information.

Keeping your accounts at an FDIC-member bank is also a smart move. On the off chance that your bank fails, which again is unlikely, your deposits are protected. The current FDIC coverage limit is $250,000 per depositor, per account ownership type and per financial institution.

Again, you can talk to your financial advisor about the best ways to manage bank accounts and mitigate risk. Your advisor can give advice on where to keep your money and how to manage risk when investing.

The Bottom Line

risk management in banks

Risk management in banking might seem like a boring topic, but it’s helpful to know what kind of risks banks face. Understanding how risk management works can help you develop a strategy for protecting yourself against factors that might derail your financial plans.

Banking Tips

  • If you keep larger amounts of money in your bank account, then you might want to talk to your financial advisor about other places where you could keep it. Deposits over the FDIC limit would not be insured should something happen to your bank. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Credit unions face the same risks that banks do and they manage them the same way. One difference between keeping your money at a bank and opening accounts at a credit union is how they’re protected in the event of a failure. The National Credit Union Administration (NCUA) insures member credit unions up to the same limits that the FDIC insures banks.

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