What Are the Main Risks Faced by Banks and How Does a Bank Attempt to Manage These Risks?
What are the main risks faced by banks and how does a bank attempt to manage these risks?
A Bank is a financial intermediary that acts as an economic firm producing goods and services. With this view in mind it’s easy to see that a bank exists to make a profit. In order for a bank to be successful and make a profit, it has to take risk. A bank that is averse to risk will be a stagnant institution unable to adequately serve its customers effectively and produce a profit. However, a banking institution that takes excessive or unnecessary risk is also likely to run into trouble. All risk is uncertain but with bounds the probability of an outcome can be predicted using expectation. A bank can also run into trouble if it decides to take a
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There are a number of alternative, if yet less desirable options available to the bank to solve a liquidity problem. The banks can also turn to the central bank, the Bank of England, who, instead of only helping banks in occasional crisis, as used to be the case, now provide liquidity to the banks for very short periods of time, usually overnight, in order to enable the smooth running of the financial system. Another solution to the liquidity risk has become more prevalent in recent years with the development of the ‘interbank market’. This market allows banks with surplus funds to lend, at a rate of interest, to banks that need increased liquidity. Again this is normally only for very short periods of time, usually over night. This system is effective as it spreads the existing stock of liquidity over the whole market, supplying according to need. The drawback with the system is that it means banks have to borrow from their competitors and may not always get a fair rate of interest. Banks can also go to the central Bank for larger loans if needed, though this is known as turning to the ‘Lender of Last Resort’ as it is undesirable. This occurred very recently, although in secret, when the Bank of England injected £61bn into