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Managing Risks in Commercial and Retail Banking by AMALENDU GHOSH

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CHAPTER 1

Business Risk in Banking

1.1 CONCEPT OF RISK

Risk in banking refers to the potential loss that may occur to a bank due to the happening of some events. Risk arises because of the uncertainty associated with events that have the potential to cause loss; an event may or may not occur, but if it occurs it causes loss. Risk is primarily embedded in financial transactions, though it can occur due to other operational events. It is measured in terms of the likely change in the value of an asset or the price of a security/commodity with regard to its current value or price. When we deal with risks in banking, we are primarily concerned with the possibilities of loss or decline in asset values from events like economic slowdowns, unfavorable fiscal and trade policy changes, adverse movement in interest rates or exchange rates, or falling equity prices. Banking risk has two dimensions: the uncertainty—whether an adverse event will happen or not—and the intensity of the impact—what will be the likely loss if the event happens (that is, if the risk materializes). Risk is essentially a group characteristic; it is not to be perceived as an individual or an isolated event. When a series of transactions are executed, a few of them may cause loss to the bank, though all of them carry the risk element.

1.2 BROAD CATEGORIES OF RISKS

Banks face two broad categories of risks: business risks and control risks. Business risks are inherent in the business and arise due to the occurrence of ...

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