Definition of ‘Risk Management’
Risk Management is a process of identification, analysis and either acceptance or mitigation of uncertainty in investment decision-making. Essentially, risk management occurs anytime an investor or fund manager analyzes and attempts to quantify the potential for losses in an investment and then takes the appropriate action (or inaction) given their investment objectives and risk tolerance. Inadequate risk management can result in severe consequences for companies as well as individuals. For example, the recession that began in 2008 was largely caused by the loose credit risk management of financial firms.
Investopedia explains ‘Risk Management’
Simply put, risk management is a two-step process – determining what risks exist in an investment and then handling those risks in a way best-suited to your investment objectives. Risk management occurs everywhere in the financial world. It occurs when an investor buys low-risk government bonds over more risky corporate debt, when a fund manager hedges their currency exposure with currency derivatives and when a bank performs a credit check on an individual before issuing them a personal line of credit.
The banking system has experienced many significant structural changes. The new legislation will put brokerage firms and insurers on a par with banks by allowing them to enter into the full range of financial activities and compete globally. Customers, on their part, are demanding more sophisticated and complicated (Crouhy, Galai, Mark. 2001). Banks are, therefore, increasingly engaged in what might be called “risk shifting” activities ways to finance their activities. The change in emphasis from simplistic “profit-oriented” management to risk/return management.
Banks are increasingly engaged in what might be called “risk shifting” activities. These activities demand better and better expertise and know-how in controlling and pricing the risks that banks manage in the market. As the banking industry has evolved, the managerial emphasis has shifted away from considerations of profit and maturity inter-mediation (usually measured in terms of the spread between the interest paid on loans and the cost of funding) toward risk inter-mediation. Risk inter-mediation implies a consideration of both the profits and the risks associated with banking activities. It is no longer sufficient to charge a high interest rate on a loan; the relevant question is whether the interest charged compensates the bank appropriately for the risk that it has assumed.
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