Risk Management

Taking risk is fundamental to banking. A key responsibility of directors is ensuring that management is effectively addressing the risk inherent in the bank’s operations. There are various methods to address risk. One is pricing. The bank should receive a return commensurate with the risk it is assuming. The higher the risk in a loan or investment, the higher the interest rate should be. It’s the old risk/reward adage.

risk management modelAnother method to address risk is capital. Banks taking on more risk should have a stronger capital position in order to absorb losses from higher risk activities. All of these tools can offset a bank's risk taking, safeguard its assets, promote its efficient and effective operation, and enhance the accuracy and reliability of its financial reporting.

Another way to manage risk is to avoid, sell, insure or accept it.

Finally, the bank should have a risk management system that includes the necessary systems, processes and procedures to identify, measure, monitor and control risks. A director’s major responsibility regarding risk is to provide a management structure to achieve this objective. Basic elements of risk management systems include:

  • active board and senior management oversight;
  • policies and procedures to prescribe risk limits (click on the "Basic Elements of Policies" under the Learn More column for more information); and
  • risk measurement, monitoring and management information systems.

All of these tools constitute the bank's risk management system, a system that helps protect it from events that may cause it harm.