Risk Management
Risk management is the structured process of identifying, measuring, monitoring, and mitigating financial and operational risks.
Meaning in Practice
In practice, financial institutions implement internal frameworks to assess credit, market, liquidity, and operational risks. This includes setting risk limits, conducting scenario analysis, and maintaining internal controls. Risk management functions operate independently from revenue-generating units to ensure objective oversight.
Why It Matters
Effective risk management protects institutions from unexpected losses and insolvency. It strengthens resilience during market stress and supports regulatory compliance. A strong framework enhances investor and depositor confidence.
Market Impact
Robust risk management reduces volatility in earnings and lowers funding costs. Weak frameworks can lead to sudden losses, rating downgrades, and capital shortfalls. Markets closely monitor risk controls in systemically important institutions.
Example
A bank limits its exposure to a single corporate borrower and regularly stress-tests its loan portfolio against adverse economic scenarios to avoid concentrated credit losses.