What are Corporate Credit Cards? – Different Types of Cards
February 12, 2025
Annuities can be divided into two types based on the exact time when the payments occur in a given period. The payments could either occur at the beginning of every period or the payments could occur at the end of every period. For instance when you take a house on rent, the rent is usually […]
What is a Currency War ? A currency war is a situation wherein devaluation of currency by one country is retaliated by a competitive devaluation from the other country. For instance if the United States were to devalue the dollar against the Pound Sterling and if the British retaliated with their own devaluation then the […]
The endowment effect is another important psychological barrier that helps people from realizing the full potential value of their investments. Like other cognitive biases, it obscures the thinking of the investor and gets them to make decisions, which can be described as “suboptimal,” to say the least. In this article, we will have a look […]
In the previous article, we had a closer look at the concept of covenants as well as indentures. However, we only covered the basics. Indentures and covenants are extremely important to the investors who deploy their money in fixed-income securities. It is for this reason that investors need to have a better understanding of the […]
What are Capital Controls ? Capital controls are when the governments of nations restrict the inflow and outflow of capital into the economy. In a free market economy, there should be and would be no borders. However, this is not the case in reality. Countries want to ensure that their economies stay relatively stable in […]
Banking activity is generally considered to be risky. Banks earn money by borrowing money from people and then lending them to other people at a higher rate of interest. However, commercial banking activity is considered to be even riskier. This is generally because of the huge dollar value of the transactions in commercial banking.
Hence, commercial banks are required to create a system to manage the risk in a more appropriate manner.
In this article, we will have a closer look at some of the risk factors which are associated with commercial banking.
A commercial bank is considered to be riskier as compared to other lending institutions. This is because of the various risk factors which are associated with it. Some of the important ones have been listed below:
It is common for commercial banks to lend out millions of dollars to corporations. Since the ticket size is larger, there are fewer counterparties in a commercial bank’s portfolio. A default by any single counterparty has a larger impact on the workings of a commercial bank.
For instance, many auto ancillary companies might be selling to the same automobile company. Since the business of all these companies is related so closely, there is a possibility of a contagion effect. This means that the failure of one company has an impact on another company and can induce the failure of that company. This makes lending to corporates riskier.
Now, since we know that commercial banks face higher lending risks as compared to other lenders, let’s have a closer look at some of the risks which are faced by commercial banks.
There have been many cases in commercial banking history where bank officials have colluded with large corporations in order to defraud the shareholders of the bank. Commercial banks need to take such risks into account.
In some extreme cases, commercial banks may also face temporary suspension of their license. Hence, commercial banks need to be cognizant of these regulatory risks and have procedures in place to control them.
Commercial banks also interact with the markets if they securitize their long-term loans. An adverse movement in the markets exposes commercial banks to a lot of risks. It is important for commercial banks to plan for such risks and also use derivative instruments in order to manage them.
The fact of the matter is that commercial banking is an extremely risky operation. Banks are exposed to a wide variety of risks. However, over the years, banks have developed risk management systems that are quite effective.
Your email address will not be published. Required fields are marked *