Risk Analysis of Banking and Financial Sector Companies

Introduction Bank?s financial statements represent unique risk factors which change with varying policies, practices and perceptions in the banking system which call for a different procedure for analyzing them, different from manufacturing and service sector. Risk in Banking Systems The banking system suffers from six most common risks which can be classified as 1) Financial Risks; 2) Non-Financial Risks. Financial Risks can further be classified into three main sub headings: 1) Credit Risk: The credit risk or default risk can be defined as the potential loss that can be incurred due to failure of the bank?s counterparty to meet its obligations as per the terms of the contract. For example: a homeowner stops making monthly mortgage payments. 2) Liquidity Risk: Liquidity risk arises when a bank is unable to raise funds to meet the expected or unexpected obligations of collateral or cash without adversely impacting bank?s financial conditions (funding liquidity risk) or when a bank is not able to write off its position in some financial instruments due to inadequate market depth or market inefficiencies (market liquidity risk). 3) Market Risk: Market risk arises due to movement in various market policies. The market risk management of a bank involves assessment of sensitivity of a bank?s earning to various factors like foreign exchange rates, interest rates, commodity prices and equity prices.