The Moorad Choudhry Anthology, + Website

CHAPTER 5 Banks and Risk Management

“People aren't friends till they have said all they can say, and are able to sit together, at work or rest, hour‐long without speaking…”

—T. E. Lawrence, quoted in J. Wilson, Lawrence of Arabia: The Authorised Biography of T. E. Lawrence, London 1989, p. 704

The practice of finance brings with it risk exposures that have to be understood and managed, for all participants. Banks are (or should be) at the forefront of this discipline. In fact the art of banking is the art of managing risk on both sides of the balance sheet. In this chapter, we introduce the “universe” of risk for banks, and develop the individual segments in subsequent chapters. In addition, there is a primer on the value‐at‐risk (VaR) risk measurement tool. Many regulators request the banks they supervise to employ the VaR technique when calculating risk exposure and thereby their minimum capital requirement, and as such it is worthwhile being aware of the methodology, the assumptions behind it, and its weaknesses.

THE RISK MANAGEMENT UNIVERSE FOR BANKS¹

It is sensible to group balance sheet related risks in banking separate from other risks. The former includes the main one for banks, credit risk, as well as market risk, non‐traded market risk, and liquidity risk. The latter would include technology risk, operational risk, and conduct risk.

Introduction

Banks are by their nature risk‐taking institutions and as far as possible seek to meet the precise needs of their ...