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Introduction:

If we closely observe the recent finance arena we shall observe that the word “risk” is associated
with our day to day life. Now a day, risk has become so important that, more emphasis is given to
study risk and mainly how to manage risk. Actuarial science, financial risk management etc are the
course related to risk management. Even risk management is given thus importance, that financial
institutions are recruiting more and more employee to successfully manage risk. The other word
which can replace risk is uncertainty.

Risk can be of different types. And we can categorize risk according to different criteria.
Systematic risk is one of the category where as the other category is unsystematic risk.

Risk Management:

Individuals own assets, and whenever we are looking at a single institution we can see either
owner, partners or else shareholders. But these are not the only assets that, the individual owns.
More over each and every asset has certain risk. Risk free asset is obsolete in the universe. So if a
person carry a portfolio of asset and thus divide risk among each other the total risk can be
managed at certain extent. But this not only the concept of risk management. Risk management has
experienced a lot of improvement in the recent year and technology has done miracle in doing
successful risk management.

Many of the English words have derived from Latin words. It has been seen that rescum is the
original word from where risk is derived. The former refers to the probabilities of danger or any
other odd happening in sea. So we can for sure state that, the concept of risk is not a new one (Pyle,
1997).

If we go back to the last century than we shall see that, the sovereign states became active to
ensure properly manage financial institutions and the main objective was to manage risk
successfully. Thus supervisory bodies were created, which started regulating financial institutions
successfully. The bodies started formulating guidelines to manage the FIs so that risk can be
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managed actively. Risk management doesn’t only mean that actions regarding managing risk. But
the banking systems along with the financial institution started finding out risk management
includes pointing out the risk, categorizing them on the basis of importance and preparing process
or flow chart to reduce it as much as possible. More over the over all process should satisfy the
stakeholders of the organization as well as comply with the states law and regulation.

Types of Risk:

Risk which is often referred as uncertainty can be of different types. There is always uncertainty of
credit, market again is quite unpredictable. Some time it is seen that, market shifts upward again
downward. There is no rigid pattern. So from the statistic point of view, probability of occurrence
i.e. the probability of market upward shift and downward shift is variable. Again, many companies
face uncertainties due to there operation and management process which also refers to risk. Among
the major categories of risks the followings are more emphasize in the finance arena:

1. Credit Risk
2. Market Risk
3. Liquidity Risk
4. Interest Rate Risk
5. Forex Risk
6. Country Risk
7. Operational Risk etc

We are going to discuss each of the categories in brief, and thus will follow towards the risk
management practice in brief.

1. Credit Risk:

It is a normal phenomenon that most of us can’t differentiate between credit risk and default risk.
The former one refers to credit risk is that one i.e. borrower can’t meet the obligation that a lender
provides. So, whenever the borrower starts failing to meet the obligation then the credit quality of
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the borrower deteriorates. Credit risk has become day to day word in the lending business thus. As
a result Credit risk management became very important.

Credit Risk Management:

The Finance specialists have been working since the last century to find out a way to reduce the
credit risk. As the banks and other financial institution have been facing credit risk heavily, they
placed this specific risk as the major emphasized one. Until recent times it has been seen in the
banking sector including the international banks to follow different ways to reduce the credit risk.
The financial institutions have been following different techniques as well. More over regulatory
bodies have also produced effective guidelines which upon following credit risk can be reduced at
a lot (Heitzmann 2002).

Some of the techniques are described below:

i. Ceiling Technique:
A limit is provided over the capital fund being exposed.
ii. Review and renewal program:
The guidelines along with the credit rates need to be reviewed and renewed y the
authority to minimize credit risk.
iii. Model to rate risk:
The authority should establish its own risk rating technique to get a clear view and thus
reduce risk.
iv. Management of portfolio:
As I have discussed earlier portfolio reduces risk at a lot, as the risk get diversified
among other assets. But managing portfolio is quite important as, if some one carry
portfolio of assets, which are all risky, then the portfolio itself become risky, so the
portfolio management should be done carefully.
v. Mechanism to review loans:
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This specific task is a very older one, as that lender needs to check whether the loan is
successful, profitable or if there is probability of failure. From this concept, the
Banking sector should also carry their own mechanism to review loans.

It is also seen in the international banks that some specialized techniques are used to control credit
risk. Such as:

a. The model: Altman’s Z Score

b. Credit Metrics
c. Credit Risk+
d. The KMV process
e. Credit Portfolio of McKinsey (Raghvan, 2003).

2. Market Risk:

As I have discussed earlier the total market shifts differently. The market means the total market of
the whole economy. With the price change of each and every commodity the market price of the
total market also changes. And the change can have adverse effect on the financial system, which
is referred as market risk. The calculation of market risk is quite difficult, as it is related to the
entire market of the sovereign state. The specialists have found scenario analysis and stress testing
as an effective technique to measure the market risk, which provided a pathway to establish an
effective market risk management technique. Market risk as early described it totally inter-related
to the price of commodities in the whole market. So market risk management combines of the total
process of taking affective action so that adverse impact on the financial system can be easily
managed, as well as equity analysis is also important.

Market Risk Management:

Specialist found out that, if any financial institution follows the following regulations than the
market risk management will be active:
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i. Management information system has been working as a vital weapon for market risk
management.
ii. Limit works wonderful to manage market risk.
iii. By maintaining effective portfolio allocating resource will help to manage risk easily.
iv. Regulators and supervisory bodies can manage market risk effectively by evaluating
performance regularly.
v. Guideline mainly certified regulation is an utmost important issue for market risk
management.

Liquidity Risk:

The another type of significant risk is liquidity risk which is the uncertainty of cash flow will not
be available to meet the bank’s financial commitment in near future or recently. This specific risk
can have severe adverse effect such as systematic effect, also known as domino effect (Hughes,
2008).

Some time it is seen that, when one financial institution severely fell prey to this risk, it spread into
other institution like cancer, and the reason behind this is bank run. There are 3 component related
to this specific risk, which is provided below:

a. Funding risk
b. Time risk and
c. Call risk

Liquidity Risk Management:

Financial specialists have been working rigorously and scientifically to find out effective solution
for liquidity risk management. If we closely observe the recession that is going on recently, the US
government has injected capital in the financial institution so that, they are not victimized by this
specific risk. But it is found by proper research that, bad management is the prime root for the
liquidity risk occurrence. That is reason why, the financial institution have been working to create
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committee such as Asset Liability Management to give check to this liquidity risk. The committee
works efficiently to manage fund mobility as well as to manage the maturity and yield of assets.

Interest Rate Risk:

Interest Rate is a regular phenomenon in the lending business. Interest rate is a variable figure,
more-over due to inflation the change in interest rate become uncertain. And this uncertain is
referred to as Interest Rate Risk. Banks and financial institutions being the main player in the
lending business is heavily exposed to this specific risk.

Interest Rate Risk Management:

The main function of interest rate risk management is to reduce the probable loss which may occur
due to this risk as much as possible. Specialists found that assets life-time is a major topic
regarding the interest rate risk management which is related to hedging risk thus risk being reduced
significantly. As hedging ensures the other assets thus interest rate risk is managed effectively.
Another weapon to deal with this risk is to reprice assets according to their maturity.

Forex Risk:

The shorter form of Foreign exchange risk is the Forex risk, which refers to the uncertainty caused
by the movement of currency around the world. It is seen that, US dollar is used the international
currency, which was at first standardized with gold. But the over all economy of different countries
changes along with their performance, which is reflected in their currency (Alwang, 2001). The
uncertainty of the movement in the currency compared to each other is the Forex risk.

Forex Risk Management:

Due to movement in the foreign exchange i.e. the currency movement have created benefit
opportunity of gaining profit, which led to establish successful foreign exchange market. But the
movement is quite uncertain and the risk associated to it forex risk is critical for them. The
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specialist is working to find out effective technique to check this risk. Simulation is working great
for most of the financial institutions as they can consider different scenario and thus forecast and
make themselves prepared to take action in each situation.

Country Risk:

Similar to other risk it is also seen that there is uncertainty regarding cross border transaction due
to different reason such as political instability, economic recession or natural disaster. This
uncertainty has probability of occurrence which is called as country risk, discussed with prime
importance in the international banking arena.

It is seen that, different financial institutions along with banks establishing entities in international
locations, offshore locations etc. And it is also seen that many of these financial institutions are
funding different projects and industries of foreign country as well as, in many cases it is a normal
scenario to find out that, many financial institutions are funding Government budgets of
developing countries. But all of this transaction bear the uncertainty due to political instability or
many other reasons.

Country Risk Management:

Country risk management is an important function of the financial institutions as well as it is

important also for the Government of the Countries. The reason behind it is country rating is very
important issue now a days, as the globalization of business has started.

More over it is found by the specialists that, if any financial institution just relies on country rating
of any agency, this will lead the institution to be victimized by the country risk. The financial
bodies should develop their own mechanism to prepare country rating, accompanied by other
country rating done by international agencies. Moreover the management should prefer news and
other media of information to forecast the overall situation of a country which will help a lot to
reduce country risk.
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Operational risk:

Again the organizations and financial institutions due to their operation faults, human error,
management misconduct and natural disaster fell prey to some uncertainty, which is referred as
operational risk. Finance people along with the management people found that, inadequate skill,
faulty process of management etc are the main reason behind their reason of being victimized by
this specific risk. This specific risk is of the same importance as of the other, as it also can have
systematic affect such as bank run etc.

Operational risk management:

It is hard to calculate the probable operational risk of any financial institution, as well as, it is hard
to formulate scientific way to reduce operational risk. Moreover it is seen that, by providing better
management process along with safeguard activities followed by guidelines, operational risk can
be reduced at a great extent. Basel Accord is a set of guidelines, which helps the financial
institutions to run their business in a sound manner, so Basel proposal works better for operational
risk management in the international banking sector (Holzmnn, 2001).

Basel Accord and Risk based supervision:

As discussed earlier Basel Committee has established Basel Accord in Basel by the meeting and
negotiation between the top 10 countries of the world, which provided set of rules and guidelines
for Banks to run in sound manner (Saunders, 2003). The committee believes that, by following the
guidelines of Basel Accord the over all risk management can be done. More over the financial
institution started introducing risk based supervision technique to cross check their activities, so
that they can reduce risk as much as possible (Pyle, 1997).

Risk Management Practice in UAE banks:

As we have discussed earlier it is quite clear that, risk management is important for each and every
financial institutions. The UAE banks such as Mashreq, RAK bank, ABN Amro along with other
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international banks are maintaining standardized risk management process such as simulation
process. More over the banks are conducting research every day to find better option to reduce risk
at a great extent.

Conclusion:

Say, I am carrying water from one place to another place by a tank, and there is a lick in it, from
where water is dropping, which I don’t know. This is a uncertainty for me, the same way risk
should be identified and forecasted and thus measures should be taken to reduce risk as much as
possible. Thus the company or organization will run smoothly soundly and also profitably. By
studying the total risk part, we got a clear idea that forecasting is important, but to forecast we
need help of historical data. So management information system should be thus active that it
interprets and also analyze the historical data along with different situation and thus forecast. In
today’s world the business is global, so if there is systematic risk, it can have adverse impact,
that’s why we need to focus on risk management with great importance.