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Economics of Banking Topic 3: Major risks faced by banks (What kinds of…
Economics of Banking Topic 3: Major risks faced by banks
3.How do banks manage these risks?
What kinds of risks do banks face?
What arises risks?
Mismatch between assets and liabilities
Default /credit risk
Definition/two aspects of avoidability of credit risk.
Two sources of default risk
Moral hazard
Physical hazard
Banks' control over default risk
Screening
Monitoring, in compliance with covenants
Portfolio diversifiation
Interets rate risk
Definition
Structure of interest rate
Yield to maturity: internal rate of return that equates
the present value of future cash flows
from a bond to
the current market price of the bond.
Duration:
Why take on interest rate risk?
Liquidity risk
Definition: Risk that an asset owner would not able to realize the full value of the asset at the time a sale is desired.
Source of liquidity problem:
Reducing liquidity risk
With liquid asset
Dissipating withdrawal risk
With a lender of last resort
How are these risks interrelated?