1.1 BACKGROUND OF THE STUDYA risk could be definedas a situation involving exposure to danger. In other words, according to NASDAQ,financial risk is the peril that the cash flow of the issuer will not be enoughto satisfy its fiscal. It also refers to as the additional risk that a firm’sstakeholder bears when it uses debt and equity (NASDAQ, 2016). The etymology ofthe tidings “Risk” can be delineated to the Latin word “Rescum” meaning Risk atsea or that which burns (Raghavan, 2015).
Risk is associatedwith uncertainty and reflected by means of a charge on the fundamental basic,i.e. in the case of commercial enterprise it is the capital, which is thecushion that protects the liability holders of an establishment. These risksare inter-dependent, and events affecting one country of harzard can haveramifications and penetration for a range of other categories of risks (Centre, 2017). The financialsystem and banking, in particular, are exposed to certain inherent risks whichinclude: credit risk, interest rate risk, market risk, liquidity risk, marketliquidity risk, operational risk, a risk of fraud, reputation risk, legal risk,systematic risk and many more. Even though this work pays special considerationon measuring credit risk and liquidity spill over.
Failure to adequately manage these risksexposes banks not only to losses but may also threaten their survival asbusiness entities, thereby, endangering the stability of the financial system (RISKS AND RISK MANAGEMENT IN THE INDIAN BANKING, March 2014). Financial servicesorganizations around the world face extraordinary challenges related toprofitability, complexity and new regulations in an economic environment webring up to as one of “permanent volatility”. With a return on equitybelow memorable norms, many firms are undergoing a fundamental restructuring oftheir business models while trying to distribute with the impact of regulationssuch as Dodd-Frank, Base iii, and solvency ii, which can increase both capitalrequirement and compliance cost (Accenture consulting, 2018).
These pressures maypush some firms to exit particular lines of occupation or specific geographies.Many companies are also shelling out with layers of complexity – a legacy fromyears of rapid growth – and with the consequences of under-investment intechnology during the recent years of cost-cutting. In this challengingenvironment, the integration of risk and finance can be a source of competitiveadvantage for financial services companies (consulting, 2017).
Hazard Analysis andRisk Management has got much importance in banking today. The foremost amongthe challenges faced by banking sector today is the challenge of understandingand managing risk. The very nature of banking business is having the threat ofrisk imbibed in it. The banks’ main role is to intermediation between thosehaving resources and those requiring resources. Globalization has resulted in the pressure on gross profits. The lowerthe gross profit, the heavier is the demand for hazard management. As aconsequence, risk management has become a key of focus. Additionally, due tothe failure of many banks/financial institutions in recent past, it hasattracted the attention of regulators (Centre, 2017).
The banking sector holdsa pivotal part in the evolution of an economy; it is a central driver ofeconomic growth of the country and has a dynamic character to play inconverting the idle capital resources for their optimum utilization so as toachieve maximum productivity (Set, 2016). In fact, thefoundation of any strong economy depends on how sound the banking sector is (KISHOR, 2014). Banking is consideredto be a really hazardous line of work. Financial institutions must take therisk but must do so consciously (Carey, 2001). However, it shouldbe noted that banks are fragile institutions which are built on costumerstrust, brand, and reputation, above all dangerous leverage. Inward in casesomething goes wrong, banks can collapse, and bankruptcy of one bank issufficient to send shock waves right through the economy (Rajadhyaksha, 2004).