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Funding risk depends on how risky the market perceives the issuer and its
funding policy to be. An institution coming to the market with unexpected
and frequent needs for funds sends negative signals that might restrict the
willingness to lend to this institution. If the perception of credit standing
deteriorates, funding becomes more costly adversely affecting profitability.
It also affects its ability to do business with other financial institutions and
to attract investors. Market liquidity risk materialises as an impaired ability
to raise money at a reasonable cost.
• Market liquidity is affected by volume of trading. Due to
lack of volume, prices become highly volatile, sometimes
embedding high discounts from par.
• Asset liquidity risk results from lack of liquidity related to
the nature of assets rather than to market liquidity. Holding
a pool of liquid assets acts as a cushion against fluctuating
market liquidity because liquid assets allow meeting short
term obligations without recourse to external funding.
Some assets are less tradable than others because their trading volume
is narrow. Similarly some stocks trade less than others. Exotic
products might not trade easily because of their high level of
customization., possibly resulting in depressed prices. In such cases,
any sale might trigger price declines so that proceeds from progressive
or one shot sale become uncertain and generate losses.
To a certain extent, funding risk interacts with market liquidity and
asset liquidity because the inability to face payment obligations
triggers sale of assets possibly at depressed prices. Extreme lack of
liquidity results in bankruptcy making liquidity risk a fatal risk.
However, extreme conditions are often the outcome of other risks e.g.
unexpected losses may trigger massive withdrawls.
Asset Liability Management (ALM) restricts liquidity risk to bank
specific factors and tries to manage future liquidity gaps ( the
mismatch between time profiles of cash inflows and outflows). The
market liquidity or asset liquidity are not considered.
Operational Risk
• People
• Processes
• Technical
• Information Technology
• ‘People ‘ risk designates human errors, lack of expertise, frauds and lack
of compliance with existing procedures and policies.’Processes’ risk
scope includes:
• The data-gathering phase is the first stage followed by data analysis and
statistical techniques. They help in finding correlation and drivers of risks.
For example, business volume might make some events more frequent
while others depend on different factors. The process ends with some
estimate of worst case losses due to event risks.
Foreign Exchange Risk
The currency risk is that of incurring losses due to changes in
the exchange rates. Variations in earnings result from the
indexation of revenues and charges to exchange rates or of
changes in the values of assets and liabilities denominated in
foreign currencies.