Community bank is an independent, small and locally-owned commercial bank, which operates and obtains its funds solely from the community, where it is based.
Community banks focus on providing traditional banking, derive deposits locally and mostly make loans to local businesses. It is widely known that today community banks provide most of the loans to our nation's small businesses and are an important financial resource to small cities. Because of that and because of the fact that they have knowledge of their local community and their customers, they are called “relationship” banks. They base their credit and loan decisions on data obtained through relationships and rarely rely on the official managing models used by larger banks. The reason community banks were able to build those close relationships with customers is because they are smaller in size, regulate their business and are controlled locally.
London city bank is a local community bank, which is based downtown of East End London. The bank has only one location and its office is situated in a 2 800 square foot building. Team that operates and helps the bank run is not large and consists of 29 members. All the employees live in the neighborhood area and are professionals in the financial sphere. The bank is focused on traditional lending and deposit activities. It is an independent bank, which is owned privately and manages relationships at a personal level. London city bank operates within a limited market area and manages relationships at a personal level. All the citizens of the neighborhood know that it is easier to obtain a loan from their community bank because of its greater knowledge of the local market: the bank considers character and local history.
Banks' boards of directors consists of local citizens and some advantages can be seen for the local area: loans benefit the neighborhoods where depositors live and work, the bank offers a wide range of banking services with lower fees, credit and debit cards have competitive rates, due to the conditions the bank also helps small businesses and agriculture develop.
Managers in large and small companies undertake risk management activities to assess, control and manage the business, while Enterprise-wide risk management greatly helps a corporation to manage risks and to achieve objectives. ERM is a continuous process in the organization that is performed to identify, assess, decide and mark all the opportunities and threats that are facing. Enterprise-wide risk management is a “discipline by which an organization in any industry assesses, controls, exploits, finances, and monitors risks from all sources for the purpose of increasing the organization's short- and long-term value to its stakeholders” (Enterprise Risk Management Committee, 2003). ERM provides a framework for risk management, which describes an approach for analyzing, monitoring and identifying risks and opportunities within the internal and external environment of the company.
ERM can make a major contribution towards helping an organization manage the risks to achieving its objectives. Constant financial troubles faced by financial entities created the need for bank risk management. The financial industry continues to meet challenges from new technologies, financial instruments, growing numbers of new financial institutions and business processes. ERM enables banks to approach the integrated view of enterprise financial risks.
Even though everyone in London city bank plays a great role in ensuring successful enterprise-wide risk management, main responsibility for identifying risks and successful managing lies on the management team, namely on the senior management. Without senior management’s involvement ERM is impossible because of the size of the bank, its complexity and because the manager defines the roles and responsibilities of the personnel. A dedicated risk management department is built to monitor, manage, and measure the risks of the current portfolio of assets, loans and deposits, liabilities. Monitoring, meetings with experts, review of analytical reports is typically done by management. The department also communicates with other bank departments to reduce the possibility of potential loss. The management team selects a risk response strategy for a specific risk that may face the bank and it may include following: identifying and analyzing potential risks; integrating and assessing risks; treating and monitoring.
At first, bank management will estimate financial risk appetite and objectives, possibility for risk administration and planning, cost-benefit of risk management efforts. Secondly, risk areas and boundaries of risk strategy and management will be defined. Continuous monitoring is obligatory. The information and the results of the ERM will be used to improve the business process. Their management policies demand a lot of time and money.
Successful ERM implementation results in better governance process, reduces and control of all the risk management costs, increases confidence in bank’s activities and decreases bank’s risk profile.
The risk appears from different expected or unexpected events on the financial market or in the economy. There are many types of risks that banks face and here are several financial risks that face London city bank: credit risk; market risk; liquidity risk; operational risk; inflation risk.
Credit risk is the most apparent of the risks - it is a risk, when a borrower fails to meet his obligations according to the agreement terms. It is a “risk of default on a debt that may arise from a borrower failing to make required payments” (Basel Committee on Banking Supervision, 2000). Banks should be very patient and be able to determine the likelihood that a customer will pay what was loaned to him. This financial risk is caused by loans, interbank transactions, bonds, equities, trade financing, foreign exchange transactions, financial futures and etc. In other words, when a borrower takes a loan from a bank and is not able to repay because of inadequate income, death or for example unwillingness, the bank faces credit risk. Credit risk also marks the inconstancy of losses on credit exposures: loss in the today’s and future earnings from the credit and loss in the credit asset’s value.
As well as financial stability of banks, credit risk management is very important. London city bank to avoid such problems will look closely at credit risk before lending money to consumers and will determine how much of a credit risk it is able to take on a certain consumer. Following factors are associated will unstable borrowers: unsteady income, employment type, low credit score. If the borrower is associated with high credit risk, the bank will minimize the risk by increasing interest rate. London city bank will also have appropriate credit rules for the debtors and will properly manage their portfolios. The banks will take into account different economic factors that influence credit capabilities of the borrowers.
Banks lose money, when the markets do not behave properly. With the changeable nature of current markets, managing market risk is becoming more and more essential today, but it is not new to the modern bank system. Factors, different market conditions, that consequently influence net asset value of banks are following: changes in finished product’s prices, fluctuation in exchange rates, equity rates and interest rates. Market risk is a financial risk that occurs due to changes in equity interest rates, credit spreads, prices, foreign-exchange rates, commodity prices, and etc. Four standard market risk factors are
equity risk –when stock prices change;
interest rate risk -when interest rates change;
currency risk – when foreign exchange rates change;
commodity risk –when commodity prices change.
The most appropriate strategy for managing market risk is diversification. London city bank will ensure that all assets will be held in a wide range of investment options. The bank will obtain diversification by building a portfolio of many bonds and equities and will narrow further dispersion of possible negative outcomes. Hedging is another method for reducing risk where a combination of assets play a great role. A combined portfolio of stock and option today does not move below a given value.
Liquidity risk is a vulnerability of today’s banks. By definition the term liquidity means that any bank is able to meet payment obligations from its depositors and has a necessary amount of money to give loans. Thereby liquidity risk is the risk of not being able to fulfill the liability and day-to-day operations. You are therewith always at risk, if you are planning to transform short-term deposits into long-term assets. Not being able to meet commitments to clients and financial institutions is very crucial for banks in general and for their reputation. Due to the current situation on the financial market, a lot of people, many investors took out their deposits out of banks.
Many banks worldwide face operational risk today, as it may occur in all day-to-day bank activities and in almost all bank departments—credit, treasury and investment. Operational risk is “a broad discipline, close to good management and quality management” (Credit Suisse Group, 2014). The operational risk includes fraud risk, lawsuits, personnel problems and business and marketing model risk. It is a risk when human or machine, error or failure result in financial losses. Mostly operational risks occur from following sources: people risk - incompetency of personnel, misuse of power; process risks - errors in data transmission and extraction, inaccuracy of output, failure of internal control process; information technology risk - downfall of the information technology system, the hacking by outsiders, and programming errors; failure internal auditing and control measures.
A couple of approaches have been developed to overcome operational risk. London city bank will take into account the “matrix” approach. All the losses will be categorized due to the business line when the event appears and the bank will be able to identify which events have the most impact and which are most perceptive to operational risk. Databases for controlling different losses and monitoring risk indicators will be constructed. The bank will insured itself against natural disaster damages. Establishing of excessive backup facilities will decrease electrical or telecommunications losses. Powerful internal auditing procedures, good management information and planning will help the bank identify losses due to internal reasons - employee fraud or product flaws. Board of directors will establish different internal processes for reviewing operational risk strategy and implement monitoring systems, those processes will be integral to bank’s activities and include bank personnel.
Inflation risk appears when the cash invested won't be worth as much in the future due to the changes in economy, purchasing power because of inflation. The loss turns out from destruction in income, assets value against the background of rising costs of services. A greatly high public debt and regular interventions usually leads to inflation. London city bank to deal with the consequences of inflation risk will issue innovative inflation-protected products. The bank will also attract new investors and build a strong funding profile while earning margins on services. This will help to protect the assets against inflation, new product ideas will be implemented and customer loyalty will be improved. Monetary policy is the best solution to provide an environment of stable inflation.
Every banking organization needs exclusive risk management. A conclusion can be made that enterprise risk management helps banks to achieve goals and avoid surprises. Companies should understand the challenges, risk areas and different types of ERM activities which could protect the business. A successful ERM can ensure that the risk of the bank will be compensated and the bank already knows the amount of risk that it will face. Many banks nowadays integrate risk and control processes, build a framework for checking risks. The risk management is becoming more and more popular today because of its efficiency and supporting the entire process.
References
Enterprise Risk Management Committee (May 2003). Overview of Enterprise Risk Management" (PDF). Casualty Actuarial Society: 8. Retrieved 2008-09-15.
Principles for the Management of Credit Risk - final document. Basel Committee on Banking Supervision. (September 2000). Credit risk is umost simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Retrieved 2013-12-13.
Credit Suisse Group. Operational Risks in Financial Services: An Old Challenge in a New Environment (PDF). Retrieved 2014-04-29.
