TYPES OF FINANCIAL RISK
April 28, 2023 | by
Rebbeca Makau
Risk is any action or activity that leads to loss of any type therefore, financial risk is the possibility of losing money
on a business venture or investment. These hazards can arise from various sources, including market conditions, economic
factors, and internal issues within an organization. Managing financial risks is an essential aspect of any financial institution's operations, as it helps to ensure the stability and long-term viability of the organization. There are several types of financial risks that organizations face. Understanding these risks is crucial for financial managers, investors, and other stakeholders. In this article, we will explore some of the most common types of financial risks.
Recent findings by the International Finance Corporation (IFC) have spotlighted the tangible benefits of prioritising ESG
considerations in investment decisions. Over the 2010-2015 period, the IFC reviewed the performance of 656 investments,
revealing a compelling correlation between superior E&S performance and financial success. Companies excelling in E&S
outperformed their counterparts by 210 basis points on return on equity and 110 basis points on return on assets. But
the impact doesn't stop there listed clients with high E&S scores also outshone the MSCI Emerging Market Index by 130
basis points, demonstrating that responsible practices not only contribute to financial prosperity but also position
organisations as leaders in the competitive landscape.
1. Credit risk
Credit risk is the risk of loss that arises from a borrower's failure to repay a loan or meet other financial obligations.
This type of risk is prevalent in lending institutions such as banks, where the institution's primary business is to provide
credit to customers. Credit risk can also arise in other financial transactions, such as trade finance. To manage credit risk,
institutions must assess the creditworthiness of borrowers, set appropriate terms and conditions for loans, and monitor borrowers'
compliance with those terms.
2. Market risk
Market risk is the risk of loss that arises from changes in market conditions. This type of risk can arise from fluctuations in
interest rates, exchange rates, commodity prices or stock prices. Market risk is prevalent in investment portfolios, where investors
are exposed to fluctuations in the value of their investments. To manage market risk, investors must diversify their portfolios,
use hedging strategies and closely monitor market conditions.
Market risk is prevalent in investment portfolios, where investors
are exposed to fluctuations in the value of their investments. To manage market risk, investors must diversify their portfolios,
use hedging strategies and closely monitor market conditions.
3. Liquidity risk
Liquidity risk is the risk of loss that arises from an inability to meet financial obligations when they come due. This type of risk can arise when an organization
does not have sufficient cash or liquid assets to meet its obligations. Liquidity risk is prevalent in financial institutions, where customers may suddenly withdraw
deposits and the institution may not have enough cash on hand to meet those withdrawals. To manage liquidity risk, institutions must maintain adequate reserves of
liquid assets such as cash or short-term investments.
4. Operational risk
Operational risk is the risk of loss that arises from internal issues within an organization. This type of risk can arise from a wide range of factors, including
employee errors, system failures, fraud, or regulatory compliance issues. Operational risk is prevalent in financial institutions, where a failure to manage this
risk can result in reputational damage, legal liabilities, or financial losses.
To manage operational risk, institutions must implement robust risk management systems and procedures, including internal controls, monitoring and reporting
mechanisms as well as emergency plans.
In conclusion, financial risks are potential hazards that could lead to losses in the financial sector. Managing and understanding financial risks is an essential
aspect of any institution's operations. By identifying, assessing, and managing financial risks, organizations can ensure
