It is always advisable to be ready for global financial crisis and for sound and comprehensive risk governance. Board members and senior executives of banks need to have an inclusive view of risk control and far-reaching value creation. They must be clear on how risk categories are interconnected to the economy, capital allocation and the value of the business.

A risk is defined as an unplanned event with financial consequences resulting in loss or reduced earnings. Therefore, a risky proposition is one with looming loss. Risk stems from uncertainty or unpredictability of the future. In a commercial venture risk generates profit or loss depending upon the way in which it is managed. Risk can be defined as the instability of the potential outcome.  Risk is the possibility of something adverse happening.

Risk management is the process of evaluating risk, taking steps to reduce risk to tolerable level. Thus, we can say that after the risks are identified, risk management attempts to lessen their effects.  For example, we buy insurance to lessen financial risks. Also, sometimes when people visualize too many hurdles in a project, they re-plan the whole project.

Following are some common risks occurring in the banking industry:

Credit Risk:  The main risk under this category is the risk of non recovery of loan and the risk of lessening in the value of asset.   Banks face credit risk when customers repay loans by making the pre-payment, thus resulting in loss of opportunity to the bank to earn higher interest income. When banks give huge amount of loans to a single borrower, or to a single industry or to a single city, state or country risk arises due excess exposure.  In regards to excess loans given in a country, the element of country risk arises due to losses in foreign exchange reserve or unfavorable political or economic situations in the country or its neighboring country.

While the definition of credit risk sounds simple and straight forward, measuring it is not so simple.  Some examples are poor or falling cash flow from operations which is often needed to make the interest and principal payments, rising interest rates, changes in the nature of the marketplace such as a change in technology, an increase in competitors, or regulatory changes. The credit risk associated with foreign bonds also includes the home country’s sociopolitical situation and the stability and regulatory practices of its government. Rating agencies like Moody’s and Standard & Poor’s analyze credit risks on various securities.

Interest Rate Risk: This risk arises due to fluctuations in the interest rates.   It can result in reduction in the revenues of the bank due to fluctuations in the interest rates which are dynamic and which change differently for assets and liabilities.   Interest rates are market determined and banks have to fall in line with the market trends even though it may suppress their Net Interest margins. Interest rates depend of economic growth (demand and supply of money) fiscal policy (in a booming economy, many firms need to borrow funds to expand their plants, finance inventories and even acquire other firms). Consumers might be buying cars and houses. That need keeps the demand for capital at a high level and interest rates higher than they otherwise might be) monetary policy (Central banks modify the money supply to try to manage the economy and control inflation. If a government loosens monetary policy, this means that it has “created more money”) another key factor for rate fluctuation is inflation. Investors try to preserve their “purchasing power,” during period of high inflation as they get higher interest rate on their investments in the shortest period of time.

Liquidity Risk: Liquidity is the ability to meet commitments as and when they are due and ability to undertake new transactions when they are profitable. Liquidity risk may derive due to net outflow of funds arising out of withdrawals, non renewal of deposits, non-recovery of cash receipts from recovery of loans, conversion of contingent liabilities into fund based commitment and increased sanctioned limits.

Foreign Exchange Risk: Banks face risk which arises due to foreign exchange. Foreign Exchange risk arises when a bank holds assets or liabilities in foreign currencies and impacts the earnings and capital of bank due to the fluctuations in the exchange rates. No one can predict what the exchange rate will be in the next period, it can move in either upward or downward direction regardless of what the estimates and predictions were. This uncertain movement poses a threat to the earnings and capital of bank, if such a movement is in undesired and unforeseen direction. Foreign Exchange Risk can be either Transactional or it can be Translational. When the exchange rate changes unfavorably it give rise to Transactional Risk, as the name implies because of transactions in Foreign Currencies, can be evaded
using different techniques. Other one Translational Risk is an accounting risk
arising because of the translation of the assets held in foreign currency or abroad.

Regulatory Risks:   Regulatory risk is the risk of a change in regulations and law that might affect the banking industry/ a particular sector. Such changes in regulations can make significant changes in the framework of an industry, changes in some clause regarding lending etc. Change in laws and regulations materially impact a security, business, sector or market. When a change is made in law or regulations made by the government or a regulatory body it can increase the costs of operating by banks; it immediately affects the depositor’s and borrower’s behavior. It reduces attractiveness of investments and also changes the competitive landscape.

Technology Risk:  This risk is associated with computers and the communication technology which is being increasingly introduced in the banks.  Banks face risk of obsolescence and   the risk of losing business to technologically strong financial institutions. A global survey conducted by Deloitte Touche Tohmatsu Limited (DTTL) confirms that there are big challenges on the operational risk and technology side such as cyber threats. The acceleration of speed in the capital markets and overall risk management issues, are bothering the financial institutions such as banks. Technology or operations risk software; technology risk is often lumped under the label “operational risk.”

Market Risk: This is the risk of losses in off and on balance sheet positions arising from movements in market prices.

Strategic Risk: This is the risk arising out of certain strategic decisions taken by a bank for sustaining itself in the present day scenario  for example decision to open a subsidiary may run the risk of losses if the subsidiary does not do good business.

“Basel III” is a comprehensive set of reform measures in banking prudential regulation developed by the Basel Committee on Banking Supervision to strengthen the regulation, supervision and risk management of the banking sector. The measures aim at improving the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source may be, to improve risk management and governance and to strengthen banks’ transparency and disclosures. Basel III has provided a framework for stricter and better capital quality, risk coverage, measures to promote the build-up of capital that is unseen in periods of crisis or boom. Secondly, it introduced the ratio of leverage (>=3%) and reconsider the raking system. These changes aim to raise banks’ capability of facing systemic shocks due to economic crisis.

In 1963, Milton Friedman – an American Economist and Statistician also known as the free-market philosopher described corporate social responsibility as “fundamentally subversive”, writing that corporate responsibility is the pursuit of personage interest of an organization to survive in an uncontrolled market. He also said that firms do not exist in vacuum.

Organization will grow bigger and stronger in proportion with the rise of community standards.  Stakeholders are increasingly demanding information regarding an organization’s environmental, social and economic impact on society. Inclusive growth is a multidimensional concept that needs considerable commitment from business organizations. Theoretical and empirical analysis indicates that firms can strategically engage in socially responsible activities to increase private profits. While a firm gets noticed for its social efforts, the firm can obtain additional benefits such as enhancing the firm’s reputation and the ability to generate profits by differentiating its product, the ability to attract more highly qualified personnel or the ability to extract a premium for its products.

In India around Rs 22,000 crore is expected to be poured into the social sector from 2015 onwards as Indian business houses ramp up CSR funding. Under the Companies Act, 2013, which stipulates companies with a net worth of Rs 500 crore or a turnover of Rs 1,000 crore or a net profit of Rs 5 crore to spend at least 2% of their average net profits made over three preceding years on CSR programes.

Many organizations are staring at the inadequacy of the CSR initiatives they had been flaunting over the years. Till now, many companies kept postponing their CSR funding. After an initial phase of indifference and, later, even sly attempts by a few at gaming the rules  fitting in what they are doing currently as CSR or looking for loopholes to avoid doing what they ought to be doing, companies are now preparing for a new era or a new genre of CSR interventions. On the flipside, the mandatory interventions of government will spoil scene – companies which used to spend much more on CSR may now get away spending less; this is just a thought.

At the moment, CSR or corporate social responsibility is an ever hotter topic. The Economist Intelligence Unit finds CSR becoming rising corporate agenda not only in the US, UK and China but globally. Everyone has an opinion on it. It is a hot topic in Commerce and Management lectures.

CSR has a big role to play in enhancing corporate image. A research conducted by McKinsey found that 95 per cent of CEOs felt that society has elevated expectations from businesses in regards to social responsibilities today than five years back. Consumers prefer buying products and services from companies supporting worthy social cause. CSR has multidimensional effects on a firm’s existence in society.

Risk Management: Commitment in CSR activities help organizations to manage emerging social risks which at times emerge as an offshoot of their operational activities; when the weather is bad, and when things go wrong corporate can influence the perception of people at large in society. Corporate usually get clean chit from the consumers, community, regulators, employees and the suppliers.

Brand Positioning: Consumers usually like to get associated with a company, which is ethical and has a positive image; many companies are becoming innovative while contributing to social cause. P&G’s CSR program ‘Shiksha’ is an integral part of their global philanthropy program. It is based on of the theme ‘Live, Learn and Thrive’. Shiksha has helped 2,80,000 underprivileged children access education. The programe is built and supported over 140 schools across India in partnership with many NGOs. The advertisements of P&G state that when P&G products are bought, some portion of the price paid for it goes into their Shikha initiative.

CSR increases ability to attract, motivate and retain employees: CSR helps companies to attract good employees. With Gen Y (called also millennial) making up more of the modern workforce, it is becomes important to pay attention to what they think about an organization. Research has found that 88 per cent of Gen Y (children born between the years 1980 to 2000) chose employers based on strong CSR values; it also showed that 86 per cent would consider leaving if the company’s CSR values no longer met their expectations. Business schools, like New York University’s Stern Business School, added courses related to CSR to keep up with their students’ rising demand. The Gen Y is known as responsible corporate citizen with sensitivity towards social and environmental issues. Therefore, a good corporate image helps employees and communities assist the corporate in achieving its Vision and Mission, as they all feel alike and contribute towards a common goal. According to Forbes, the 10 companies that are best at CSR are Microsoft, Google, Walt Disney, BMW, Apple, Daimler (Mercedes-Benz), Volkswagen, Sony, Colagte Palmolive and Lego. All of these firms attract young and enthusiastic workforce.

Investors like investing in these firms: There are many financial institutions globally, which have made it part of their policy to study the CSR activities of the company before investing. M&A decisions are also taken after consideration of CSR and Sustainability activities, even if it makes perfect economic sense for the investors.

CSR Boosts Corporate Image: It allows the company to have certain respect in the society among its stakeholders. Companies that implement CSR, like Unilever with its sustainable living plan, have enjoyed increased growth and profits. I would love to quote here how TNT has used its core business to help people in disasters. Through its CSR programe which is established at its Amsterdam headquarters, 50 designated employees are always on call to intervene anywhere in the world at 48 hours’ notice. The programme was established based on the company’s strong internal culture that places an emphasis on giving back to society. Due to their access to transportation and logistics, the cause became an easy fit. Employees have responded to over two dozen emergencies, including the Asian tsunami in 2004, since its inception.

A survey was recently conducted by Reputation Institute which is a global research institute for carrying surveys and research. Their surveys enable business leaders to take more confident business decisions that build and protect the business image globally. Reputation Institute recently conducted a CSR pulse survey globally, which found that CSR was responsible for more than 40 per cent of a company’s reputation and 42 per cent of people based their feelings about a company on the firm’s CSR. About 31 per cent of global consumers believe businesses should change the way they operate to align with social and environmental needs.

Another study shows that nine out of 10 consumers want companies to go beyond the minimum standards required by law to operate responsibly and address issues. 53 per cent of workers think that they like to contribute to a job which can make an impact on social wellbeing. And, such a job makes them happier. About 35 per cent would even take a pay cut to work for a company committed to CSR. Another study found that the more actively a company pursues worthy environmental and social efforts, the more engaged its employees are.

So that is a strong indication that CSR is not simply a superficial matter, but has a solid impact on consumers, employees and communities. There is a concrete rise in awareness of CSR and real demand for it. Greater than any strategy, CSR can give business a competitive advantage while also making positive changes to the community and the environment.