Introduction

When managing risks, it is important to be aware of the range of risks that an institution might face. The particular risks faced will differ from firm to firm, and new risks will develop over time. This means that no list of risks can be exhaustive. However, it is possible to describe the main categories of risk, and the ways in which these risks affect different types of organisation.

Market and economic risk

Market risk is the risk inherent from exposure to capital markets. This can relate directly to the financial instruments held on the assets side (equities, bonds and so on) and also to the effect of these changes on the valuation of liabilities (long-term interest rates and their effect on life insurance and pensions liabilities being an obvious example). Closely related to market risks are economic risks, such as price and salary inflation. Whilst these risks often affect different aspects of financial institutions – market risk tends to affect the assets and financial risk the liabilities – there is some overlap and both can be modelled in a similar way.

Banks face market risk in particular in two main areas. The first is in relation to the marketable securities held by a bank, where a relatively straightforward asset model will suffice; however, this risk must be assessed in conjunction with market risk relating to positions in various complex instruments to which many banks are counter-parties.