The risks arising from any transaction can be categorized in two broad categories:
1. Risks that may affect the bank
2. Risks that may affect the borrower
a. RISKS THAT AFFECT THE BANK
These include:
i. Capital Risk: The risk that deterioration in the asset quality from loan losses will impair the Bank’s capital.
ii. Liquidity Risk: The risk that the Banks may have insufficient cash or short term marketable assets to meet needs of depositors or borrowers.
iii. Legal Regulatory Risk: The risk arising from non-compliance with laws, rules, regulations or prescribed practices in the effective jurisdiction.
iv. Credit Risk: The risk that counter-party fails to perform its obligations to the bank.
v. Market Risk: The uncertainty that an asset will earn an expected rate of return or that a loss may occur. This risk is there even after extensive diversification.
vi. Concentration Risk: The risk of concentration of the exposure on any one single borrower, group of borrowers, sector of the economy.
vii. Documentation Risk: The risk of suffering losses as a result of inaccurate or incomplete legal or other documentation relating to a transaction/credit.
viii. Operational Risk: The risk that deficiencies in the information systems or internal controls, will result in damage or losses. Security Enforceability Risk of suffering losses due to unenforceability of the security in hand
ix. Settlement Risk: The risk that counter-party defaults on transactions in the process of being settled where value has been delivered to the counter-party but not yet received in return.
x. Reputation Risk: The risk that entering into a transaction may result in loss of reputation of Bank.
b. RISKS THAT AFFECTS THE BORROWER
These include:
i. Liquidity Risk: The borrowers may endure from meeting short-term obligations due to liquidity crunch.
ii. Default Risk: The risk that the borrower will not be able to pay the principal and mark-up payments on due dates to the Bank.
iii. Market Risk: The risk that market conditions may change, preferences may change, which may adversely affect the demand for the product. New and aggressive competitors enter; promotional policies and market strategies may fail.
iv. Working Capital Risk: The risk of built-up inventories and receivables tying up the cash resulting in mismanagement of working capital.
v. Regulatory Risk: The risk that tax structure or custom duties on the major inputs may change which may adversely affect the business.
vi. Management Risk: The possibility of having disputes within the management, management change or succession-plan of the management or failure of new management to operate the project efficiently.
vii. Political Risk: The possibility that the political instability and conditions may adversely affect the project.
viii. Environmental Risk: The possibility that environmental hazards may adversely affect the project.
ix. Human Resource Risk: The possibility of losing skilled human resource which may adversely affect the operations.
x. Financial Risk: The risk of unavailability of timely and adequate financial support.
xi. Delivery Risk: The risk of delivery failure in specified period of time which may result in penalties, cost escalations etc.
