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If the bank uses service organizations to provide core services or activities, such as cash and securities
settlement, the responsibility for compliance with rules and regulations and sound internal controls
remains with those charged with governance and the management of the outsourcing bank. The auditor
considers legal and regulatory restrictions, and obtains an understanding of how the management and
those charged with governance monitor that the system of internal control (including internal audit)
operates effectively. PSA 402, “Audit Considerations Relating to Entities Using Service Organizations”
gives further guidance on this subject.
Understanding the nature of banking risks
Country risk the risk of foreign customers and counterparties failing to settle their obligations
because of economic, political and social factors of the counterparty’s home country
and external to the customer or counterparty
Credit risk the risk that a customer or counterparty will not settle an obligation for full value,
either when due or at any time thereafter. Credit risk, particularly from commercial
lending, may be considered the most important risk in banking operations. Credit
risk arises from lending to individuals, companies, banks and governments. It also
exists in assets other than loans, such as investments, balances due from other
banks and in off-balance sheet commitments. Credit risk also includes country risk,
transfer risk, replacement risk and settlement risk.
Currency risk the risk of loss arising from future movements in the exchange rates applicable to
foreign currency assets, liabilities, rights and obligations.
Fiduciary risk the risk of loss arising from factors such as failure to maintain safe custody or
negligence in the management of assets on behalf of other parties.
Interest rate the risk that a movement in interest rates would have an adverse effect on the
risk value of assets and liabilities or would affect interest cash flows.
Legal and the risk that contracts are documented incorrectly or are not legally enforceable in
documentary the relevant jurisdiction in which the contracts are to be enforced or where the
risk counterparties operate.
This can include the risk that assets will turn out to be worth lesser; liabilities will
turn out to be greater than expected because of inadequate or incorrect legal
advice or documentation. In addition, existing laws may fail to resolve legal issues
involving a bank; a court case involving a particular bank may have wider
implications for the banking business and involve costs to it and many or all other
banks; and laws affecting banks or other commercial enterprises may change.
Banks are particularly susceptible to legal risks when entering into new types of
transactions and when the legal right of counterparty to enter into a transaction is
not established.
Liquidity risk the risk of loss arising from the changes in the bank’s ability to sell or dispose of an
asset.
Modeling risk the risk associated with the imperfections and subjectivity of valuation models used
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Desiree D. Cemefrania, CPA
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to determine the values of assets or liabilities.
Operational risk the risk of direct or indirect loss resulting from inadequate or failed internal
processes, people and systems or from external events.
Price risk the risk of loss arising from adverse changes in market prices, including interest
rates, foreign exchange rates, equity and commodity prices and from movements in
the market prices of investments.
Regulatory risk the risk of loss arising from failure to comply with regulatory or legal requirements
in the relevant jurisdiction in which the bank operates. It also includes any loss that
could arise from changes in regulatory requirements
Replacement (sometimes called performance risk) the risk of failure of a customer or
risk counterparty to perform the terms of a contract. This failure creates the need to
replace the failed transaction with another at the current market price. This may
result in a loss to the bank equivalent to the difference between the contract price
and the current market price.
Reputational the risk of losing business because of negative public opinion and consequential
risk damage to the bank’s reputation arising from failure to properly manage some of
the above risks, or from involvement in improper or illegal activities by the bank or
its senior management, such as money laundering or attempts to cover up losses.
Settlement risk the risk that one side of a transaction will be settled without value being received
from the customer or counterparty. This will generally result in the loss to the bank
of the full principal amount.
Solvency risk the risk of loss arising from the possibility of the bank not having sufficient funds to
meet its obligations, or from the bank’s inability to access capital markets to raise
required funds.
Transfer risk the risk of loss arising when a counterparty’s obligation is not denominated in the
counterparty’s home currency. The counterparty may be unable to obtain the
currency of the obligation irrespective of the counterparty’s particular financial
condition.
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Desiree D. Cemefrania, CPA
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