Risk management in banking: A guide to risk & risk management strategies for financial institutions

The world continues growing increasingly complex and interconnected, such that the financial systems operating in national, regional and international markets have concurrently become more globally accessible and technologically sophisticated. As a result, financial institutions and the banking and investing instruments they offer to individuals and organizations have become exposed to greater and more technologically driven threats.

As financial institutions evolved with technology, they became able to present customers with more innovative ways to save and invest money. Long gone is the need to call a trader on the phone to facilitate paper trades on a floor. Now, individuals and organizations have the access they need to plan, review and orchestrate trades themselves using complex online trading platforms developed and operated by digitally adept brokerages.

But just as banking and investment customers gained greater access to their accounts and financial markets in which to invest, bad actors gained greater access to customers, their holdings and other valuable assets. Today, financial institutions routinely work to defend their customers from malicious activity that threatens their cybersecurity and the privacy of their personally identifiable information (PII) and other personal data.

Financial markets are also prone to volatility in the wake of abrupt changes that affect the ability to trade or trading volume, such as wars or armed conflicts and extreme weather events. So as international political tensions have risen and more frequent and more massive natural disasters have occurred, banks and other financial institutions subsequently worked to improve their awareness of such risks and their preparedness for inevitable scenarios like these.

At the same time, more wealth is currently in the hands of financial institutions, markets and exchanges than at any point in human history. The World Bank Group estimates that in 2025, the total market capitalization for listed domestic companies around the world stood in excess of $141.3 trillion, and is projected to have only grown since then.

When you add this all together – that it’s never been easier for individuals and organizations to control their wealth, there’s never been more total wealth to control and there’s never been as much malicious activity and volatility potentially affecting all of that wealth – the threat landscape that emerges makes it clear why banks and other financial institutions must increasingly prioritize the development and deployment of robust risk management strategies.

But haven’t financial institutions always prioritized risk management? So much of people’s lives depends on the security of holdings by banks, credit unions, savings and loan associations, mortgage lenders and so on, so it’s reasonable to believe that risk management has always ranked highly for these organizations. But this hasn’t always been the case.

Consider this: financial institutions have served customers for hundreds of years, but risk management in banking has only risen to its current level of importance in recent decades. The oldest bank in the world that remains in continuous operation today is the Banca Monte dei Paschi di Siena, founded in 1472 – but the person broadly recognized to serve as the first Chief Risk Officer (CRO) of a corporation was appointed in 1993. And where? GE Capital.

So let’s talk about risk management for financial institutions, paying special attention to the types of risks financial institutions must address within their risk management strategies, why risk management is so important for financial institutions and specific risk management strategies these institutions can use to mitigate threats and improve their preparedness and resilience.

What is risk management in banking?

Generally speaking, risk management is the identification and assessment of potential risk exposures, the mitigation of exposures that can be resolved and the management of any exposures that cannot be neutralized. It is an inherent part of running any organization, from a small business to an enterprise operation or government agency, and is vital to protecting that organization from as much disruption, damage and loss as possible.

Risk management in banking applies this framework to the secure storage, transfer, investing and lending of wealth and other assets by individuals and organizations through financial institutions. And as financial institutions themselves also regularly perform these actions, some elements of strategies for risk management in banking address the unique risk exposures that are created when financial institutions move holdings for one another or amongst themselves.

Types of risk in banking

There are a number of different types of financial institutions that offer a variety of services to individuals and organizations, from retail and commercial banks to credit unions and insurance companies. As such, some types of risks apply to all kinds of financial institutions while others can vary depending on the categories of financial services offered.

Operational risk

Operational risk in banking refers to risk exposures that threaten a financial institution’s ongoing, day-to-day operations, usually related to the processes involved in its ability to deliver financial instruments or services to its customers. As a result, operational risks typically only threaten an institution’s short-term goals, such as the successful creation of new accounts, completion of financial transactions or other processes or projects.

Because operational risks center more closely on day-to-day operations, they tend to be more predictable and smaller in magnitude, and therefore more easily mitigated by effective risk management countermeasures. However, this depends on the scale of the exposure. For example, if a bank was suddenly unable to complete over-the-counter transactions at any of thousands of branches worldwide, this would be a large-scale issue despite its more day-to-day operational nature.

Strategic risk

Strategic risks in banking are risk exposures that threaten a financial institution's larger strategic goals. They usually relate to long-term, “big picture” objectives set by high-level internal team members and the course of action chosen to achieve those objectives – in other words, the future of the entire institution. As a result, the threats they present have the potential to cause significantly more disruption, damage and loss than their operational “cousins.”

Because strategic risks aren’t as closely related to day-to-day operations, they tend to be less predictable and are therefore less easily mitigated by even the sharpest risk management programs. Some strategic risks are systemic in nature, such as a global economic downturn, a public health crisis or a shift in technology that outmodes a certain type of service or other offering – and in spite of best efforts, these kinds of exposures can almost never be avoided.

Credit risk

In banking, credit risk refers to the risk that an individual or organization who has entered into a financial contract or other binding agreement will not follow through on the obligations listed within it. This term is commonly used in lending to refer to the risk that a borrower will default on a loan issued by a lender, and is one of the central risk exposures that a qualified lender will evaluate as they determine whether or not to enter into a loan agreement with that borrower.

When a lender performs a credit risk assessment to determine the probability of default posed by a potential borrower, the lender reviews key factors such as the borrower’s earning power, their length of stay with their employer and their debt load at the time of application. Calculating credit risk also helps the lender to determine the interest rate and repayment term that they would assign to a loan for that borrower should they decide to make an offer.

Market risk

Market risk in banking is broadly defined as risk exposures for losses that occur as a result of either market-level shifts in the price of securities, commodities or other tradable assets or interest rates borrowers must pay on their loans. Because market risk exists at the system-wide level and generally occurs due to the overall performance of financial markets, it’s the type of risk that banks and other financial institutions have the least recourse to mitigate themselves.

As market-level risk is so broad in scale, it is generally the result of major events with similarly far-reaching effects, such as a global economic downturn, a public health crisis or a terrorist attack. Its scale also carries the potential to affect every individual or organization that trades, lends or borrows within a given market at once, leaving relatively few of them unscathed.

Liquidity risk

At its core, liquidity risks in banking are risk exposures for losses resulting from the inability to meet short-term collateral obligations requiring liquid cash or other liquid assets at reasonable prices – as per market conditions at the time – or within the required timeframe. These losses often occur when a financial institution fails to maintain a baseline level of liquidity, whether from an imbalance between assets and liabilities or the inability to convert illiquid assets into liquid assets at market value.

If a financial institution finds that it must make suboptimal decisions in order to remain solvent, such as to sell illiquid assets at depressed prices to meet their short-term collateral obligations, this can have more far-reaching effects than the loss of value from those assets. For example, a bank may take on a loan with a subpar interest rate to maintain an operating cash flow, or investors may lose faith in the bank’s management team and choose to sell off their shares.

Reputational risk

Reputational risk in banking is widely regarded as a financial institution’s risk of financial losses or a drop in market value resulting from a loss of brand equity or brand perception due to the actions or opinions of certain individuals or groups. Such entities include but are not limited to investors, investment advisors, competitors, financial journalists or other credible financial market observers, partners, financial market regulators and of course, the institution itself.

When a financial institution’s reputation is harmed in the public space, the damage is often severe and irreparable, resulting in significant losses or threatening its continued operation. To recover from this, institutions often work to demonstrate that changes have been made, such as replacing those who made bad decisions. Institutions also tend to offer public assurances that their new strategy shows wisdom and is neither disorganized nor intentionally deceitful.

Compliance risk

As regulators pass new and more stringent legal requirements for financial institutions operating in a given jurisdiction, institutions must continuously comply with each change in the law or create risk exposures for losses resulting from noncompliance. In banking, compliance risk can lead to potential losses such as steep fines or the loss of a license or other classification that enables the institution to legally operate within that jurisdiction.

As the choice to comply with changing regulations rests entirely with a financial institution’s management team, its ability to successfully perform compliance risk management and mitigate or wholly prevent such losses is well within its control.

Why risk management in banking is important

Risk management is an essential component of any organization’s enterprise resilience strategy – but for banking, it’s even more important for a number of reasons:

• Banking is designated as critical infrastructure: Billions of people and nearly every organization in the world regularly interact with banking and investing offerings or services through financial institutions. Since free access to securely held financial assets is so integral to the health, safety and security of so many, the financial services sector and the institutions that operate within it are considered essential to the functioning of society.
• The downstream effects of a single incident can be catastrophic: So many people and organizations depend on individual financial institutions – including other financial institutions – that the failure of one bank has the potential to cascade and ripple across the global financial system, magnifying the impact of its collapse. The exacerbating effect of the Great Financial Crisis of 2008 on the Great Recession of 2007 –2009 is a perfect example of how a scenario like this can potentially play out.
• Preparedness yields savings: When disaster strikes, the more predictable costs of resilience strategies like risk management is nearly always less than the less predictable collective costs of losses from damage, cleanup costs and recovery costs. According to a 2024 study produced by Allstate, the U.S. Chamber of Commerce and the U.S. Chamber of Commerce Foundation, every $1 invested in resilience and disaster preparedness saves $13 in economic impact, damage and cleanup costs after an adverse event.
• Hesitation yields losses in value: The ability of more resilient organizations to recover faster and more efficiently can affect quantifiable metrics like share price – and risk management programs directly contribute to the resilience of financial institutions. According to a study conducted by PwC and Oxford Metrica, resilient organizations showed a 10% greater recovery in shareholder value 250 days after a crisis, while less resilient organizations showed a 15% reduction in shareholder value for the same timeframe.
• Prudent risk management is a competitive advantage: More resilient financial institutions are more prepared to mitigate their losses, and therefore sustain less financial damage, when adverse events happen. So while your less resilient competitors are forced to spend more of their cash reserves to repair damage or break even, you’ll have more freedom to invest in growth strategies and own your future.

Best practices for banking risk management

Financial institutions that are working in the best interests of their employees, management, investors and customers should already be deploying risk management strategies as part of a more comprehensive approach to enterprise resilience. But for banks or other institutions who could use a review of some best practices – either to develop new risk management strategies or review their current ones – here are some operating principles to consider:

• Risk identification: View your financial institution’s risk landscape through the lens of the different types of risk to identify and quantify potential risk exposures. This should give you a broad understanding of your organization’s overall resilience posture, and point you in a clear direction when deciding which types of risk to prioritize or address first.
• Risk assessment and measurement: Parse through each risk exposure you’ve identified and quantify the magnitude of potential impacts should it evolve into an active incident scenario. By understanding your vulnerabilities, your organization can improve its ability to both identify early risk warning signals and mitigate the primary and secondary impacts of both predictable and inevitable adverse events.
• Risk mitigation: Reduce or control the potential impact of your financial institution’s risk exposures from either directly leading to an adverse event or indirectly enabling a more severe one, such as by setting limitations on activities of a certain risk threshold, increasing investment in protective actions or systems like cybersecurity protocols and diversifying assets or investments. As resources are finite, you should prioritize risk exposures and apply resources as they become available to neutralize risks in sequence.

The clearest distinction by which your risk management team can prioritize risk exposures is to organize them by the severity of the threat each one poses. Some risks only pose marginal threats to day-to-day operations, while others, should they cross the threshold from risk to incident, can have more devastating, long-term consequences with the potential to derail operations or threaten the entire organization.

• Risk monitoring and reporting: Periodically perform additional risk assessments and review known risk exposures to identify changes in your risk landscape and any needs for subsequent adjustments to your risk mitigation strategies. Document and securely share findings with your institution’s upper management team to track changes and keep shareholders informed, enabling them to compare actions with risk appetite.
• Regulatory compliance: Stay abreast of changes to legal standards for organizational risk management as outlined in federal, state or local laws, paying special attention to those that apply to financial institutions, and ensure that your institution fully complies. Often, new risk management regulations are passed to force banks to perform actions like risk assessments, risk mitigation and other risk-driven actions you may already do.

The applicability of some new regulations may differ by the size of your financial institution or the jurisdiction or jurisdictions within which it operates — but the burden of compliance is always yours to meet.

Elevate your financial institution’s approach to risk management

The increasing density and complexity of the threat landscape in the modern era requires your organization to upgrade its approach to risk management to meet the moment. Luckily, there are available advanced digital solutions that let you codify the different types of risk in banking, evaluate the risk exposures that pose an active threat to your institution and pursue courses of action driven by industry-standard best practices to improve your institution’s preparedness and overall resilience.

Don’t wait to get ahead of your risk management needs – request a demo of Noggin and check it out for yourself.

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