Banks face several types of risk in day-to-day business. They include:

a. Liquidity risk—the risk that customers will demand cash immediately.

i. Liability-side liquidity risk arises from deposit withdrawals.

ii. Asset-side liquidity risk arises from the use of loan commitments to borrow.

iii. Banks can manage liquidity risk by adjusting either their assets or their liabilities.

b. Credit risk—the risk that customers will not repay their loans. Banks can manage credit risk by:

i. Diversifying their loan portfolios.

ii. Using statistical models to analyze borrowers’ creditworthiness.

iii. Monitoring borrowers to ensure that they use borrowed funds properly.

iv. Purchasing credit default swaps (CDS) to insure against borrower default.

c. Interest rate risk—the risk that a movement in interest rates will change the value of the bank’s assets more than the value of its liabilities.

i. When a bank lends long and borrows short, increases in interest rates will drive down the bank’s profits.

ii. Banks use a variety of tools, such as gap analysis, to assess the sensitivity of their balance sheets to a change in interest rates.

iii. Banks manage interest rate risk by matching the maturity of their assets and liabilities and using derivatives like interest rate swaps.

d. Trading risk—the risk that traders who work for the bank will create losses on the bank’s own account. Banks can manage this risk using complex statistical models and closely monitoring traders.

e. Cyber risk and other operational risks—the risk of loss resulting from inadequate or failed internal processes, people, or systems. This includes losses arising when information technology systems fail or are compromised.

i. These risks can be very difficult to manage, as it is difficult to keep up with malicious actors.

ii. While the burden of protecting individual systems falls on individuals, the presence of spillovers means there is a role for government to ensure a sufficient level of resilience.

f. Other risks banks face include foreign exchange risk and sovereign risk.