Posted: 30.06.2021 | 10:33
What is Financial Risk?
Financial risk; refers to the probability that companies, businesses or individuals will lose money or existing valuable assets. Financial risks are divided into groups as market risk, credit risk, liquidity risk and operational risk. Financial risk is quite common in any financial transaction. The important thing is to prevent these risks as much as possible by making a good risk management and to minimize the loss of income. Problems that may be encountered with a good risk management are determined in advance and a precautionary program is prepared accordingly. Financial risks generally arise depending on economic conditions. For example, an economic recession affects market and credit risks.
Market risk refers to the financial loss of the company or the investor due to the volatilities (fluctuations) in the market. Investors may face direct and indirect market risk. Fluctuations in stock and commodity prices and changes in currency fluctuations are examples of market risk. Factors causing market risk include economic recessions, political crises, changes in interest rates, disasters, and terrorist attacks.
Credit risk or default risk is the inability of a company or an investor to fulfill its contractual obligations in a timely manner. There is a possibility of financial loss as a result of this situation. A “rating system” has been created to measure credit risk. A country may also have credit risk, and in such a case, an economic crisis may occur if credit risks reach very high levels. The worst economic crises that have occurred before in history have occurred due to credit risk, the 2008 financial crisis can be given as an example.
Liquidity risk, which can also be called fund risk, can be explained as the risk of not being able to quickly convert existing assets into cash when cash is needed. It can also be expressed as the risk of not being able to buy or sell assets of a certain size in a certain period without adversely affecting their prices. In a market with insufficient liquid flow, the risk ratio of making large trades for a short period of time can be very high.
Operational risk is a type of risk that arises due to system problems, personnel errors, security vulnerabilities, procedural errors and expresses financial loss. To prevent such a risk, strong risk management is required. Companies should conduct regular audits to minimize operational risks and establish a strong internal audit mechanism for this. Operational risks often arise as a result of accidental error or deliberate malicious attacks. Apart from these, there are operational risks that affect the system from outside, and natural disasters are an example.