The rapid spread of new technologies has been both a boon and a bane. Conventional and traditional forms of occupation and enterprises are undergoing enormous paradigm shifts. The character of concepts like “work” are going through huge transitions in a highly globalized economy.
Today’s reality is dominated by the overwhelming fears of financial and social crisis. Along with this fear is the non-awareness of the underlying causes of these problems and a lack of will to analyze the deeper reasons for such issues.
In financial terms, the concept of risk is of great importance, as it occurs in a rapidly changing global scenario. The world today is highly inter-connected and complex, with multiple societies in different stages of wealth and development. A robust financial sector is crucial to a productive and modern economic structure. Banks and financial institutions play a vital role in ensuring that businesses get the life-blood of finance to sustain and grow them. The economy of a country cannot operate efficiently without a smoothly functioning financial system.
However, when these structures fail, it can cause immense damage to personal and public financial well-being.
What Is Risk?
Risk can be defined as the chance that a return on investment could be different than what was expected. The size of this difference in perception is also to be taken into account. There is a likelihood that the entire original investment can be lost. This is the concept of volatility or unpredictable variability of returns. However, on the flip side, “risk” can also apply to positive impacts or gains. Here risk can be termed as “opportunity.”
Risk is a factor in all aspects of life and managing risk is an essential part of any undertaking. It can apply to aspects of daily living or to managing large industries or economies.
Financial Risks In Modern Society
- Risks Are Essential: Finance is crucial to the allocation of resources in the economy. Productivity, growth and raising standards of living are dependent on access to finance. To do this, financial markets must take certain risks and most of the time, they are calculated, appropriate and well-thought-out. However, when there’s excessive risk-taking, ignoring certain precautions and safeguards, the systems become vulnerable.
- Regulations: Risks in the financial sector are well-regulated in mature economies. Government regulators and central banks ensure that financial institutions follow proper procedures and principles of corporate governance, remuneration policies and risk management. However, these regulations should not create unnecessary obstacles or impede the natural laws of risk taking.
- Banks and Their Role: Banks are a key player in the financial system. They serve not only individuals but also governments with funds. They make liquidity transformation possible enabling investors to get immediate access to funds, they also provide loans over a longer time-horizon. To do this, they have to engage in a complex system of risk-taking, where the risk is spread more widely and wider savings and investment opportunities are provided. However, there is no real certainty as far as banks are concerned – only risk management and negotiation.
- Inter-connected Markets: Today, financial institutions are highly connected across geographies. This means they’re exposed to common risks and the impact of a shock can rapidly flow into other institutions. In a serious crisis, such shocks can affect the solvency of the entire financial system and the larger economy of the country.
- Capital Is The First Line Of Defense: Banks being well-regulated is an important aspect of financial stability. They are required to hold capital as the first line of defense. This means that owners have to monitor risks very carefully and formal legislation/contracts are required to provide state support in case of a crisis. Depositors in banks around the world are reassured to a certain extent by insurance that their investments are partially protected in crisis situations.
- Crisis Spreads Rapidly: In September 2008, the collapse of Lehman Brothers had a domino effect across the world and led to the worst economic downturn and global financial crisis in 60 years. The Great Depression, the Asian financial collapse, etc show that such disasters can materialize almost instantly, causing huge economic meltdowns.
Risk-taking is an important aspect of financial growth and development. The greater the chances of return, the higher the risk involved – this is a fundamental principle in financial risk-taking. Individuals, governments and organizations have different attitudes, appetites and tolerances regarding risk-taking, risk management etc. It involves overcoming fears, anxieties and human factors that could prevent large scale investments that contribute to the ultimate well-being of the individual and the nation.
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