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What is risk management in banking & financial services?

  • Risk management jobs are all about identifying, quantifying, and mitigating the risk inherent to a financial services firm’s activity.
  • There are many paths to specialize in in risk management, including market, credit, operational, and liquidity risk.
  • A bank’s risk profile is heavily regulated, as high-profile bank failures have led to substantial legislation.
  • Risk management roles can be very lucrative, with notably better work-life balance than other divisions in a bank.

What do risk management jobs in financial services involve?

If you work in risk in the financial services industry, your role will be to help prevent your employer from becoming unstuck by virtue of any of the things that could cause a shock to the institution. There are four broad kinds of risk you need to be aware of: market risk, credit risk, operational risk, and liquidity risk.

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Market risk reflects the risk of loss from changes in market prices, yields, and volatilities and correlations. At its heart, market risk provides a gauge of sensitivity of P&L, and ultimately capital, to changes in market conditions. Its core responsibility is to identify, measure, monitor, and control exposure to these risks in accordance with a bank’s size, risk capacity, and overall risk appetite, and to report on these exposures to senior management and the board. The fundamental role of market risk management is to ensure that management is fully informed about the risk profile of the bank and to protect the bank against unacceptably large losses resulting from the concentration of risk.

Credit risk is the potential that a borrower or counterparty – a person or entity that owes money - will fail to meet their payment obligations. The goal of the credit risk management function is to keep a company’s credit risk exposure within predefined credit limits. These are usually calculated at the issuer, currency, industry, country, and regional levels. About half of all bank assets in the US consist of loans, making them the largest single source of credit risk, but banks also incur credit risk in their investment portfolios. This is usually in the form of bonds and in their trading books, but also through counterparty and settlement risk (i.e., the risk that a trade doesn’t settle properly). In addition, banks also take credit risk via guaranties and letters of credit.

The Bank of International Settlements defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people, and systems, or the risk of loss from external events. Operational risk typically includes legal risk but excludes strategic and reputational risk. Some of these risks result in actual financial losses, while others lead to inefficiencies, lost opportunities, and other indirect costs. In essence, operational risk captures those direct and indirect risks not captured by market or credit risk. If you work in operational risk, your role will be focused on the maintenance of an effective control environment within a firm.

Liquidity risk is a different type of risk altogether and is one which has come under increasing regulatory scrutiny since the 2008 financial crisis. Liquidity risk gauges an organization’s ability to meet its

immediate cash obligations to its creditors. It sounds simple, but it’s not. Ready cash in a financial institution comes from bank balances, the capacity to borrow, and the ability to sell (or “liquidate”) assets without suffering severe losses. Meanwhile, obligations incurred include loan and bond interest and principal, contractual obligations to lend, and derivative securities commitments. Failure to meet any of these obligations can have severe repercussions, up to and including bankruptcy. The liquidity risk function in a bank measures and monitors sources of uses of cash, including both those of a fixed nature and those driven by markets and client behavior.

Career paths in risk

How your career evolves in risk management will depend upon the area of risk you go into.

For example, career paths in market risk often start out in desk coverage or in the reporting function. The reporting function conveys to management and the board the risks associated with trading activity, decomposing them into their core equity, commodity, interest rate, foreign exchange, and volatility components. They aggregate risks by type and compare them with the firm’s risk limits, ensuring that risk-taking is within management’s risk appetite. They also calculate statistical measures of risk, including Value-at-Risk (VaR), and run stress tests to ensure capital adequacy. This reporting is done on both a regularly scheduled and ad-hoc basis. Market risk professionals with quantitative backgrounds also move into model risk and quantitative audit roles.

Once you’ve done your time in reporting, you might move into desk coverage. This is the process by which teams of risk management staff are assigned to cover specific trading desks. These teams are co-located with the trading desks and are actively involved in the new products process, model implementation, regulatory and management reporting, and limits monitoring. Staff in these areas are expected to monitor market conditions closely and be able to articulate clearly what the risks are in any particular area. They are also expected to understand and leverage IT infrastructure to get information.

Credit risk analysts usually start out by doing financial statement analysis in the case of issuer credit risk. For counterparty credit risk, new analysts focus on how expected exposure is measured, aggregated, and reported.

Many credit risk professionals stay in the credit risk function for extended periods in their careers. They often manage groups of credit analysts and become specialists in particular industry areas like media, energy, or hospitality. This specialization requires them to become experts in their fields both with respect to the balance sheets of the companies involved and in the fundamentals of the business itself. From there, some move on to manage credit exposure in hedge funds, pension funds and mutual funds. Others can apply their knowledge of how cash moves through a business in the private equity business, where financial statement analysis is a core competency.

Operational risk as a career path has only really existed since the early 2000s. The people engaged in operational risk since it became a Basel focal point are thus career trailblazers, establishing new career paths. Currently, many op-risk professionals are expanding into cyber risk management and environmental/climate risk management. In these new areas of interest, the skills associated with event risk identification and event reporting are highly valued, as is the development of risk appetite frameworks.

Liquidity risk management as a discipline is also relatively new, although banks have been managing liquidity for years. New analysts here tend to focus on particular areas within liquidity risk like balance sheet management and analysis, repo/ reverse markets, or regulatory reporting. There is frequent movement in both directions between the bank treasury and liquidity risk management areas as the skill sets required are fungible. Liquidity risk management skills are also readily applicable in both nonbank financial institutions and in corporations, where cash management is just as important.

Which skills will you need for a risk management career?

If you want to work in risk, you’ll need an inherent interest in the way markets and companies work, an appreciation of the importance of process, and a core level of quantitative competency.

While many are attracted to the financial rewards of a career in finance, the primary requirement is a curiosity about companies, products, and markets. You really need to look at the markets and companies the way an entomologist studies an anthill or a beehive. People drawn only to the financial rewards often burn out. At a minimum, they are often less willing to devote the time and effort required for success. If you are not naturally drawn to markets, this may not be for you.

Process at the heart of everything that takes place in risk management. In order for risk to maintain its key role – to keep senior management aware of the risk profile of the firm and to prevent unacceptable concentrations of risk – business activities need to be carried out in a regular, orderly fashion in a way to which everyone involved agrees. This is obviously easier in small organizations but is absolutely crucial in large ones.

Quantitative competence is also a must in all areas of risk management. While there are certainly many subjective elements to risk management, its essence lies in the analysis of numbers. Both market risk and liquidity risk are heavily dependent upon econometrics, statistics, and of course finance. There is a great deal of on-the-job training, but having a basic background in these areas is very helpful. Since rates of change are often of interest, calculus is also important. Counterparty credit risk is dependent on market conditions and therefore it helps to understand markets. Issuer credit risk is more focused on financial statement analysis because these statements reflect a company’s financial health. Therefore, here, an understanding of basic accounting is essential. An understanding of corporate finance and how firms manage their capital structure is also helpful.

Education & qualifications for a risk management job

Even though risk is a support role in a financial services firm, it still requires a similar educational background to the front-office. When we analyzed Morgan Stanley and Deutsche Bank risk juniors, the most popular degrees were in economics and finance, although law and accounting graduates were also represented in the junior cohorts.

There are additional qualifications that can supplement your risk career, too. Although some risk professionals carry a Chartered Financial Analyst (CFA) qualification, the more specifically relevant qualifications in the field are the Financial Risk Manager’s (FRM) qualification and the Professional Risk Manager’s (PRM) qualification.

Although both are based in the US, both are also recognized worldwide. The PRM especially is seen as a prerequisite to a career in the field. But it’s worth nothing that both require two years of work experience, however, so it’s probably the sort of thing you’d want to think about a few years into your career.

Salaries & bonuses in risk management

Compensation in risk roles are not as good as they are in front-office roles such as investment banking and sales & trading, but they’re still pretty healthy.

Our 2024 salary and bonus report showed that salaries for risk management professionals increase at a similar rate to front-office roles (albeit from a lower base). It was when it came to bonuses that risk professionals lagged behind: bonuses in risk are an average of 30 to 40% of salary compared with the 50 to 100% ratios we see for front office jobs like sales and trading.

The author acknowledges the following sources:

http://www.federalreserve.gov/supervisionreg/topics/market_risk_mgmt.htm

http://www.bis.org/publ/bcbs75.htm

http://www.bis.org/publ/bcbs54.htm

http://www.auditboard.com/blog/operational-risk-management

http://www.fcic.gov/about/financial-reports/

http://www.db.com/ir/en/download/DB_Annual_Report_2017.pdf

http://www.occ.treas.gov/publications-and-resources/publications/comptrollers-handbook/files/bank-supervisionprocess/pub-ch-bank-supervision-process.pdf

References

1. www.federalreserve.gov/supervisionreg/topics/market_ risk_mgmt.htm

2. http://www.bis.org/publ/bcbs75.htm

3. http://www.auditboard.com/blog/operational-risk-management/

With additional material from Zeno Toulon.

Have a confidential story, tip, or comment you’d like to share? Contact: +44 7537 182250 (SMS, Whatsapp or voicemail). Telegram: @SarahButcher. Or email editortips@efinancialcareers.com. Signal also available.

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AUTHORKen Abbott Insider Comment
  • Le
    Le6tan
    19 January 2022

    Risk is probably the best pay per hour job in finance right now. And it allows you to have a proper family life, etc. ... If you are not the type of person who would sleep in the office, than Risk is your job ...

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