The Four Financial Risks

Almost every exposure a financial firm carries falls into one of four buckets. Knowing which is which is the starting point for measuring and managing it.

Market risk

The risk of loss from moves in prices, rates, volatility and spreads — the oil price falling, a currency moving, a yield curve shifting. It is the risk you are usually paid to take, and it is measured with tools like Value at Risk and stress testing. See Market Risk.

Credit & counterparty risk

The risk that a borrower or trading counterparty fails to pay. For a bond it is issuer default; for a derivative it is the counterparty defaulting before the trade settles. Managed with collateral, netting and credit limits. See Credit & Counterparty.

Liquidity & funding risk

The risk of not being able to meet cash obligations (funding liquidity) or to trade without moving the price (market liquidity). A correct hedge can still fail if margin calls can’t be funded. See Liquidity & Funding.

Operational risk

The risk of loss from failed processes, people, systems or external events — fraud, error, cyber, legal and rogue-trading risk. Unlike the others it isn’t taken for return, so the goal is control. See Operational Risk.

These four rarely occur in isolation — the 2022 energy crisis, for instance, was a market shock that became a liquidity crisis through margin calls — which is why enterprise risk management looks at them together.

Sources & further reading

• Minimum capital requirements for market risk (FRTB) — Basel Committee on Banking Supervision (BIS)
• Principles for the management of credit risk — Basel Committee on Banking Supervision (BIS)
• Liquidity Coverage Ratio (LCR) — Executive Summary — Basel Committee on Banking Supervision (BIS)
• Principles for the Sound Management of Operational Risk — Basel Committee on Banking Supervision (BIS)