Types of Risk: Market, Credit, Operational
In finance, Risk is the probability that the actual return will be different from the expected return. Banks and large companies hire "Risk Managers" just to worry about these three things.
1. Market Risk (Systematic Risk)
The risk of losses due to movements in market prices. You cannot avoid this; you can only manage it.
Sub-types:
- Equity Risk: Stock market crash (e.g., 2008 Crisis, COVID Crash).
- Interest Rate Risk: When RBI raises rates, bond prices fall.
- Currency Risk: If you own US Stocks and Dollar falls against Rupee, your value drops.
- Commodity Risk: Oil prices shooting up affects paint companies (Asian Paints).
Mitigation: Diversification (Don't put all eggs in one basket).
2. Credit Risk (Default Risk)
The risk that the borrower will not pay back the loan.
Examples:
- For Banks: Vijay Mallya taking a loan and not repaying.
- For You: You lend ₹10,000 to a friend, and he stops picking up your calls.
- For Bond Investors: Investing in a company that goes bankrupt (DHFL, IL&FS).
Mitigation:
- Check Credit Score (CIBIL).
- Invest in AAA-rated bonds only.
- Ask for Collateral (Gold, Property).
3. Operational Risk
The risk of loss resulting from failed internal processes, people, or systems. It's not about the market; it's about execution.
Examples:
- Human Error: A trader accidentally types "Sell 10,000" instead of "Buy 10,000" (Fat Finger trade).
- Fraud: An employee stealing money.
- System Failure: HDFC Bank's app going down for 2 days.
- Legal Risk: Government banning your product (e.g., Maggi ban, Paytm Bank ban).
Mitigation: Strong internal controls, audits, and insurance.
Comparison Table
| Risk Type | Source | Example | Can you eliminate it? |
|---|---|---|---|
| Market Risk | External Factors | Stock Market Crash | No (Only reduce via hedging) |
| Credit Risk | Borrower's Ability | Friend not repaying | Yes (Don't lend / Collateral) |
| Operational Risk | Internal Failures | Server Crash / Fraud | Yes (Better systems) |
7-Day Action Plan
Day 1: Analyze your portfolio for Market Risk. If Nifty falls 20%, how much will you lose?
Day 2: Check your Credit Risk. Have you lent money to anyone? Is it likely to come back?
Day 3: Check the Credit Rating of debt funds/bonds you own. Exit anything below AA.
Day 4: Think about Operational Risk in your personal life. Do you have backups for your passwords?
Day 5: Read about the "Nick Leeson" case (Barings Bank) - a classic Operational Risk disaster.
Day 6: Understand "Beta" of your stocks. High Beta = High Market Risk.
Day 7: Diversify. Ensure you have Gold/FDs to balance Market Risk.
Quiz
Test Your Knowledge
Question 1 of 5
1. Market Risk is also known as:
💡 Final Wisdom: You can't cross the ocean without risking storms (Market Risk). But you can ensure your ship doesn't have holes (Operational Risk) and your crew doesn't mutiny (Credit Risk).