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Textbooks say that banks transform risks: What are the risks involved? and how are they transformed?

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  1. Introduction.
  2. Definition and management of the pure risks: Credits risk and liquidity risk.
  3. Definition and management of the speculative risks: Interest-rate risk, currency risk and market-risk.
  4. Conclusion.
  5. Bibliography.

Financial crisis may be very damaging for the whole society, as bank failures can either lead to runs or to panic. Bank runs occurs when problems at a bank ?undermine depositors' confidence.? The depositors' reaction is to rush to withdraw their money since they know that the bank's reserves are limited and that there won't be enough cash for all the depositors, assuming they follow the same strategy. Nevertheless, banks run are limited to the bank involved and unlike panics they don't affect the whole economy. Indeed, banking panics paralyse the whole system in general and have severer consequences. Such a scenario happened in Argentina in 2001 following a confidence crisis in the Argentina's central bank.

[...] Secondly, banks must also deal with speculative risks such are currency risk, interest rate risk or market risk. These are the consequence of the new trend of the financial system which is more internationalised and in which financial instruments such as derivative for instance play an important role. Nevertheless, these are not the only risk faced by bank. Some important risks are about banks' management and behaviour. That's why, it is important to have good regulation authorities to supervise banks and to avoid bank's failures. [...]

[...] Then, banks must deal with moral hazard problems which are about the ?risk that the borrower will engage in activities that are undesirable from the lender's point of view because they make it less likely that the loan is repaid.?[7] To reduce this risk, banks can use restrictive covenants which aims are to discourage undesirable behaviour and monitor borrowers' actions. Diversification is also a key element of risks transformation. Banks pool the deposits of thousands of people and make many loans, each of which is small relative to the size of its total portfolio. [...]

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