Financial Risks to assess before making an investment

When companies are going to make an economic investment, they face numerous risks, which can cause the product or service that they intend to sell not to work as expected and the entire investment is lost. The analysis of these Financial Risks is a key task for experts in Financial Risk Management.

Main Financial Risks of an investment

The Financial Risks that a company faces when making an investment are diverse, and are applicable to banking, but also to other companies:

Credit risk

It is the possible loss that an economic agent assumes as a consequence of the breach of the contractual obligations of one of the parties with whom it relates. It is usually linked to banks, but it does not have to do only with them, since it can also affect any company in its relationship with suppliers and customers.

Today two types of credit risk:

Retail credit risk: Usually affects banks. It is that risk that originates mainly in financing to individuals and SMEs. For example, when a loan is given, a mortgage or a credit card is sold.

Wholesale credit risk: Here we take into account the risk granted to large and small companies. That is, when the entity lends money to companies or makes any contract with a company, such as a supplier.

Market risk

Market risk refers to the risk of possible loss of value of an asset as a result of fluctuations or variations in the market. That is, the financial risk that is generated by variations in the prices of merchandise, shares, currency exchange rates, etc. This can cause our market to be unstable and the investment to have more risk.

Depending on this type of risk, there will be contingency tools to apply in Risk Management to reduce possible damage caused by changes in the market.

Liquidity risk

In finance, it is the risk that an asset has to be sold at a lower price than the market due to its low liquidity. In economics, however, this risk refers to the difficulties that a company, person or institution may have in meeting its short-term obligations due to lack of liquidity, which could harm our company.

Operational risk

It is that risk that can cause losses due to human errors, inadequate or defective internal processes, system failures and as a consequence of external events. This includes legal risk and reputational risk. It is inherent to all activities and products of the company. It occurs, for example, when an employee takes money from the till or when an external cyber attack occurs. This is a financial risk that is difficult to prevent.

Reputational Risk

It is derived from actions by the entity that may generate negative publicity related to its business practices and relationships, which may cause a loss of confidence in the institution, and thus affect its solvency, or other aspects such as loss of clients, sanctions, difficulty of access to financing, etc.

Compliance Risk

They are the possibilities of incurring legal or administrative sanctions, significant financial losses or loss of reputation for non-compliance with laws, regulations, internal rules or codes of conduct. This financial risk of the investment usually affects highly regulated sectors, such as banking, electricity, gas, etc.

Risk country

It is all risk inherent to investments and financing in one country in contrast to another. Concern about this risk grew with the development of foreign trade, multinational companies, and above all, international banking operations.

Originally posted 2023-02-02 10:30:19.