Types of Risks
1. Business Risk
Definition: The risk that a business will not be able to generate enough revenue to cover its
operating expenses and repay its debts. It is influenced by both internal operations and market
conditions.
a. Cyclicality of Revenues
Businesses whose revenues are highly dependent on economic cycles (e.g., tourism, real
estate) face greater uncertainty. When economic activity declines, these businesses see
large drops in revenue, increasing risk and beta (a measure of volatility).
b. Operating Leverage
Refers to how much of a company’s cost structure is fixed. Firms with higher fixed costs
have higher operating leverage, meaning their profits are more sensitive to changes in
sales. A small drop in sales can lead to a big drop in profit.
2. Financial Risk
Definition: The risk that arises when a company uses borrowed funds (debt). Higher levels of
debt increase the company’s fixed financial obligations and therefore its vulnerability to financial
distress during downturns.
3. Industry Risk
Definition: The risk that a company is unable to meet its obligations due to factors outside its
control, affecting the entire industry. It is divided into:
4. Supplies Risk
Occurs when there is disruption in the supply of key inputs such as raw materials, labor,
or equipment. This can be caused by strikes, power outages, geopolitical issues, or
disasters. Assessing this risk involves analyzing the input cost structure and identifying
vulnerable areas.
5. Sales Risk
Refers to potential disruption in product demand due to shrinking markets, new
competitors, regulatory changes, or the loss of a major client. It is evaluated through
marketing data, industry trends, and customer dependency analysis.
6. Company Risk
Definition: The risk that stems from within the company itself, leading to potential failure even
if external conditions are stable. It includes:
7. Company Position Risk
This is the risk of a firm failing due to a weak or non-competitive market position. It
occurs when a business cannot stand out in its industry, lacks brand strength, or is losing
market share.
o 8. Performance Risk
Arises when the firm’s internal weaknesses are so severe that it may fail to
perform, even in a favorable market. It is assessed using SWOT analysis, trend
analysis, cash flow forecasts, and credit reports.
o 9. Resilience Risk
Refers to the company’s inability to bounce back from sudden external shocks
(e.g., economic downturns, political instability). It depends on liquidity, financial
health, leadership strength, and operational flexibility.
10. Management Risk
Definition: Risk due to ineffective or poor management that fails to properly utilize the
company’s assets or respond to internal and external challenges. Divided into:
11. Management Competence Risk
This occurs when the management team lacks the skills or experience to run the company
efficiently. Assessment involves reviewing the background, decision-making ability, and
structure of leadership and teams.
12. Management Integrity Risk
This relates to dishonesty or unreliability in the management team. If managers
misreport, hide information, or act unethically, it creates risks of fraud or
mismanagement. It is assessed through background checks and analysis of reporting
behavior.
13. Security Risk
Definition: This is related to the collateral or security offered for a loan. It arises when the bank
is unable to recover the full loan value from the collateral due to either legal or valuation issues.
Divided into:
14. Security Control Risk
Happens when the bank cannot gain control of the security due to incomplete
documentation or legal complications. To assess this, banks verify documents, visit sites,
and check for insurance and compliance.
15. Security Cover Risk
Occurs when the collateral’s market value is lower than the loan amount. This risk
increases if liquidation is slow or market conditions are poor. Banks evaluate this by
estimating how fast and for how much the asset can be sold.
