CapitalInsightBD - Residual Risk, LCR and Risk Management Terminologies

In today’s complex, regulated, and risk-sensitive financial environment, effective bank risk management depends on a clear understanding of core concepts such as residual risk, liquidity risk, capital adequacy, and supervisory frameworks. This page provides a comprehensive overview of essential risk management terminologies used in modern banking, including Residual Risk, Risk Register, Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR), Risk-Weighted Assets (RWA), Capital Adequacy Ratio (CAR/CRAR), ICAAP, SREP, Risk-Based Supervision (RBS), Risk Governance, Non-Performing Loans (NPL), Portfolio at Risk (PAR), and the Internal Ratings-Based (IRB) Approach. It also addresses emerging risk areas such as cryptocurrency risk, regulatory restrictions, and financial stability concerns, with a specific focus on Basel III compliance and Bangladesh Bank regulations. By connecting liquidity management, capital planning, credit risk, supervisory review, and governance structures, this article serves as a practical reference for bankers, risk officers, regulators, students of finance, and policymakers seeking to understand how quantitative ratios, regulatory standards, and enterprise risk frameworks work together to safeguard bank resilience, solvency, and systemic stability.

1. Residual Risk:

Residual risk refers to the level of risk that remains after all risk mitigation measures have been implemented. It is the remaining unavoidable exposure to loss or harm once controls, such as policies, procedures, and safeguards, are applied. Financial institutions must assess residual risk to ensure it aligns with their risk appetite and tolerance levels and must manage through capital reserves, insurance, or contingency planning. Effective monitoring and periodic reviews are essential to manage residual risk and implement additional controls if necessary.

2. Risk Register:

A risk register is a key component and structured tool of enterprise risk management (ERM), helping banks track, prioritize, and manage risks effectively. It serves as a central repository for risk-related information and it typically includes risk categories, assessment criteria, control measures, and assigned responsibilities for risk mitigation.

3. Liquidity Coverage Ratio (LCR):

The Liquidity Coverage Ratio (LCR) is a Basel III requirement that measures a bank’s ability to meet short-term liquidity needs during a 30-day stress scenario. It is calculated as the ratio of high-quality liquid assets (HQLA) to net cash outflows. The minimum LCR requirement is 100%, ensuring banks maintain sufficient liquidity buffers. In Bangladesh, the Bangladesh Bank mandates LCR compliance to strengthen the banking sector’s resilience to liquidity shocks.

LCR=High-Quality Liquid Assets (HQLA)/ Total Net Cash Outflows over 30 days×100%

4. Net Stable Funding Ratio (NSFR):

The Net Stable Funding Ratio (NSFR) is a Basel III liquidity standard designed to promote long-term financial stability. It measures the proportion of stable funding sources relative to the liquidity needs of a bank’s assets and activities over a one-year horizon. The minimum NSFR requirement is 100%. In Bangladesh, the NSFR ensures that banks maintain a stable funding profile, reducing reliance on short-term volatile funding.

NSFR= Available Stable Funding (ASF)/ Required Stable Funding (RSF)×100%

5. Crypto Currency:

Cryptocurrency is a digital or virtual currency that uses cryptography for security and operates on decentralized networks, such as blockchain. Examples include Bitcoin and Ethereum. While cryptocurrencies offer benefits like fast transactions and lower fees, they pose risks such as volatility, regulatory uncertainty, and potential use in illicit activities. In Bangladesh, cryptocurrency transactions are restricted by the Bangladesh Bank due to concerns over money laundering and financial stability.

6. Risk-Weighted Asset (RWA):

Risk-Weighted Assets (RWA) represent the total assets of a bank, adjusted for their risk levels. Different asset classes (e.g., loans, investments) are assigned risk weights based on their credit, market, and operational risks. RWA is used to calculate capital adequacy ratios, such as the Capital to Risk-Weighted Assets Ratio (CRAR). In Bangladesh, banks must maintain adequate capital against RWA to comply with Basel III standards and ensure financial stability.

RWA=∑(Asset Value×Risk Weight)

7. Risk Governance:

Risk governance refers to the framework and processes through which an organization identifies, assesses, manages, and monitors risks. It involves board oversight, risk committees, independent risk functions, and internal control mechanisms. Effective risk governance is critical for aligning risk management with strategic objectives and regulatory requirements. In Bangladesh, banks are required to implement robust risk governance frameworks to comply with central bank guidelines.

8. ICAAP (Internal Capital Adequacy Assessment Process):

ICAAP is a Basel II and III requirement that ensures banks assess and maintain sufficient capital to absorb potential losses based on their unique risk profiles and business models. It involves stress testing, scenario analysis, and capital planning. In Bangladesh, the Bangladesh Bank requires banks to implement ICAAP as part of Basel III compliance to enhance risk management and financial stability.

9. Risk-Based Supervision (RBS):

Risk-Based Supervision (RBS) is a regulatory approach that focuses on identifying and addressing the highest risks within financial institutions. It involves assessing the risk profiles of banks, prioritizing supervisory activities, and allocating resources accordingly. In Bangladesh, the Bangladesh Bank employs RBS to ensure that banks maintain sound risk management practices and comply with regulatory requirements, thereby safeguarding the stability of the financial system.

10. CAR / CRAR — Capital Adequacy Ratio

The Capital Adequacy Ratio (also known as the Capital to Risk-Weighted Assets Ratio) measures a bank’s available capital in relation to its risk-weighted assets. It ensures that the institution has adequate financial buffers to absorb unexpected losses. A higher CAR reflects stronger financial stability and reduces the probability of bank failure. Regulators worldwide, including in Bangladesh, require banks to maintain minimum CAR thresholds as part of Basel compliance.

11. NPL — Non-Performing Loan

Non-Performing Loans are credit facilities that have stopped generating income for the bank. Generally, a loan becomes NPL when repayments are overdue beyond 90 days or when it is considered unlikely to be repaid. High NPL levels indicate weaknesses in credit risk assessment, collection processes, or borrower solvency. Managing NPLs is crucial because they erode profitability, consume capital, and weaken the overall banking sector.

12. PAR — Portfolio at Risk

Portfolio at Risk measures the percentage of outstanding loan balances that are in arrears or at risk of default. It captures the total value of loans with delayed payments compared to the entire portfolio. PAR is a widely used indicator in banking and microfinance to assess portfolio quality. Lower PAR reflects better credit performance, while a rising PAR signals early-stage stress requiring corrective action.

13. SREP — Supervisory Review and Evaluation Process

SREP is the regulator’s independent assessment of a bank’s overall risk profile, governance, and capital adequacy. Through SREP, supervisors evaluate ICAAP submissions, review risk management practices, and determine whether additional capital buffers or corrective measures are necessary. It strengthens financial stability by ensuring banks manage risks not just on paper, but in practice.

14. IRB — Internal Ratings-Based Approach

The Internal Ratings-Based (IRB) Approach allows banks to use their own internal credit risk models—rather than standardized risk weights—to calculate regulatory capital requirements. Under IRB, banks estimate key parameters such as Probability of Default (PD), Loss Given Default (LGD), and Exposure at Default (EAD). While IRB offers more risk-sensitive capital calculations, it requires strong governance, quality data, and regulatory approval.

Written By-Md Kollol Hossain, CEO, CapitalinsightBD

Residual Risk, LCR and Risk Management Terminologies