• Risk Avoidance Strategy

    The easiest risk management strategy is to avoid risk by not taking an exposure to a loan or financial assets which have higher risks. Banks may decide not to provide any loan or funding to some specific sector with high credit risk and borrowers with low credit rating in order to reduce its risk exposure.

    Suppose the whole airline sector is struggling due to high ATF price and lower travel due to global slowdown. In this case, banks can completely avoid lending any new loans to any airline company in order to safeguard itself from any potential loss. The same thing is applicable for individual lenders as well. Banks may simply refuse to provide any loans to borrowers with low credit rating in order to reduce their risk exposure. During subprime crisis, Banks provided loans to house buyers with very low credit rating at very high interest rates which led to one of the worst financial crisis ever.

    For financial markets, banks may decide not to deal in complex derivatives for trading purposes and keep their exposure limited. Risk avoidance can also be a regulatory strategy, where regulators restrict banks from taking certain exposures in complex derivatives and high risk financial instruments.

    But complete risk avoidance is not possible for a bank as it reduces its interest income on the loans it has provided to other borrowers. Also banks earn high income through different types of derivatives transactions. So this risk avoidance strategy is mainly applicable when the banks do not understand the risk or are unable to manage the same or the reward for taking such risk is not sufficient.

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