The most important risk management strategy is Risk mitigation where the banks use all their expertise and different methods to mitigate their risk exposures. Risk can be mitigated in number of ways like diversification, continuous monitoring of the risk exposure and proper due diligence before providing loans.
Diversification ensures that the risks that are specific to entities are diversified away by investing in different entities. For example, banks can limit its loan exposure to a particular industry or sector so that poor performance of the sector does not affect much to the bank. By investing in different non-correlated sectors, banks can easily reduce their total risk exposure.
Suppose real estate and auto sector are highly interest sensitive sectors while pharmacy and FMCG are very low interest rate sensitive sectors. Banks can choose to invest in all these sectors at the same time, so that the total interest rate can be reduced significantly.
This is applicable for countries as well and that is why large banks try to spread their operations globally so that it mitigates the risk of being exposed only to one country like political or any country specific risks.
Investment in Gold, Risk free assets, Government bonds etc. offer lower return along with lower risk exposure. Banks invests some percentage of their total funds in these instruments to safe guard their capital. Regulatory authority of most of the countries have made it mandatory for banks to invest some percentage of their overall capital in government bonds, pension funds etc. in order to reduce their risk exposure.