Impact of International Risk Exposure on UK Banks

Introduction

An overview of the study is provided in this chapter. First, the research’s historical context established the foundation for studies on failure prediction in the current environment of significant volatility and unpredictability, resulting in numerous collapses of major corporations worldwide. These failures and economic uncertainties significantly impact user and supplier relationships (Ghadge et al., 2021)). As a result, companies must find novel approaches to retain customers and set themselves apart from rivals. The explanation of the research problem and questions follows. A summary of the study’s purpose and objectives, justification for the investigation, contribution, delimitation, and underlying presumptions came next.

Background 

According to Park & Kim (2020), financial risk is the unpredictability or volatility of returns. It consists of risks related to credit, liquidity, and markets that raise the possibility of financial performance volatility (Park & Kim, 2020). The theory is if financial risk is adequately handled, financial performance will succeed. The financial crisis reached previously unheard-of heights and permanently harmed people, nations, and economies. Every entrepreneurial endeavour and business decision has some level of risk. Every financial organization faces a number of the same hazards. These include credit risk, liquidity risk, market or price risk, operational risk, compliance and legal risk, and strategic risk, and they affect both banks and microfinance firms. The developments in the financial markets that have significantly influenced risk management techniques in the modern era can be mainly attributed to deregulation. Globalization has increased since the 1970s as a result of the deregulation of capital flows (Braun, B., Krampf, A., & Murau, S. 2021). The deregulation of industries has facilitated the quick growth of new businesses like Enron (Zekos & Zekos, 2021), and the deregulation of financial operations has brought about new risks because some banks are now offering insurance products, and insurance companies are writing market and credit derivatives (Sereix, 2021). A financial institution’s operations involve identifying and controlling financial risk.

An organization exposed to the financial markets has the risk of suffering a loss, but it also has the chance to benefit. Exposure to the financial markets may have competitive or strategic advantages. Since financial risk is a subset of the company’s hazards, the justifications for managing financial risk are the same as those for putting a risk management system in place. Reducing the volatility of cash flows or earnings due to exposure to financial risk is one of the primary goals (Dhanani et al., 2017). The company can make more accurate projections because of the reduction (Bishev & Boskov, 2016). Additionally, this will contribute to ensuring adequate funds for dividends and investments. Preventing financial turmoil and the associated expenses is another justification for risk management (Lindström & Giordano, 2016).

A retail bank’s credit risk management strategies include decision-making frameworks related to lowering exposure to loan loss provisioning and classification of credit assets. According to BCBS (2003), bank risk management reduces the likelihood that a borrower or counterpart would not fulfil its commitments per the agreed-upon terms. The risk of suffering a financial loss due to changes in market prices is included in market risk. The danger that retail banks cannot fund asset increases on time or satisfy their obligations to depositors without suffering unacceptably high expenses or losses is known as liquidity risk (Lartey et al., 2021). Liquidity risk is the potential for detrimental consequences on the interests of the financial institution’s owners, clients, and other stakeholders due to the incapacity to satisfy present cash obligations in a timely and economical way. According to Ogol (2011), liquidity risk typically results from management’s incapacity to sufficiently foresee and prepare for changes in funding sources and cash needs. Sufficient cash reserves must be kept on hand, and to optimize profits, as much money as possible must be invested.

Rationale 

The banks and financial institutions are those that are mainly driven by the complexities of the dynamics and the protection from exposure to risks, such as financial sector risk exposure or liquidity risk, that are inherently present in the banking industry. Making a deposit on which almost 85% of the bank’s liabilities are held, these institutions extremely rely on revenue from the return on the supplied loans for profitability and development. However, the intensification of competition between the financial institutions pushes them to enlarge and expand the range of their services and products to reinforce the clientele. This diversification provides a serious financial risk-bearing aspect that must be monitored with great care. The capacity of reinventing through diversification is represented as “in a lifetime,” thus urging the rate of wisely reflective settling down. For now, the key focus of the financial sector is the exposure to risk, which can lead to a reduction of asset values and profit margins, necessitating comprehensive solutions to inform management decisions on risks and operations. These data support the study as this area is broadly considered by the World Bank to be an essential part of the banking system’s stability, success in the short and long terms, as well as asset growth.

Research problem 

The economy is significantly impacted by changes in the performance and structure of commercial banks, the leading financial institutions (Bishev & Boskov, 2016). Because deposits from depositors account for about 85% of a bank’s liability, the entire nature of the banking industry is highly delicate (Sereix, 2021). Customer retention, financial risk, legal and compliance risk, strategic risk, technology risk, and fierce rivalry from MFIS, mortgage companies, and SACCOs are among the current issues in the financial services sector. The impact of financial risk on profitability was the study’s primary concern for the Kenyan banking industry. Despite the financial services sector’s significant expansion, UK banks continue to need help managing the risks they are exposed to (Muriithi, 2016). A decline in asset quality is associated with a rise in credit risk, which lowers predicted profitability. The volatility of interest and foreign exchange rates also contributes to market risk, as banks take financial instruments vulnerable to price swings as collateral for loans. The imbalance between assets and obligations and recessionary economic conditions give rise to liquidity risk.

Thus, it is necessary to have a broad perspective. Additionally, bank size was included in this study as a suitable moderating variable, and the use of GMM improved the approach over earlier research. The effect of bank size on the financial performance of banks has been researched by Said et al. (2008), Awojobi (2011), and Al Karim et al. (2013); however, their findings need to be more consistent. Prior research conducted in Kenya has not examined bank size as a moderating influence. Thus, research into the moderating role of bank size on financial risk and Kenyan commercial banks’ financial performance was necessary.

Research aim 

To comprehensively analyze and understand the impact of international risk exposure on the financial performance of central UK banks, specifically Barclays Bank, HSBC Holdings, NatWest Group, Standard Chartered Banks, and Lloyds Banking Group.

Research objectives 

1. To examine risk management practices and investigate international risks
2. To quantify the direct and indirect impact of international risk exposure on the financial performance metrics of the selected banks, emphasizing profitability and key financial indicators.
3. To compare the influence of the regulatory environment on the international risk exposure and risk management strategies of the selected UK banks, focusing on compliance and adaptability.
4. To forecast future trends and challenges related to international risk exposure and provide strategic recommendations for enhancing the resilience of the banks, considering emerging global financial landscape dynamics.

Research questions 

1. What steps do UK banks take to mitigate risks that come from abroad in order to maintain a good financial position?
2. Is the international risk exposure of the selected banks positively or negatively related to their success?
3. The approach to international risk management and its consequence on financial performance, what similarities and differentiations exist in the banks?
4. What is the regulatory context which supports international risk management, and what is the view on the future outlook of the role of international risks on the financial results of these banks?

Justification of the study 

Financial institutions are often expected to manage their financial risk to prevent placing themselves in situations where an excessive amount of risk is involved, which could lead to a reduction in performance. The banking industry’s very nature is highly delicate because deposits from depositors account for 85% of their liabilities. Most financial institutions rely heavily on these deposits as a primary source of income generation. The rivalry has forced financial institutions to seek outside their current service and product offerings to gain a broader spectrum of customers. However, because this diversification advantage entails a significant financial risk, it is a once-in-a-lifetime opportunity that should be used carefully and wisely.

Financial institutions are currently concerned about financial risk, and better processes and systems must be developedto provide better insight into future performance. Regulators, business leaders, and investors place great weight on financial risk and shared exposures. Regulating agencies and the government will significantly benefit from the study. It will facilitate the regulators’ comprehension of the extent of financial hazards and how to improve the financial industry’s systems regarding rules to assess how well the regulator’s risk management is working. The report will also benefit investors, top management, and oversight boards of UK financial institutions. All commercial bank managers will better understand how financial risk affects UK retail banks’ financial performance. They will benefit from implementing the study’s suggestions and consulting with the appropriate parties to decide whether to reduce financial risk to increase returns. These research findings will fill the existing knowledge vacuum in the literature about how financial risk affects these institutions’ financial performance.

CHAPTER TWO 

Review of literature 

Introduction 

This chapter provides an overview of the theoretical and empirical literature about international risk exposure. The study constructs a theoretical framework, surfaces with a critical evaluation of the current state, and elaborates on the research deficiencies regarding the impact of financial risk on the financial performance of commercial banks. This literature review seeks to evaluate the existing theoretical and empirical academic research on risk management and the methodologies employed by financial institutions for assessing financial risk (Dičpinigaitienė & Novickytė, 2018). The initial focus is on the fundamental principles of risk management and how they impact the overall performance of banks. Furthermore, the financial risk assessment models of UK financial institutions are supported by a wide range of variables, which are thoroughly identified and explored. The chapter provides an overview of the existing literature on financial risk in the banking industry. It then specifically examines the theories and methodologies used for financial risk assessment and exposure in the United Kingdom.

Empirical literature review 

An empirical literature review is a comprehensive analysis of existing research studies and scholarly articles that are based on observations and data. Financial institutions encounter significant obstacles in their quest to discover novel and superior methods to expand top-line revenues, uphold essential capital ratios, enhance profit margins, fortify balance sheets, and optimize efficiencies within the organization. Financial risk management has garnered heightened scrutiny in recent years (Galletta & Mazzù, 2023). Financial hazards, while not being the primary expertise of non-financial companies, significantly impact their company operations (Triantis, 2020). Financial risk exposures can manifest in various forms. On one hand, there are external financial risks that are contingent upon fluctuations in financial markets.

Conversely, internal financial risks refer to hazards that originate from within the organization itself (Galletta & Mazzù, 2023). The rationales for overseeing financial risk are the same as those for implementing risk management, as financial risks are a subset of the organization’s hazards. An important goal is to decrease the instability of earnings or cash flows caused by exposure to financial risk (Dhanani et al., 2017).

Retail banks utilize financial risk management procedures to guarantee that risks are taken with full awareness, clear intention, and understanding rather than to prohibit or discourage risk-taking behaviour. The objective is to measure and mitigate these risks. According to Allen (2023), corporate financial risk management aims to control a company’s vulnerability to many elements influenced by the financial market, such as currencies, interest rates, energy, and commodities. It is a continuous process that constantly adapts to the changing threats faced by enterprises. Nevertheless, numerous banks that have recognized diverse dangers in their operations need explicit risk policies or plans to effectively handle these risks through an officially sanctioned procedure (Dhanani et al., 2017). Companies would derive advantages from using a process that is integrated into their overarching business strategies and management process. According to a study done by (Stroeder, 2018), When engaging in retail activities, it is necessary to make judgments on a regular basis, even when the outcomes cannot be accurately predicted due to limited information. The uncertainty associated with all forms of business activity is referred to as risks (Roncalli, 2020). Risk management can enhance the value of a firm in situations when market imperfections such as progressive taxation of the company, anticipated expenses of financial hardship, or agency problems exist (Roncalli, 2020). Consequently, risk management is a duty that falls upon each stakeholder. Financial risks are also mitigated to prevent financial hardship and the associated expenses (Roncalli, 2020). and Drogt et al., 2008). The motivation for financial risk management can stem from the managerial self-interest of maintaining stable earnings or keeping tax levels steady (Dhanini et al., 2007). A primary objective of financial risk management is to mitigate volatility and prevent substantial losses.

Analysis of the relationship between financial risk and financial performance. Financial risk encompasses credit risk, liquidity risk, and market risk, which collectively influence the instability of financial performance and exposure (Tafri et al., 2019; Dimitropoulos et al., 2020). The primary financial risk that impedes the performance of banks, particularly in the UK, is credit risk. This refers to the potential danger of the fluctuating value of assets caused by the counterparty’s failure to fulfil its contractual debt obligation (Gupta & Sikarwar, 2020). Interest rate risk refers to the potential for changes in lending or deposit interest rates, which can lead to fluctuations in financial outcomes (Dimitropoulos et al., 2010). Banks may face interest rate risk when the lending interest rate of a retail bank is higher than the market rate or when the deposit interest rate is lower than the market rate. The exchange rate risk is linked to the devaluation of the domestic currency, which leads to higher prices and reduced output (Berument & Dincer, 2018). When a bank inaccurately values currency during the buying and selling of foreign currency or when the value of foreign currency consistently decreases, the bank incurs an exchange rate loss. Profitability provides insight into the bank’s capacity to take on risks and develop its operations.

The primary metrics utilized to assess bank profitability are return on equity (ROE), which is calculated as net income divided by average equity; return on assets (ROA), which is calculated as net income divided by total assets; and the financial leverage indicator, which is calculated as equity divided by total assets (Lestari, 2021). Bank earnings are frequently used as a standard metric of bank performance ((Lestari, 2021).). Bank profitability can be assessed using the return on assets (ROA), which is a ratio of a bank’s profits to its total assets. Retail banks’ income statements disclose pre-tax and post-tax profits. Another effective metric for evaluating bank performance and risk exposure is the ratio of pre-tax earnings to equity, known as return on equity (ROE). This measure is preferable to using total assets, as banks with a larger equity ratio are expected to yield a greater return on assets (Lestari, 2021). The long-term sustainability of a bank relies on its capacity to generate sufficient profit from its assets and capital. The assessment of profit performance significantly depends on comparing key profitability indicators, such as return on assets and return on equity, with industry benchmarks and peer group standards (Lestari, 2021).

The capital of a banking institution refers to the sum of money invested by the owners of the institution, known as paid-up share capital. This capital grants them the entitlement to receive all the future profits generated by the bank. Alternatively, it can be viewed as the total amount of capital owned by individuals that can be used to sustain a bank’s operations ((Stroeder, 2018)). The latter concept encompasses reserves and is also referred to as total shareholders’ funds. Regardless of the chosen definition, a bank’s capital is commonly utilized to assess its financial robustness ((Stroeder, 2018). Lestari (2021) and Kwan and Eisenbeis (2015) have shown a direct relationship between returns and capital. In their study on the factors of UK banks’ performances from 1980 to 2010, they found that the banks with the highest performance are the ones that have made efforts to enhance labour and capital productivity, as well as strengthen their equity and also know how to handle risks due to exposure.

Analysis of risk exposure and its impact on financial performance 

The primary objective of a bank’s existence is to receive deposits and provide credit facilities, which necessarily exposes them to the risk of default on loans. The primary risk that banks encounter is credit risk, and the effectiveness of their operations relies heavily on the precise assessment and effective control of this risk, more so than any other hazards. (Tsatsaronis et al, 2024). In their 2019 study, Hosna et al. examined the correlation between non-performing loans and capital adequacy ratios, as well as profitability, for four Swedish banks from 2010 to 2018. The analysis demonstrated an inverse relationship between the rate of non-performing loans and capital adequacy ratios with return on equity (ROE). However, the extent of this relationship varied among different banks. Similar correlations between profitability, performance, and credit risk measures were observed in previous studies conducted by Achou and Tenguh (2018), Kolapo et al. (2012), Musyoki and Kadubo (2011), and Tomak (2013). These studies investigated the determinants of bank lending behaviour in UK retail banks, using a sample of eighteen out of 25 banks. The goal of the research was principally to determine the factors that influence the operation of a bank and the extent to which it is at risk.

These consisted of dimensions like the availability of long-term financing, interest rates, GDP expansion, and rate of inflation. This study has proved that a bank’s size, its ability to borrow for a long period, and inflation have a large positive effect on the bank’s optimization of risks and its response to them. But, we learn that interest rates and GDP exert little influence. Kithinji’s (2019) study is proof of this impact. This study showed that the credit risk, as determined by the loan and advances ratio to total assets as well as the percentage of non-performing loans to total loans and advances, had an impact on the return on total assets in UK banks from 2004 to 2008. The study found that traditional retail banks’ high profits, regardless of credit and non-performing loans, are a common phenomenon. In his words, banks generally experienced a large increase in their profits by learning how to deal with risks. The profitability range of the retail banks traded mostly from one-half to two-half, but it finally improved during this period.

The profitability was generally modest during the time of analysis. The level of credit provided to customers was initially large but gradually decreased during the years. While the level of credit and profits was consistently low, the amount of credit was significantly large and subject to frequent changes. Kithinji’s findings suggest the need to examine additional factors that may influence a bank’s performance, as well as conduct a study over a longer period to obtain a more accurate understanding of the banks’ performance. Therefore, this study examined the effects of liquidity, market risk, and operational risk on financial risk.

Risk Management Practices and International Risks

Market risk is a primary cause of income volatility in financial organizations globally. Based on the classification of banking risks proposed by international economists Koch and MacDonald (2016), market risk can be broadly defined as comprising three sub-risks: stock price risk, interest rate risk, and foreign exchange risk. Aldasoro (2020) states that banks face market risk when they accept financial instruments that are vulnerable to changes in market prices as collateral for lending. The price fluctuations, or volatility, fluctuate in the day-to-day market. This form of risk mostly pertains to both stocks and options. It typically exhibits strong performance during a bull market characterized by growing prices and weak performance during a bear market characterized by dropping prices. Typically, higher market volatility increases the likelihood of investment growth or decline. Market risks can be categorized as interest rate risks and exchange rate risks, as well as gold, share price, and commodity price risks. These risks arise from any unfavourable changes in interest rates, exchange rates, share prices, and commodity prices. In 2021, Wachiaya was surveyed to identify the market risk management measures employed by retail banks in the UK and assess their effectiveness in reducing financial losses. The study employed a census survey as its research design. The study employed a questionnaire as a means of collecting primary data from the target population to obtain information pertaining to the pertinent concerns of the investigation.

The study’s findings indicated that Scenario analysis and Stress Testing were extensively employed as the primary methodologies. Securities were partially subjected to mark-to-market valuation. The primary discovery was that limits effectively facilitated the control of risk exposure in accordance with the bank’s risk tolerance. Additional factors were the implementation of restrictions to ensure that banks adhered to permissible boundaries, as determined by the shareholders, and the adoption of careful management practices to mitigate market risk. Additional minor factors included the need to maintain responsible oversight of the bank’s assets and obligations, as well as for monitoring (Wachiaya, 2021). Based on the findings mentioned earlier, banks in the UK must adopt the most effective methods from each other to manage market risk exposure and minimize the impact of losses caused by this risk. This study differs from previous studies as it examines the impact of market risk on financial performance through the utilization of financial indicators.

The impact of the regulatory environment on international risk management.

The role of the regulatory framework impacting international risk management should be addressed because it is what has been necessary for understanding how UK banks adapt and make things in the current global system. The impact of such influence is in line with the sophisticated domestic and global regulatory rulemaking institutions, such as the Financial Conduct Authority (FCA) in the UK and the Basel Committee on Banking Supervision globally. These regulations are at the centre stage of global policy norms, making the house rules upon which banks manage foreign risks. The focal point of the rules is complying with global standards (Aldasoro, 2021). Banking authorities compel banks to report their particular risk exposures to foreign countries meticulously; otherwise, they will conflict with some reporting and obligation disclosure requirements. Within the context of TCFD, this is seen as the release of risk modelling, the outcomes of stress testing, and the information pertaining to the regional distribution of risk. Not only do those rules improve openness, but they also give regulators a chance to monitor the effectiveness of banking institutions’ risk management strategies.

The deregulatory atmosphere is always rapidly changing, with new laws and regulations being introduced. The banks should show the ability to be flexible in adaptation to the already existing dynamic economic environment, including updating their risk assessment plans and reporting requirements (Lestari, 2021). The merits of regulatory oversight for this purpose are clear, as it is intended to supervise banks’ risk management activities, scrutinize the adequacy of risk governance features, and assess the performance of risk mitigation techniques. Therefore, regulatory standards also provide the banks with incentives for optimal global risk management strategies, for example, Ghadge et al. (2021). By recognizing and rewarding organizations that have demonstrated exceptional results and success in the area of risk identification, analysis, and minimization, we will encourage organizations to continue striving for excellence by implementing and improving risk management systems. Incentivization by no means is limited to sticking to risk management; however, it is also a symbol of commitment and being empowered to be better in risk management.

Anticipating Future Patterns and Obstacles in Global Risk Management

Monitoring the risk and predicting trends in the international financial market is a critical function of risk management. Many studies have focused on the ever-changing character of the global market, technological progress, and geopolitical shifts, which not only imply a higher degree of risk for banks but also pose great challenges. Through studying these evaluations, we could propose ideas about how banks would be able to build up their resilience in an evolving global environment (Ghadge et al., 2021)). A deep delve into the zoom of the economic map comprised of economic indicators, trade patterns, and monetary policies that assist in predicting future trends is fundamental to a world economy. Banks can implement proactive strategies in their risk management processes by analyzing economic cycles, adjusting demand requirements, and getting acquainted with the price dynamics of commodities. For instance, if banks foresee an economic downturn, they will diversify their balance sheet and secure their capital adequacy to be able to withstand future financial challenges.

The extraordinary extent to which innovation in technology is advancing and global risks are constantly evolving represent the matters of new risk exposure. Banks can remain on top of the changing technologies as well as cutting-edge technologies, including artificial intelligence, blockchain, and digital currencies, effectively handling both the benefits and the pitfalls. If banks use the data collected to forecast the trajectory of technical trends, they may take proactive steps to counter cyber-attacks and operational disruptions. Therefore, they can also take the possibility of improving the risk modelling instruments and gaining higher efficiency through digital transformation as well (Park & Kim, 2020). World politics is an important contributing factor to international risk management since various arguments against economic integration, political instability and diplomatic controversies may take place (Lestari, 2021). In order to predict those geopolitical upheavals, one should keep a keen eye on the events that are happening on the global stage and comprehend how they can have an impact on the activities that take place beyond the national borders. Banking experts will have a better image of future geopolitical trends, which will enable them to offer strategic advice, making it possible for banks to have buffer plans, diversify operations, change investment portfolios or apply hedging technologies. Thanks to such decisions, banks can lessen the impact of geopolitical uncertainties.

In light of the regular changes in laws and regulations, banks need to grasp the risks arising from changes in the regulatory environment. Foresight into likely future developments of the regulatory environment involves observing planned amendments, international treaties, and regulatory responses to emerging dangers. Banks can use the strategic advice obtained from stress tests made based on regulators’ projections to modify their risk management procedures beforehand. This implied customizing compliance procedures, bettering reporting frameworks, and checking the risk strategy against the estimated regulatory standards.

Furthermore, risk management now deals not only with environmental, social, and governance (ESG) issues but also with a new aspect of global risk management. Based on the anticipated patterns for ESG regulating factors, customers’ inclinations and societies’ expectations, banks will consider sustainability factors in their risk assessment. Banks may adopt ESG projection to offer strategic support and link it with their dynamic risk management methods in response to changing public opinion (Park & Kim, 2020). With that, a sustainable banking system will be created to promote durable resilience and ethical financial practices. (Zekos & Zekos, 2021) In a nutshell, a forward outlook on world risk management and characterization of threat issues makes it possible for banks to go through difficult times of globalization relatively well. Financial institutions may be better able to mitigate risks created by new developments by constantly being prepared to accommodate economic dynamics, technology, geopolitics, regulation, and the ESG environment. Engaged in strategic advising, these forecasts aim to build flexibility for banks so that they are well-equipped to adjust the risk exposure in the face of a constantly changing foreign environment.

In the same vein, a corresponding cooperation among regulators is of particular importance. Working together allows for the harmonization of regulations at the international level through the decrease of trade-offs to set a standard level worldwide. The World Banking Union is about developing a common risk management framework for all the participating countries or areas, making the banking business fairly competitive for international banking institutions (Demirgüç-Kunt et al., 2021). Regulatory frameworks are crucially meant to ensure that the techniques employed by different UK banks in handling global risks will be employed effectively. The resilience of these banks and the stability of international finance are enhanced by their compliance with universal standards, ability to react beyond-the-scenes changes, effective oversight, and the incentives for safer practices. The assessment of both banks’ strategy details makes us realize the relevance of the existing legal framework and shows the way for improvement in the global risk management system.

Extreme value theory 

Bernoulli considered the sum of the average of the maximum distance starting point when N points were randomly placed on a straight line of a given range (Rafiu et al., 2024). A century later, Fourier advanced up to the case of a Gaussian distribution (in which the likelihood of the deviation being above three times the square root of two standard deviations from the mean is approximately 1 in 50,000) was assumed. Consequentially, it can be considered meaningless (Kinnison, 1985). Along with the investors, especially the financial institutions, which have the main trading activities in their schedules, were also highly vulnerable to abrupt market fluctuations. Consequently, the management of market risk has emerged as the top issue for regulatory agencies and internal risk management. To do this, the factors should be analyzed, and indicators should be found that will demonstrate the level of danger that organizations face and the efficiency of measures taken to remove the danger.

Financial institutions mostly use the value-at-risk (VaR) model to determine the maximum loss a market portfolio or a financial institution could incur during the given time frame. Portfolio VaR is portrayed as the biggest possible value loss that might occur to a portfolio within a particular period, stated according to specific confidence levels and taking into consideration market risks (Rafiu et al., 2024). Breach of market risk rules is considered to be an infringement suffered by financial institutions and their branches with a considerable size of trading. Banks should have capital that is enough to cover not just the general risk they are exposed to but also the specific risk they may face. The value of capital is decided according to the bank’s risk assessments.

Therefore, a lot of alternative methods are proposed nowadays for the calculation of VaR, one of them known as the Extreme Value Theory (EVT). Extreme Value Theory (EVT) tactics extract only the data from beyond the distribution tails for purposes of Value of Risk (VaR) estimation, therefore providing insight into risk exposure to banks. This method, instead, aims to avoid the full distribution of the model, and each tail can be computed separately (Clark et al., 2023). Precise quantification of Value at Risk is of utmost importance as it serves to plot the level of risk susceptibility the company is exposed to on a scale. Nevertheless, the VaR may exceed the risk level, and so the firm will have wasted capital meant to mitigate the risk, which could have been utilized for something else (Clark et al., 2023). Extreme value theory has a positive impact on the minimum and maximum sums of money that should be spent on protection from market risks. To achieve this target, banks need to please market risk management by controlling financial leverage use.

Literature Gap 

Based on the previous examination of relevant literature, it is clear that research on bank risks has been conducted, although not in a comprehensive manner. The majority of the literature examined revealed that prior researchers focused solely on credit issues, neglecting the elements of market risk. The present analysis has an expanded scope as it encompasses additional significant variables pertaining to liquidity, market, and operational risks that were overlooked in prior studies. This enhances the comprehensiveness of the investigation. This study aims to address the existing gaps in the literature by examining the impact of financial exposure on the financial performance of retail banks in the UK.

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