`Residual' implies a subject, an object or an issue which is left over from a total mass, magnitude or quantity, but possesses an overall significant effect. In banking risk family, the credit risk dominates, followed by market risk and operational risk. Residual risk, however, has no place of pride, though, at times such a risk may create catastrophic effect—a sudden fatal misfortune on the well-being of a bank. Probably, this is why the Basel Committee treats residual risk as an integral part of Basel Accord II.

Every piece of banking activity gives rise to a risk-reward relationship as in any other business. But comparitively, banking being more sensitive, and more importantly, it being cash-focused, its risk-reward relationship stands slightly on a different pedestal for obvious reasons. Although, complexion of banking business has been undergoing a process of transformation, quite rapidly, in some countries, over the last five years, two of its voluntary activities/segments have not undergone any change.

Therefore, the risk dimensions occur mainly and substantially from the aforesaid activities. However, in many countries, over the last one decade it has been noticed that another class of business risk, the operational risk, as an involuntary process often creates tremendous adverse effects on the safety, stability and soundness of banking system. This type of risk is the heir-apparent of credit risk and market risk. Residual risk has a flow-on effect on overall risk dimension in any bank.

Keeping in view the above discussion, residual risk may be defined as a genre of risk arising out of risk reduction initiative (against credit, market and operational risk) but, is often offset, on account of legal risk, documentation risk and/or procedural/systemic inefficiency risk of the transactions and business flows of a bank.

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