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Financial Risk Management - Assignment Example

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Financial Risk Management

The banking and financial institutions of a country are responsible for the development and progress of different sectors in the economy. They mobilize household savings and lend it to the potential investors in a country. Investments made in the business corporations help them to expand and generate more employment opportunities in a country. Thus, financial institutions and banks play a pivotal rule in the progress of a nation (Saunders and Cornett, 2011). Figure 1: Classical Banking Model (Source: PPT) Figure 1 above depicts the simplest version of banking model in an economy. However the primary task of these institutions also constitute in offering loans to only the worthy borrowers. Rise in the threshold of bad debts result in acute loss of all the related economic entities. Thus, controlling credit, interest and operational risk is one of the most important tasks conducted by all financial institutions. However, the actual framework of banking system in an economy is more complex, this takes into account the market securities and banking risks involved in lending operations (ECB, 2011). Figure 2: Securitization Model of Banking (Source: PPT) Figure 3: Optimization Model (Source: PPT) Risks and Challenges to the Banking Institutions The modern banking and financial institutions have faced several challenges and risks in its process. One of the primary challenges is to introduce mobile banking as regular mode in all banking activities. They have executed several operations to stimulate growth in an economy, sustaining profit levels in an environment with low interest rates etc. They have taken active measures to enhance capital quality and improve capital surplus. Modern banks have tried their best to enrich customer relationship along with restoring public confidence regarding industry. In the recent years the managers of the financial institutions are giving high importance in risk managements. In 1970’s large sums of loans were offered by the financial institutions to different business enterprises in the Eastern bloc, Latin American and less developed economies, but in 1980’s it was found that many borrowers were unable to pay back their loans in time. Government in many economies have introduced the tool of Sovereign Debt Ceiling. By this rule, the borrowers are forced to be defaulters even though they comprise strong credit rating. The global financial instability is increasing with time. Financial crisis in most of the developed and developing economies have increased the credit risks faced by the banking and financial institutions. Many developed economies are suffering from huge debts and failed projects are demanding implicit bail outs from the government. Figure 4: Emerging Market Risks (Source: IMF, 2011) The above cob wed model explains the increased market risks faced by banking and non banking financial institutions in the modern era. Banks and financial institutions deal with different currencies in different economies thus they are often exposed to exchange rate fluctuation risks. They also suffer from high price volatility risks. Interest rate risks faced by the commercial banks are of different types. Repairing risks are also known as the maturity risks, these are the risks that arise due to the inverse relationships between bond prices and interest rates in the market. Basis risks are the ones that arise due t ...Show more

Summary

Financial Risk Management Introduction Money lending in different forms has always taken place in the history of mankind. Money lenders of some form or the other have existed in the market over long ancient years. In the beginning of the twentieth century, modern industry required a state regulated banking system (Hammonds, 2006)…
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