Risk Management in Banking and Insurance - Essay Example

Risk Management in Banking and Insurance Table of Contents Introduction 3 Task A 3Risk Culture 3 Inappropriate Risk Cultures 3 Specific Risks in Banking and Insurance Sector 4 Systematic Risk 4 Credit risk 4 Operational Risk 4 Legal Risk 4 Factors led to the Global Crisis 4 Barclays Plc. Scandal Case 4 Siemens AG Scandal Case 4 Task B 5 Risk Management Strategies 5 Effectiveness of Risk Management Strategies 5 Measures adopted by Financial Institutions 5 Conclusion 6 Reference List 6 Introduction The global crisis of 2007-08 started off as a mortgage crisis principally concerted in the United States, however it quickly transformed into a international financial catastrophe where the financial institution staggered on the border of bankruptcy or insolvency in most of the countries. Apart from the crisis of subprime mortgage, other factors which contribute to the financial crisis were improper risk culture and unethical behaviour of the employees in many financial institutions and banks. There were many banking scandals which took place between 2007 and 2008 (Tong and Wei, 2009). The improper risk culture and the functioning of financial institution in the unethical manner refers to the act of the financial institutions caught out supporting drug runners and swindling London Interbank Offered rate (LIBOR) (Roe, 2014). Unethical behaviour may not be considered as the greatest risk towards market stability. However, greater risk may come from the assumptions of investors that unethical deeds will not take place. The main purpose of this report is to appraise different viewpoints on risk. It also considers recognizing and evaluating definite risk in the insurance and banking sector. Further, this report encompasses the evaluation of the performance of operational and managerial strategies to handle risk as well as take into account the specific approaches in order to help the financial institution to manage risk. Task A Risk Culture It is defined as the system of behaviours and values present in the business organization that outlines risk decisions of employees and management. One component of risk customs is a general understanding of the firm and its purpose. A strong culture in an organization is crucial to its soundness and safety and also to economic stability (Treasurers, 2014). Companies should also make sure that that there is an effectual communication around risk and ethics. The culture of risk management has an important impact on the capability of an organization to effectively take the strategic risk as well as deliver on the performance promises. There are various components in order to effectively establish the significance of the risk culture in the organization. Employees must be incentivized for doing the correct things only. Ethical behaviour is considered as a main element of a well-built risk culture and also there is proof of a significant connection between the continuations of ethics plan and the fair behaviour of workforce (Ncsu, 2009). Inappropriate Risk Cultures An improper risk culture indicates that definite teams or individuals will undertake inappropriate activities, along with the left part of the organization condones, and ignores what is happening in the organization. This hinders the accomplishment of operational, strategic, tactical and environmental objectives. In few banks ethics were neglected and the products which are sold to the customers are harmful and inappropriate for them. Some banks give incentives to the traders to take huge risks that were usually not transparent and thus led to losses for banks as well as for society. In certain financial institutions and banks, the management culture is brutal, daunting quality control and therefore permitting risks to grow. The executives of some banks were praised for their success in the face of incompetence and abject failure. Problems with the culture of risk management are often instituted at the origin of organizational collapses and scandals (Reuvid, 2012). Specific Risks in Banking and Insurance Sector Systematic Risk It is the threat of asset price change related with the systematic factors. It is considered as an undiversified risk. In the insurance and banking sector, alteration in the rates of interest and the comparative currencies value led to the systematic risk. Credit risk It arises from under-performance by the borrower. It may take place from either unwillingness or an inability to execute in the contract which is discussed earlier. It also refers to the divergence of the portfolio presentation from its usual value. It is diversifiable though not easy to eradicate completely. Operational Risk It is related with inaccurately processing, making or taking delivery on the trades in substitute for cash. Moreover, it also occurs in processing system malfunction, record keeping, and compliance with several regulations. Legal Risk New statutes, regulations, court opinions, and tax legislations can put previously well-established business into disputation even when entire parties have initially performed adequately as well as are fully capable to execute in the near future. Fraud, infringement of laws and regulation leads to terrible loss (Santomero, 1997). Factors led to the Global Crisis There are a range of factors which led to the worldwide crisis. Improper risk culture and the unethical behaviour of the employees in the banks and financial institutions are one of them. Barclays Plc. Scandal Case Barclays Plc. faced a $440 million fine, having intentionally tried to control London Interbank Offered rate (LIBOR). This totals to the fine of £59.5 million by the FSA (Financial Services Authority) – the utmost fine imposed by British FSA and correspondingly £128 million by the CFTC (Commodity Futures Trading Commission). Barclays Plc. has also been fined £38 million by the country regulators failing to maintain the assets of its clients separate from their own. The company also tried to alter liquidity condition and the main violation took place before the global economic crisis which was to give monetary assistance to the derivative traders. These attitudes of the company led to its bad reputation and also harm its financial position. Barclay’s inequitable culture is regarded as the major cause which led to its bankruptcy (Cervellati, Piras and Scialanga, n.d.). Siemens AG Scandal Case There was sequence of scandals related with Siemens that are concerned with the employees of the company bribing the foreign officials in order to get contracts as well as creating slush finances for this idea. Siemens was also charged of bribing the labour representatives to receive their support generally for its plans and policies. As a result, the Chairman and the CEO of the company has to give their resignation even though both of them were not directly related to the scandal (Icmrindia, n.d.). Task B Risk Management Strategies A proper risk management approach provides a coherent and structured move towards identifying, measuring as well as managing risk. By assessing the risks the company will be capable to be dynamically alert of where improbability surrounded by outcomes or events exists as well as identifying the steps which could be taken in order to guard the organization (Diycommitteeguide, n.d.). The institutions must set a framework including the managers who supervises the entire risk management process. The function of risk management is responsible for ascertaining that effective practices are in place generally for identifying emerging and current risks; establishing practices, control mechanism, and policies to handle risks; developing emerging and current risks; developing the limits of risk tolerance for board and senior management approval; examining positions against the approved limits of risk tolerance; and reporting risk monitoring results to the senior management (Sarkar, 2005). The risk management framework is taken into practice to focus on the procedures and policies, due diligence practices, accounting and internal reporting. It will help to address the issues such as lack of the board direction in reverence of the requisite risk culture, lack of lucidity about how to implant project risk management, and lack of apparent understanding of current culture (Reuvid, 2012). In order to manage the credit risk, the board should ensure that the credit risk disclosure is maintained at the prudent levels as well as reliable with the existing capital. They should establish a method of ongoing, independent evaluation of the credit risk control process. The objective of such reassessment is to measure the process of credit administration, the credit rating accuracy including the adequacy of prerequisite for losses, as well as overall feature of the credit portfolio (Kaplan and Mikes, 2012). Banks that attain liquidity from the capital markets must know that these resources are more unpredictable than the conventional retail deposits. Moreover, public disclosure develops transparency, supports valuation, reduces ambiguity in markets as well as strengthens the market position (Bank for International Settlements, 2008). Effectiveness of Risk Management Strategies The benefits which the companies get by applying the risk management strategies are: it gives assurance that there is more possibility of the goals to be achieved; damaging things would not take place or may be happen less; and there would be more chances of the beneficially things to be attained. A suitable risk management approach gives upward assertion from administrative functions and business activities to the team of senior management and finally to the board. Additional benefits from the risk management strategy are: helps to support business and strategic planning and effective utilization of resources; assist in promoting constant improvement; quick grip of the new technologies; reassuring stakeholders; and helping to focus on the internal audit plan (Schwartz and Smith, 1997). Measures adopted by Financial Institutions There are various measures that could be adopted by the banks and financial institutions in order to create more suitable risk culture. They should review the business units as well as shut down those units that ran schemes of tax avoidance. They can also launch a change programme that specifies the cultural change and can introduce new values. For example, the new CEO of Barclays Bank has decided to put the culture in the right place. He refused the bonus of £2.75 million for the year 2012 and also announced that the employees should dress professionally i.e. no brash belts or ties. He launched the change programme that specifies the cultural change which is considered as the main part of agenda. New mission is also created for the bank which signifies helping people in order to accomplish their goal in the correct way. New values has been introduced such as employees will get bonuses and also be evaluated on matters like respect, excellence, integrity, stewardship, service, and achieving financial targets. He also communicated to all staff members that they should follow all these guidelines or else they can leave (Francke, 2014). Conclusion The main purpose of this report was to focus on the unsuitable risk culture and the unethical behaviour of the employees in the financial institutions and the banks. It encompasses two examples showing how the Barclays Plc and Siemens AG’s unethical behaviour inside the organization led them to give huge fines as well as the resignation of its Chairman and CEO. It also focuses on the different types of risks in the insurance and banking sector. Further, the report has highlighted the strategies of risk management and their effectiveness in the organization. Suggestions are given on the measures which needed to be adopted by them as well as the measures taken by Barclays Bank have also been discussed. Thus, by adopting proper strategies the organizations will be able to achieve its objectives in a most appropriate way. Reference List Bank for International Settlements. (2008) Basel committee on banking supervision. Switzerland: Bank for International Settlements. [Online] [Accessed on 30th December 2014] http://www.bis.org/publ/bcbs144.pdf Cervellati, E.M., Piras, L. and Scialanga, M. (n.d.) Corporate culture and frauds: a behavioral finance analysis of the barclays – LIBOR case. Unknown place of publication: Unknown publisher. [Online] [Accessed on 30th December 2014] http://www.virtusinterpress.org/IMG/pdf/Enrico_Maria_Cervellati_Luca_Piras_Matteo_Scialanga_paper.pdf Diycommitteeguide. (n.d.) What is a risk management strategy. [Online] [Accessed on 30th December 2014] http://www.diycommitteeguide.org/article/what-risk-management-strategy Francke, A. (2014) FT guide to management. United Kingdom: Pearson Education. Icmrindia. (n.d) The bribery scandal at siemens AG. [Online] [Accessed on 30th Decembeber 2014] http://www.icmrindia.org/casestudies/catalogue/Business%20Ethics/BECG076.htm Kaplan, R.S. and Mikes, A. (2012) Managing risks: a new framework. [Online] [Accessed on 30th Decembeber 2014] https://hbr.org/2012/06/managing-risks-a-new-framework Ncsu. (2009) Risk culture of companies. [Online] [Accessed on 30th Decembeber 2014] http://erm.ncsu.edu/library/article/risk-culture-companies Reuvid, J. (2012) Managing business risk. United Kingdom: Kogan Page Publishers. Roe, K. (2014) Leadership: practice and perspectives. United Kingdom: Oxford University Press. Santomero, A.M. (1997) Commercial bank risk management: an analysis of the process. Pennsylvania: University of Pennsylvania Press. Sarkar, A.N. (2005) Strategic business management and banking. New Delhi: Deep and Deep Publication. Schwartz, R.J. and Smith, C.W. (1997) Derivatives handbook: risk management and control. United States of America: John Wiley & Sons. Tong, H. and Wei, S.J. (2009) Real effects of the 2007-08 financial crisis around the world. New York: Tong and Wei. [Online] [Accessed on 30th Decembeber 2014] http://www.finance-innovation.org/risk09/work/1201504.pdf Treasurers. (2014) Lifting the lid on risk culture. [Online] [Accessed on 30th Decembeber 2014] http://www.treasurers.org/node/8609 Read More