Finance 550 24hours - Essay Example

Briefly Explain How Wholesale Banks Have Diversified Risk Via Co-Insurance And Re-Insurance Mechanisms In Markets For Inter-Bank Deposits And Syndicated Loans. Discuss, Using Historic Examples (During 1980 To 2007 Have Contributed To Problems In The ‘More Advanced’ Wholesale Bank During The 2008-2009banking Crisis), How Systematic Risks Can Arise In These Wholesale Markets And How They Can Threaten The Wholesale Financial Intermediation Process And The Existence Of The Wholesale Bank.Name:Course Name:Instructor:Date:Interlinkages between banks and insurance companies are one of the most significant economic developments that have been witnessed in many countries in the recent past.

The separate segments of financial service industry have converged as an effective way of transferring risks. Whereas banks are shedding financial and credit risks to insurance firms, insurance companies are employing banks as means of hedging some of the foreseeable market risks that are commonly associated with their portfolios of retail products (Buckle and Thompson, 2005).How wholesale Banks diversify risks via re-insurance and co-insuranceOff commercial banks’ balance sheets: As suggested by Lewis and Davis (1987), commercial banks have engaged is securitization of residential mortgage loans through Asset Backed Securities (ABS) since 1980s.

Whole banks have expanded these markets to include a vast range of asset types such as syndicate loans and deposits. Through Asset Backed Commercial Paper (ABCP) programmes, wholesale banks have managed to warehouse assets. In the recent banks, these banks have also used collateralized loan obligations (CLOs) to transfer risks associated with syndicate loans and deposits to re-insurance and co-insurance companies. Through these programs, co-insurance provides syndicated loans to be held by commercial banks or loans that can be sold as securities.

Wholesale banks and policy-makers recognize that liquidity is paramount in the dynamics of financial risks and its measurement aids in regulating systematic risks. Wholesale banking has maintained enough buffer liquid assets by transferring some assets to co-insurance or re-insurance companies. WB have traditionally provided liquid funds to its clients by issuing transactions deposits, which often act as substitute for money. Liquidity productions from deposits allow clients to take cash on demand from commercial banks.

Based on knowledge and information collected by WB, commercial banks can invest float from these transactions thus creating a positive carry for them. WB knowledge on credit risks and future opportunities for economic growth is attained by monitoring customers over the life of loan given. Wholesale banks pool funds from several depositors and they lend money on their behalf. Since WB monitors loans on behalf of the numerous depositors, they will be diversified. As such, this structure allows the entity to reduce expenses incurred when delegating duties of monitoring loans from the principal depositor to the agent financial banker.

Deposits are basically low in risk hence they act as a store of value (Rule, 2012).How systematic risks can arise in wholesale markets how they can threaten the wholesale financial intermediation process and the existence of the wholesale bankBanks and insurance companies have been at the center of financial activity for a long period. However, bank’s share of financial intermediation has reduced in the recent past and this has threatened their activities. Banks makes loans on the asset sides of their balance sheet.

They also take demand deposits based on the liability side of their balance sheet. According to Cummins (2005), banks consider loans as long term assets that cannot be liquidated easily. However, there are circumstances which forces banks to liquidate them before maturity and this often results in reduced value relative to their value at maturity. This often happens when majority of rational depositors decides to withdraw their funds quickly and at the same time. Ineffective public policies can also generate systematic risks.

For instance, savings and loan problems experienced in the United States of America in late 1980s are believed to have been caused by policies that never addressed concerns related to moral hazards. The public policy passed by the government favored expansion of deposit insurance hence leaving large depositors less motivated to monitor risks of financial institutions. Due to poor public policy, some firms failed to handle insolvent issues accordingly thus encouraging management of these firms to invest in high risk businesses in their bid to restore solvency (The Geneva Association, 2010).

In the event that commercial banks and other financial institutions experience systematic risks, there are high chances of them getting insolvent. This would mean that wholesale banks would have no purpose for their existence. ReferencesBuckle, M & Thompson, L 2005, The UK Financial System: Theory and Practice, Manchester University Press. Cummins, D 2005, Convergence in Wholesale Financial Services: Reinsurance and Investment Banking, viewed April 27, 2013 Lewis, M & Davis, K 1987, Domestic & International Banking, Philip Allan.

Rule, D 2012, Risk Transfer between Banks, Insurance Companies and Capital Markets, viewed A27 April 2013, The Geneva Association, 2010, Systematic Risk in Insurance: An Analysis of Insurance and Financial Instability, viewed 27 April 2013