Financial Risk Management - Essay Example

Financial Risk Management Risk management is an essential requirement that has to be considered in the course of carrying out any activity. This means that there are various forms of risk management in relation to the different activities that individuals are involved in. In each of these activities, the underlying factor is that risk management is aimed at reducing the effect of a risk, or at least managing it in the event that it occurs (Franke 79). In light of this, financial risk management calls for the management of risks likely to be met within the financial sector. It is a more specialized insight into risk management, and uses financial instruments to look into the elements of risk within the financial sector. An analysis of the article Risk Management Lessons from the Credit Crisis can effectively assist in evaluating financial risk management particularly in light of the credit crisis. In presenting its cause, the article is divided into a number of parts each of which has its own speciality. Section 1 looks at the various structures of the modern risk measurement systems. Of particular interest is the position-based risk measurement system that tackles the various drawbacks brought by the traditional returns-based system. The traditional system is shown to be rigid in that it cannot adjust to the various new parameters that characterize a dynamic society. In essence, they prove to be largely unreliable, thereby necessitating the adoption of the position-based measures. The article highlights how the position based risk measures are more versatile and can accommodate various aspects in relation to the dynamism of the contemporary society. Part 2 of the article focuses on the various risks that establishments are exposed to. The classification is divided into broad categories of known knowns, the unknown unknowns, and even the known unknowns. All of these categories are reached at depending on the pre-existing uncertainties, with the most uncertain risk being classified under the unknown unknowns. Known knowns are fairly manageable, and are the most basic of uncertainties that an institution is bound to encounter. On the other hand, known unknowns are the points that may be well understood, but the correct way of mitigating them is yet to be identified. The unknown unknowns are the most extreme and uncertain occurrences, which may be too abrupt even for the most advanced risk management system. Finally, part 3 of the article looks at the various lessons that can be learnt from the evaluation. There are lessons for risk managers, such as the fact that risk management should be guided by forward-looking people who can easily deploy position-based management systems. The basic point is that risk managers need to be dynamic and easily adjust as per the tendencies they note in their models (Jordon 5). Additionally, there are lessons for regulators, with an analysis of the various distinguishing factors between the winners and losers of the 2007 financial crisis. A hierarchical approach to management was found to be one of the defining features of failure. Rigidity and a strict approach to model application is also idealized as being retrogressive. In all, the conclusion posits that big losses are bound to be experienced irrespective of the advancement in the risk management system put in place. Despite this idealization, the credit crisis of 2007/2008 exposed some voids in the risk management systems that could have easily been plugged. Risk Management Lessons from the Credit Crisis contributes a lot towards understanding the essentials of risk management. One major contribution is the importance that it gives risk management. Throughout the article the underlying message is that there is no other way of getting out of risks apart from investing in a powerful and well-structured risk management system. Through this, most of the effects of a risk turning to reality can easily be kept under control. Moreover, by breaking down the various categories of risks and evaluating them in line with the credit crisis, the article gives various perspectives that are essential in improving the current risk management systems. The credit crisis was one of the major financial disasters of our time, and such a detailed evaluation of the lessons we can get from it contributes a lot towards a better understanding of the intrigues that define financial risk management (Hopkin 301). Consequently, its contribution cannot be understated from any perspective. Despite the various considerations that the article makes, there are certain aspects that make it fall short of a full representation of the essentials that define financial risk management. The article is more of a generalization of financial risk management in a society, and does not seem to identify the fact that there are different industries, markets, and numerous other delineations of parties that eventually form a society. A general approach that tries to come up with an analysis for all these different factions tends to be shallow, as there is no real deep evaluation that can take all the elements into consideration (Kristofferson 254). Therefore, as much as the article focuses on ways that we can learn from the credit crisis, the generalization makes it too wide to enable any real adoption into a particular real-life scenario. This is one of the major Achilles heel of the article. Similarly, the lessons have only been tailored for risk managers and regulators, yet there are quite a number of industry players in the financial sector that would have gained quite a lot from it. Though the lessons extend beyond the directly named beneficiaries, a breakdown to cater for the various other industry players would make it much easier to adopt and gain from the lessons. As it exists, the lessons are a mere representation of an analysis, and not readily applicable to the entire financial system. This is true because the article focuses on the credit crisis, and the factors that led to the crisis are well beyond the regulators and risk managers as the article tries to put it. Therefore, as much as we appreciate the identification of numerous ideals from the article, the generalization of the analysis and lessons make it difficult to effectively gain from it. Certain extensions that could be added include a more detailed analysis of the way that the managerial structure delimits financial risk management from the general management of an institution. One of the major shortcomings of financial risk management systems is that they often result in a conflict of interests due to a not-so-well-structured management system (Chew 199). Those involved in financial risk management should not be directly under the larger managerial structure since this hinders their effectiveness. Apart from this exclusion, they need to partner up with other financial risk management systems to result in some sort of global system (Malls 167). This makes it easier to learn from each other and understand the link between the various factions that make up the entire financial system. While this description takes a subtle approach, the underlying fabric of the point is an intricate network of interdependent financial risk management system. Through this approach, the various shortcomings that exist will be reduced, if not eliminated altogether. In all, Risk Management Lessons from the Credit Crisis effectively evaluates the most important aspects of financial risk management in light of the credit crisis. The focus on position-based approach is welcome as it provides an avenue for avoiding the drawbacks of traditional methods. Despite all this, a risk management system is shown not to be able to be completely fool-proof. Nonetheless, a detailed understanding of the various categories of risks can mitigate the effects if effectively integrated into risk models. Works Cited. Malls, Allan. Financial Risk Management. Indianapolis, IN: John Wiley & Sons, 2011. Print. Kristofferson, Peter. Elements of Financial Risk Management. Massachusetts, MA: Academic Press, 2012. Print. Chew, Donald. Corporate Risk Management. Columbia, CO: Columbia University Press, 2013. Print. Jordon, Philippe. “Risk Management Lessons from the Credit Crisis.” European Financial Management, 2009: 1-17. Print. Hopkin, Paul. Fundamentals of Risk Management. Texas, TX: Kegan Page Publishers, 2012. Print. Franke, Michael. Risk Management: Challenge and Opportunity. New York, NY: Springer Science & Business Media, 2005. Print. Read More