Risk Management Theory in Financial Institutions Finance Essay

Risk infers the opportunity that something is going wrong that is the current and most common view. The Stanford Encyclopaedia of Philosophy 2007 explains risk as a negative role and unnecessary event. Risk is a totally chance or can be managed is an individual response. The last position is dealing to take by the management researchers. The argues on this view that we cannot eliminate risk at least we can expect it at anytime, and to decrease its impact we may put it in place processes. Insincere behaviour, financial loss, safety violations, are the important consequences of poor risk management. Researchers have established that poor control on internal issues, not sufficient government rules and regulations, and misalignment of firm incentives are to responsible (Marshall et al., 1996). Basically the process of knowing what risk actually is, the consequences or the outcomes or predicting the possibility and the outcomes of that risk, deciding what path to follow either to take risk or to either to avoid, and in last either to develop and apply strategies in responding the risk (De Zoysa and Russell, 2003). Risk management became a main concern of both organizations or businesses and government as it puts risk management on all managers due to the September 11 attacks, Enron, World Com, and the troubles in financial markets due to recent dealings (Springer, Christine Gibbs, 2009) The significant change in Banking around the world is a very clear evident from the changes that have been occurred in the financial institutions, markets and products. To argument on revenues deregulation has opened a new vista for banks; it has a greater struggle and therefore will have greater risk. To remain reasonable in the globalized environment, entry of newly developed products, cross border flows and mainly copied instruments have a significant impact on the local or domestic banking sector which drive them to correct the product mix, as it also effect there processes and operations. Consumers are highly encouraged because of these developments, they have greater choices and now they have become more intelligent and demanding forceful banks to offer wider range products through different distribution channels. The defining attributes of banks and other financial intermediaries has emerged as risk management. Now a day's globalization is the most important issue of shaping the world. The benefits of globalization are being increasingly popular and very well known. Communication and information technologies have been facilitated by wonderful advancement because of the inclusion of domestic and international markets. But such combination meant that a problem in one country will also have negative impact on one of more countries even if they are strong. The development of an efficient financial system plays a very important role in raising countries out of their low level of stability trap and this development reforms the financial sector. According to 2002 annual report of World Bank it has been observe that 'for reduction of poverty, growth and for a sound investment environment a healthy financial system is a condition. The operational atmospheres have undergone a huge change bringing to for the significant importance of controlling an entire variety of financial risks. Higher the risk the more return will you get. The meaning of risk is for different people there are different things. For some of them it is financial (interest call money rates, exchange rates), the merger and acquisition among the competitors around the world to form more powerful entities and not the leveraging IT optimally and for some it is a commitment or event which has the power to create more business liability or damaging brand image. By taking risk it does meant that u will get forth benefits as well since risk is accepted as a trade off between return and danger in business. In other words it is essential to agree to risks, if the need is to get together the expected benefits. There are so many risks which are faced in the quickly increasing world of business and the investors must be careful about them in enlarging its operations. As risk is a factor which is constantly found in making business decisions and fixing suitable ways to handle and to make less intense risks is an important part to the farthest achievement of any original investment or enlargement of an already present business process. (Alan et al 2004) As the risks have constantly being a part of economic progress, the year 1990's has seen risk management becoming an critical business purpose in the banks and some other financial institutions. The reasons, why did it become so important , were the heavy losses which the worldwide companies suffered from during the 1990's as it gave a heavy blow to the economic institutions and made them stress on risk management and to have some check and balance. However, the union of the companies and industry globalization, difficulty and the rapidly increasing request of customers were already directing to an immense/informal emphasis on to make certain that those losses did not occur due to harsh market situations, contracts failures or unsuitable and indecent controls, system or persons. These factors focussed the attention to increase the value of rules and regulations and banking and monetary institutions have got to fix fast to the principles of banking law pleaded by the Basel Capital Accord. They must increase the strength of covered controls, raise the act of useful, and open financial information and make sure the use of inspection, this is all not to sustain the healthy process of the banking and economic markets. What is included in this is, to establish the identity and to determine the quantity of several risks in advance, and to set up and to take out effective n striking risk management. Wipple said that taking risk is the heart of the business investment bank. He further said that the regulations and administration will slow down the financial system of United Kingdom. (Euro week 2009). PA consulting group pointed out after a fresh survey from 100 different banks that while the banks have the tools for the effective risk for most of the parts. To support the full variety of their business decisions they are not using those tools. According to the Dyfed Bowen, of the PA consulting Group, says while investing in risk management system that is the requirement to think regarding the business settlements and not the obedience issues. To get the benefits from the Basel LI And other controlling demands, into a positive net profit banks must change the cost of agreement. (Financial times 2002) And that's why banks need to be acting in companionship with that, as the implementation deadline is still not ended and it is up to 2006. Data ware house- type risk is the main way to meet up with these requirements, will help in providing large picture exposure of a project. Assessing operational risk can also be helped through data ware house as long as an understanding of the connection between banks and clients and the amazing activity of traders. (Financial times 2002)

Industrial background

Banking Sector:

There are a number of risks which banking process is a subject of; it includes credit, market and the risk that arises from the difficulty of selling an asset. It is an important part of their risk management that banks need to conduct and to determine the quantity of these risks on a frequent basis, carry on with the same capital and liquidity buffers that are enough to secure them against huge and negative shocks. There are many systematic tools which have been introducer to look at these risks in division, especially for credit and market risk. At all events, there is no joined economic capital model which unites risks in a sound and firm fashion. That is why, banks examine the risks separately, decode total economic capital by some already existing and fixed rules. To calculate, the risk specific buffers, is a common rule, and then just adding them up to calculate a bank's total capital. The world and United Kingdom economy is keep on benefiting from a stable time of fixed development. In the beginning of 2004 and over the last few years a strong financial performance is produced by the banks which are benefited from the economic health. There are no signs in the failing of asset quality and the banks are remaining strong capitalized. But as always the downside risk or drawbacks to the macroeconomics are always there. (Kari Hale 2004) Combination of risks, evaluation of management, analysis and some degree of risk involves in all banking activities. In Credit risk there are some more risks including cross border risk, operational risk, market risk and liquidity risk is the most important risk. Equity price risks, interest rate risks and foreign exchange risks are including in market risk. Oil and Gas sector: Risk management is of principal magnitude to the economic penalty of reserves in oil and gas industry where such reserves can go beyond US$1 billion, and several years to complete. It is due to the outmost statistical measure of the amount of fluctuation in a stock's price within a period of energy entity prices it has been considered for long enough that business performed in the petroleum, natural gas, and electricity industries are certainly easy to be affected to market prices risks and other commercial risks and the political risk management in the energy industry plays a rapidly increasing significant role since the world's oil and gas production plan is directly connected to the geopolitical position of reserves.

Airline Sector:

Due to recession around the world the time is not favourable for the Airline industry. The Airline industry is facing the worst situation as ever and it is really not easy to fight with this situation. There is a statement which shows very clearly the importance of the situation, and the statement is that the airline industry is just hardly living by keeping their head above the water. There is a lot decline in the airline flights. There is a lot decrease in the number of passengers this year. The worst has yet to come if there is a consideration of the analysis. In next few years the situation for airline industry will become more tense and worst if the same global economic recession never ended. This condition merely belongs to many factors like, the major factor considered for the fall of airline industry is that, because of the world recession there is a hike in fuel prices. The fuel prices and the recession worldwide play a vital role in the current situation of airline industry.

Managing Risk:

The assessment of complex must not be done through instinct. Sometimes we make detailed models when system gets difficult. It seems very doubtful when somebody quantify risk management. Some shortcuts were in fact measured right. But whatever the drawback of quantitative model may be, the drawbacks of unaided instinct are greater. The incentives must be associated. If one party is harm by risk then they can do assess that risk. When the public has somewhat at risk then there will be hand of regulators in modelling risk. The final risk is faulty risk management and if it is missed by the regulators, then they will fail again in addressing the issue.

(Douglas Hubbard)

Risk can be managed in many different ways.

Hedging:

A boldly handled fixed interest securities of investments that uses progressed and developed investment planning such as Positional advantage; power to act effectively, long, short and derivative positions in both national and international markets with the aim of producing high returns either in a complete sense or over a specified market benchmark. In a legal manner, hedge funds are very often set up as private investment partnership that are open for a less number of investors are demand a very large first minimum investment. Investment in hedge funds are illiquid as they often need investors keep their money in the funds at least for the period of year.

Insurance:

A promise of compensation for specific potential future losses: in exchange for a periodic payment. Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. Some forms of insurance are required by law, while others are optional. Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event. In most cases, the policy holder pays part of the loss (called the deductible), and the insurer pays the rest. Examples include car insurance, health insurance, disability insurance, life insurance, and business insurance.

Diversification:

The mean of diversification is to expand the business activities into many other fields, or to allocate funds in order to standard the risk of failure. In financial crisis diversification is used especially to reduce the risk involve in businesses. The expansion of making new goods and services and sell it to the existing or new consumers bases is very much risky, but by handling well it can change a business.

Aim:

The aim of this report is basically to examine the theory and practice of risk management, not just in high opinion of British banks but as well in other business sectors and in geographic area all over the world.

Research question:

Research question is to find out what is the role of risk management in financial sector during the financial crunch?

Hypothesis:

Ho: Risk management can save financial institution in financial crunch. H1: Risk management can not save financial institution in financial crunch.

Objective of Risk Management:

The most important goal of risk management is to secure the property, wages and the body of persons employed by or active in an organization, business, or service of the organization against damages and responsibility that legally binds an individual or company to settle a balance due that may happen due to several risks. Two different main points come out while explaining the objectives of risk management The first main point is about managing risk, increasing the productivity and creating more opportunities out of the risks. And the second most important point is regarding minimizing risk or loss and the protection of mutual assets. An organization management needs to decide on the purpose either they want to manage or shrink risk management functions. Taking educated management decisions on opportunities, outstanding the right balance between risks and controls and pressure facing by an organization is basically all about managing risk. Both the situations for example more or less controlling risks are mainly unwanted as the previous means high costs and the final means prospective risk exposure. The principal function of the risk management in the changed plans is that it is restraints not only the pure risks but also enlarge out the services to observe and control the risks of all types which arise from a business. Minimizing or explanatory of risk management means that the justifying of all risks even if there is an excess in the cost of minimizing risk and outweighs the cost benefit analysis. Furthermore it may mean that opportunities are not effectively broken. Recognition and management of risk is more famous for the financial services as compare to the consumer products industry where it is less recognized as in the context of risk management functions. What are risk management functions and what are its primary objectives? Accordance with the global survey conducted almost 35% of the respondents stated that risk management function is basically use to optimize risk. In the context of the risk management function, identification and management of Risk is more prominent for the financial services sector and less so for consumer products business. What are the primary objectives of your risk management function? When specifically asked respondents stated that their risk management function is to be sure clearly mandated to optimise risk. (Damith Kasagala 2008)

Research Methodology:

Classify experiential Research:

In any study movement, the researchers plan is to locate out wonderful about wonderful. This can be completed in diverse ways; single method, generally worn in HCI, is experimental research. Experiential research is characterising by the declaration that data or theory that is plagiaristic from it is here at as a product of explanation or research. (Robson, 2002) write down that experimental research 'absorb a systematic examination of an understanding which have to be equally unconvinced and ethical.' (Cresswell, 2005) identifies the break up progression that makes up experimental research to be alive Classification of a research problem Review of the active literature Specification of a reason Collection of facts Analysis and motivation of data Exposure on and evaluating data Normally a study crisis is formulated in a very common method and then the beneficiary recognize dissimilar reason that read out how the following data collect will acquire place and how it resolve be evaluate. In a number of examples, the beneficiary has an idea that he needs to check out; in previous belongings the researcher has experimental an experience that he wishes to extend a supposition about. These two advances are occasionally referred to as normative along with non-normative or deductive and inductive. It is ordinary to equal these come close to to two study styles, these organism quantitative study and qualitative study (Cohen and Manion, 1994).

Quantitative Research:

The broad procedure in quantitative research is to investigation a supposition by recounting self-governing variables to needy variables in a secured situation. Review and trial are usually old for quantitative learning

Qualitative Research:

It is commonly thought (wrongly) with the aim of qualitative research is any research that does not contain numbers! This is not a good explanation as it is the move near to the facts convenes that is transformed in the two styles of research slightly than the outputs. Qualitative research aims to discover, determine, understand or explain phenomena that have already been famous but are not well understand. The outfit that are second-hand used for qualitative research embrace explanation and interviews and the mechanical device is justification. In this kind of research, theories are frequently 'grounded' in data and ethnographic and storyline methods are used to help in the analysis and understanding of shared relations and phenomena. As the objectives of my research is essentially to inspect the theory and practice of risk management, not just in high attitude of British banks but as well in other business sectors and in geographic area all over the globe, So for that there are two main research methods.

Primary data

Secondary data

Primary data

Sources of in rank are usually categorised as prime, lesser or tertiary depending lying on their freshness and their closeness to the resource or beginning. For example, systematic information moves through a propagation cycle. Firstly, conclusion might be communicated easily by email, and then offered at meetings before being officially available as a primary source. Once available, they will then be indexed in bibliographic record, and repackaged and comment upon by others in less significant (secondary) sources. The description of primary, secondary and tertiary change between disciplines or subjects mainly between what can typically be clear as the knowledge and the humanities. Prime (primary) sources for censor studying the narrative of the Second humanity War are diverse from individuals for a examine scientist investigate new pills for arthritis. The critic's primary sources are the verse, stories, and movies of the time. The study scientist's primary sources are the grades of laboratory check and the medicinal records of enduring treated with the pills. You must at all times check with your coach or tutor if in hesitation. And there is some main kind of primary data which includes explanation, surveys, interviews, personal approaches, letters, handset, computer, private etc.

Secondary data

Secondary Data is presented in sequence that has been gathered for some principle Outside the development process. Obtaining Secondary Data in perform generally capital 'Desk' or 'library' research. Information can be obtained from the data that is usually composed by the planning institute or from outside sources. External data are gathered by other organizations moreover for their own use or for business use. Universal sources of unimportant data are, for example, various automated databases, relatives, other government agencies and different available sources such as Libraries and newspapers. A computerized record can provide information on an open series of topics, and lists of marketable databases are generally available in community libraries. Librarians can also be priceless in the search for definite information for development. Among the potentially useful data provided by management agencies are demographic facts, service data and individual reports on industries. Other examples of secondary data are past information and survey data. Relations may have expensive information about management or common aspects. To estimate the importance of information for the development process it is vital to know how and why the information was shaped.

Resources and requirements

•Skills

•apparatus

•Time

•Books

•Training

The research method I am using for my research is primary and secondary data research. The research question shows that I have to write my report mainly on banking sector but I will also explain about other sectors like oil and gas and air line. I have chosen these sectors because a country economy is mainly dependant upon banking and oil and gas, air line sectors also play a vital role in country economy. The aim of this research is to study about the role of risk management in financial institutions and that's why it has relationship with research objectives, research methodology. Because in research objectives we have to look about the role of risk management in different business sector and the data which will be collected for the research are both primary and secondary.

Timescale:

The maximum time required for this project is up to three months. Collection of data up to Twenty days Five days for Introduction Ten days for literature review Ten days for Analysis and discussion. All other tasks up to one month.

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