Risk Management Processes In Banking Activities Finance Essay - Free Essay Example

Sample details Pages: 6 Words: 1944 Downloads: 5 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? Recent years have witnessed an increasing incidence of significant losses in the banking sector. Many well performing banks have suddenly declared large losses on account of crystallisation of various risks like credit, exposures, assumed interest rate, positions and exposures in derivatives that could have been taken to hedge balance sheet risks (Honohan, 2008, p 15). The subprime crises of 2008 and the subsequent credit, financial and economic crises revealed the importance of the need to adopt carefully planned risk management processes in banking activities (Honohan, 2008, p 15) Banks assumed numerous financial risks in the course of their routine financing and day to day activity. Don’t waste time! Our writers will create an original "Risk Management Processes In Banking Activities Finance Essay" essay for you Create order With risk exposures in the banking industry being extensive and multi-dimensional, the selection and adoption of appropriate risk management processes is a complex and challenging task (Santomero, 1997, p 2). Risk management processes are further compounded by the fact that whilst bankers are aware of various risks involved in their regular financing activities and can take action to reduce or protect some of the activities that are prone to risk, there are some activities where the inherent risk has to be absorbed at the level of the banks (Santomero, 1997, p 2). These include activities where the imbedded risk may be too complex in nature to communicate to third parties (Honohan, 2008, p 15). The second group of activities include proprietary positions that need to be acknowledged and accepted on account of their risks and their expected returns. The credit risk in lending activity is a clear case where risk needs to be absorbed monitored and managed by institutions (Honohan, 2008, p 15). 1.2. Definition of Problem The development of the subprime crises and the following global financial and economic crises has resulted in enormous debate and discussion, the intensification of local and global regulatory activity in the banking sector and the conscious up gradation of risk management processes by various banks. With the memories of the crises continuing to be strong, banking customers continue to be apprehensive about the risk management processes adopted by their banks and the safety of their money in the hands of banks. 1.3. Aims and Objectives The proposed research project aims to examine the various measures adopted by banks to upgrade their risk management systems and processes. The aims and objectives of the proposal are elaborated as follows. To determine the various risks faced by banks in the course of their lending and financing activities. To determine the risk management processes adopted by banks prior to the banking crises of 2008. To examine the new risk management processes adopted by banks in the last two years in order to mitigate risks involved in bank financing activities. To determine the effectiveness of such measures and the extent to which they have improved the risk management processes of bank finance activities. 1.4. Benefits The proposed research project aims to examine an important area in banking activity. Most bank depositors continue to be worried about the safety of their bank deposits and the risk management processes adopted by their banks in the wake of the financial crises. The findings of the research project will throw important light on the actual steps taken by banks to mitigate the risks of their bank financing activities and help bank depositors as well as students of finance and the larger society by revealing the actual improvements in risk management processes and their effectiveness in safeguarding banking operations and depositor wealth. Commercial banks are essentially engaged in the risk business. They assume different types of financial risks in the course of providing financial services to their clients. Market participants use the services of these banks because of their abilities in providing transaction efficiency, funding capability and market knowledge. Acting generally as principals in such transactions, they use their resources to facilitate transactions and absorb risks. Angelopoulos*** Whilst banking firms do engage in activities like underwriting, investment and trust management and packaging, securitising and distribution of loans, which do not have implications for their balance sheets, the substantial majority of their risks stem from on-balance sheet businesses (Santomero, 1997, p 2). The risks that are involved in the basic banking activity of lending and borrowing are not totally borne by banks (Santomero, 1997, p 3). Banking institutions often mitigate or eliminate financial risks that are associated with transactions through the assumption of appropriate business practices or by shifting risks to other parties through appropriate use of pricing and product design methods (Santomero, 1997, p 3). Financial experts state that such risks can be, from the perspectives of bank managements, be segregated into three types: Risks that can be reduced by appropriate business practices. Risks that can be reduced by transfer to other participants. Risks that have to be actively managed at the level of banks (Santomero, 1997, p 3). Banks use a number of practices to avoid or manage risks. These include standardisation of various banking processes to reduce inefficiencies on taking of wrong financial decisions, development of portfolios that are diversified across borrowers and reduce the impact of losses in specific sectors and processes to hold employees accountable for actions that increase the risks faced by banks (Pyle, 1997, p 1-2). Some risks on the other hand are transferred through the use of interest rate products like swaps, alteration in borrowing terms and buying or selling of financial claims to concentrate or diversify risks associated with specific client basis (Pyle, 1997, p 1-2). The risks involved in some activities or classes of assets however need to be absorbed at the bank level. These include activities or assets are too complex to communicate to others or credit risks that are integral to lending activity (Santomero, 1997, p 3). Managements of banking firms rely on various standard activities to manage such inherent risks. These include the establishment of standards and reports. The formulation of position limits, the development of investment strategies and the formulation of compensation and incentive contracts for bank employees (Santomero, 1997, p 4). Each of these processes is complex in nature. The setting of standards for example includes areas like categorisation of risk and formulation of standards for underwriting and review. Standardisation of financial reporting helps in understanding asset quality and risk posture. Position limits restrict risk taking to assets that meet specific quality standards (Santomero, 1997, p 4). Whilst the setting of such limits is an expensive and complex task, it helps in restricting the risks that can be assumed by individual employees and organisations. Investment strategies provide guidelines to bank managers in terms of concentrations in particular market areas, the degree of required exposure to asset-liabilities and the requirement for hedging against risks of particular types. Whilst such strategies help in passive risk avoidance, banks also provide managers with advice and guidance on different types of investment activity (Santomero, 1997, p 4). The risks assumed by banks in their normal financing activities include the following. Angelopoulos Market risk Credit risk Liquidity risk Counterparty risk Operational risk Legal risk Banks by and large adopt the same process of risk management, elaborated above for dealing with these different types of risks (Santomero, 1997, p 4). The aftermath of the financial crises has resulted in intense soul searching by banks and analysis of their risk management processes for each of these different types of risks, the assessme nt of their effectiveness, the analysis of their deficiencies and action to upgrade existing processes in various ways (Santomero, 1997, p 4). 3. Research Methodology The adoption of an appropriate research method is one of the most important components of a research proposal. The choice of an appropriate research method depends primarily upon the nature of the subject and the formulated research questions, as well as the resources and time available with the researcher (Bryman, 2004, p 9). Social research is shaped by two basic epistemologies, namely the positivist approach and the interpretivist approach (Bryman, 2004, p 16). Positivist epistemology is useful for research subjects that can be investigated with the adoption of scientific and quantifiable methods of investigation and analysis. Whilst much of social research, especially in areas of marketing and consumer opinion are conducted with the help of social research, they prove to be inappropriate and inadequate for research subjects that cannot be easily categorised and analysed in scientific and quantitative terms (Bryman, 2004, p 16). With humans essentially being unique and often irrational in their thoughts and actions, much of social research involves subjective issues and topics that are multi-dimensional, multi-layered and can be interpreted in various ways (Bryman, 2004, p 16). Such research subjects are best served by the application of interpretivist epistemologies and associated research methods (Bryman, 2004, p 16). The choice of research epistemology is also by and large causal in the adoption of appropriate research methods. Positivist epistemology is associated with quantitative methods of obtaining and analysing information, even as interpretivist epistemology is associated with qualitative research methods (Creswell, 2006, p 42). Whilst qualitative methods essentially make use of techniques like sampling, questionnaire based surveys and numerical and statistical analysis, qualitative methods involve obtaining information through direct and extensive interviews with respondents and the expert interpretation of the information obtained during such interviews (Creswell, 2006, p 42). Both quantitative and qualitative methods have their own merits and demerits and the skilled and astuteness of the researcher lies in making an appropriate and careful selection (Davies, 2007, p 29). The research subject taken up for investigation, whilst involved with banking, finance and management of risk is essentially too wide and complex to be analysed through purely quantitative means (Davies, 2007, p 29). Risk management processes are basically designed, implemented, assessed and monitored by individuals, who aim to achieve certain risk management objectives (Davies, 2007, p 29). With much of interpretation of various types of risks being influenced by a range of subjective and interpretative issues like economic conditions, risk profiles of specific sectors and profit objectives of individual banks, the research objective of the proposed dissertation will be best served through the adoption of qualitative methods (Davies, 2007, p 2 9). The formulation of research methods also involves the determination of the methods for obtaining information (Babbie, 2007, p 14). Information for research purposes is obtained from primary and secondary sources, secondary sources being the information available in the public domain through writings on the subject by uninvolved third parties and primary information comprising of information obtained directly from respondents involved in the matter under investigation (Babbie, 2007, p 14). With qualitative methods of research being proposed to be used for the dissertation, it is planned to obtain primary information to direct interviews with executives engaged in a risk management processes with three important banks (Cramer, 2003, p 58). Information will be obtained through the conduct of carefully planned interviews with chosen respondents on the risk management processes that were used by these banks before the financial crises, the implementation of new measures, the re asons behind selection of such measures and the impact of the new measures upon existing risk management processes (Cramer, 2003, p 58). Information from these direct interviews will help significantly in answering the previously elaborated research questions. 4. Ethics Care will be taken to adhere to all ethical norms of social research projects, including adherence to the principles of informed consent, absence of coercion, freedom to respond to questions and confidentiality of identity. All respondents shall be informed about the purposes of research. Care shall also be taken to ensure originality of research, acknowledgement of sources and elimination of plagiarism of all kinds. 5. Problems and Limitations The main problems in the conduct of the research project could arise from the availability and selection of appropriate respondents for qualitative interviews. The researcher proposes to use known contracts as well as family and friends to locate and persuade appropriate respondents to participate in direct interviews. Whilst this process could take some time, the researcher is confident of being able to obtain the agreement of appropriate respondents to participate in the research. The research will otherwise of course be limited by the expertise and knowledge of the researcher. 6. Time Plan