Homework Writing Help on Risk Management in Financial Institutions

Risk Management in Financial Institutions

Abstract

The concept of risk management in financial institutions has the potential of improving financial stability and efficiency in financial institutions. While costly, the investment of an institution on risk management strategies is based on the desire to optimize risk adjusted returns. In this study aimed at determining the factors considered by institutions in selecting risk management strategies and the effectiveness of those strategies, a qualitative exploratory study is proposed. The study will be based on primary and secondary data collected through case studies and literature reviews respectively, and analyzed through recursive abstraction.

Risk Management in Financial Institutions

Introduction

Background Information

In the financial services business, risk is imperative and every transaction has some degree of risk associated with it. Banks and other financial institutions have thus been practicing risk management even before their inception. Ignorance of risk management has the potential of resulting in economy-wide losses in the financial sector (Meyer, 2000). The main objectives of risk management in financial institutions include avoidance of losses and optimizing on the risk adjusted profit margins. This means that risk management strategies must focus not only on avoiding risk but also on risk measurement and management in relation to returns as well as to capital. In order to achieve this, most financial institutions tend to avoid investments with potentially high returns as well as high risk potentials. By optimizing the risk adjusted returns and focusing on capital, risk management strategies have the potential of improving the economy. This is through improved efficiency by the effective allocation of both financial and real resources to their favorable use (Carey & Stulz, 2005).

The types of risks prevalent in financial institutions include credit risk, liquidity risk, market risk, operational risk, strategic risks and compliance risks. While risk management is not free in financial institutions and may even be said to be very costly, its delay or avoidance can result in extreme losses that may even lead to the collapse of a financial institution (DBS, 2010). The aim of the proposed research paper is to evaluate various risk management strategies in financial institutions, and to find their effectiveness in risk management.

Problem Statement

Risk management is an integral part of the management of financial institutions. This concept involves several strategies that are as diverse as the risks in the financial institutions. Due to the existence of several risk management strategies, the question therefore arises as to what strategies may be applicable to what types of risk management and how efficient the strategies are in their related roles. The problem to be addressed in this paper is the relevance of various strategies of risk management and their effectiveness.

Justification of the study

While there are many studies that discuss general risk management issues in financial institutions, studies addressing specific risk management strategies that are applied in cushioning against impacts of specific risks in the financial institutions are limited. Existent research studies focus on wide aspects of risk management in financial institutions, while most of them direct their focus on the need for risk management. Consequently, there is a knowledge gap with respect to the effectiveness of various strategies of risk management. This paper seeks to address the issues surrounding specific risk management strategies in financial institutions and to compare the strategies in terms of their effectiveness. This will help in expanding the dearth of knowledge available in the field of financial management with respect to risk management in the institutions. In addition to this, the study will also address the factors that are considered in the choice of risk management strategies and how these factors play the role of increasing or reducing the effectiveness of the risk management strategies.

Research Objectives

In order to achieve the specific purpose of the research paper, which is to evaluate the existent risk management strategies and to determine their effectiveness, the specific objectives that this paper seeks to address include:

To find out the factors considered by financial institutions in narrowing down on risk management strategies

To determine some of the risk management strategies in use by contemporary financial institutions

To determine how effective the strategies in use are and to compare them with each other to find the best risk management strategies

Research Questions and Hypotheses

In order to efficiently achieve the stated research objectives, the study will be guided by the following research questions.

What are the factors considered by most financial institutions in settling on risk management strategies?

What are some of the risk management strategies that financial institutions use in the contemporary times, and how effective is each of these strategies?

Which risk management strategy is the most effective among the studied ones?

The study will be aimed at answering these research questions under the guidance of the hypotheses that the economic conditions of a country and the magnitude of risk form the greatest factors that are considered prior to settling on a risk management strategy. Secondly, it is also hypothesized that risk management strategies are varied, dependent on the type of risk in question and that no single strategy can be concluded to be most effective.

Definition of Terms

In carrying out this study, the important terms that must be understood include:

Risk – Risk in a financial institution should be taken to mean an event that has the potential of causing harm if not well managed. With respect to financial institutions, the harm is of economic nature such as a loss incurred by the institution (DBS, 2010).

Risk management – this refers to the evaluation, and control of risks and/ or prevention of harm that could result from the risk. In the financial sector, risk management aims at cushioning financial institutions against losses arising from various risks (DBS, 2010).

Financial institutions – organizations that engage in finance based businesses such as banks, and micro-finance institutions.

Assumptions and Limitations of the Study

In carrying out this study, it is assumed that financial institutions see the need to lay down risk management strategies and that risk management strategies are significantly costly and thus should not be fallible. The major limitation to this study is that it is carried out on a narrow scope. The information it provides therefore simply opens up an avenue for future studies to engage in expanding the knowledge related to improving efficiencies of risk management strategies.

Literature Review

According to Carey and Stulz (2005), risk management goes hand in hand with risk transparency. As a matter of fact, the authors suggest that risk management enhances risk transparency as well laid down risk management strategies ensure that the particular financial institution is attractive to potential clients. By virtue of risk transparency, the institutions can give a clear picture of what one is getting into by engaging the financial institution. The process of risk management is mentioned by the authors as being driven by regulators who prod the institutions towards transparency. While Carey & Stulz agree that risk management is good for financial institutions’ growth, they also highlight the relevance of risk management to the growth of the national financial sector. They suggest that risk management, being a machinery for the growth of both financial institutions and the financial sector as a whole, should neither be defied nor feared.

While acknowledging the importance of risk management to the success of financial institutions, Meyer (2000) also reports that in order for financial institutions to take the aspect of risk seriously and thus to manage it effectively, it is necessary for certain pre-conditions to exist. One of the preconditions is that the government must not offer cushioning support for financial institutions. Secondly, Meyer suggests that there must also be effective supervision as well as a lack of direct lending by the government. The prerequisites to laying down structures for institutional risk management include the limitation of the potential for a conflict of interest in the evaluation and measurement of risk, and solid accountability within the financial institutions (Meyer, 2000).

The Directorate of Banking Supervision outlines several issues surrounding risk management in financial institutions. Some of the issues tackled include the various types of risks that are prevalent in the financial institutions and various frameworks for the management of different types of risks. The literature provides a clear guideline on how to go about planning for the management of various types of risks. The specific types of risks in financial institutions are mentioned as credit risk, liquidity risk, market risk, operational risk and compliance risk. Each of these risks has a particular framework explained by the author of this material (DBS, 2010).

Boateng et al (2014), while focusing on micro-finance institutions in Ghana, explain the importance of fraud risk management in ensuring financial sustainability, survival and self-sufficiency. Each of these outcomes is only based on effective risk management strategies. Bank frauds are said to be a serious threat to institutional growth and that they have the potential of leading to bank distress. Consequently, the need for effective risk management strategies is outlined. The impacts of fraud in the banking sector are mentioned as a reduced public confidence in the banking system, and revenue losses, which may result in insolvency. The authors further assert that the financial institutions’ lack of immunity to fraud makes it imperative to invest in risk management strategies no matter how costly it may seem (Boateng et al, 2014).

Oldfield and Santomero (1997) are of the view that financial institutions have the choice of either transferring risks to the clients or absorbing the risks. However, they also agree that risk absorption require well laid down strategies for the management of risks. In support of their arguments, the authors outline the role of the financial institutions in the economy as being the improvement of the financial markets. This role however, cannot be achieved effectively with poorly laid down risk management strategies.

While these papers discuss the pertinent issues in the concept of risk management in financial institutions, they and other studies also affirm that there is still need for future research to expand the knowledge in the field of risk management. For instance, Meyer (2000) recognizes that there is need to apply more sophisticated risk management strategies in financial institutions. In order to be acquiesced to these new sophisticated strategies, research must be carried out in order to determine the effectiveness of various strategies that can be applied potentially.

Carey and Stulz (2005) also highlight the need for further research into risk measurement strategies. According to these authors, the effectiveness of a risk management strategy depends on its applicability based on the magnitude of risk at hand. The magnitude of risk can only be effectively determined by efficient risk measurement strategies (Carey & Stulz, 2005).

Boateng et al also suggest that more research should be done in the area regarding the institution of better fraud management strategies in micro finance institutions, and offering individualized risk management strategies. According to Boateng et al, these factors form the basis of the application of the recommended risk management strategies given by the authors, which are based on innovative management practices such as forensic accounting and the provision of the whistle blower act (Boateng et al, 2014). In addition to the use of these innovative strategies, Carey and Stulz also suggest the importance of risk awareness to effective planning for risk management. Oldfield and Santomero also pose a subject for study. According to these authors, it is necessary for institutions to be aware of their risk-return trade-offs in order effectively manage risks.

Research Methodology

The research proposed will be carried out from a qualitative perspective. The choice of research method is based on the type of information that is expected to be given by the study. In addition to this, the research questions also require theoretical responses hence the choice of the research method. Qualitative research is the best method for this study since it gives the opportunity for study to focus on specific theoretical information (Chenail, 2012).

Research Design

The research to be carried out is an exploratory study as it focuses on questions regarding factors (Chenail, 2012). It seeks to answer questions that deal with what rather than how and why. This makes an explorative design effective since it enables digging in depth into information that relates to the subject matter of study.

Investigation Steps

In the study, the steps that will be undertaken include data collection, data analysis, and reporting. The data collection process, both primary and secondary data will be collected as relates to the subject of study. The primary data will be collected through case studies of selected financial institutions to determine the effectiveness of various risk management strategies. Secondary data will be collected through content based literature reviews. The data analysis process will be aimed at making sense of the collected data and summarizing the results for presentation. Reporting will be by the production of a print report of the research study.

Population, Subject and Sample Selection

Five financial institutions will be selected on which to base the case studies. Different strategies used by these institutions will be taken into consideration, evaluated and reported on. In selecting the financial institutions for study, it will be necessary to consider the financial pasts of the institutions, selecting 3 institutions that have experienced financial challenges in the past and two that have had smooth operations throughout.

Data Collection

Primary data will be collected by engaging in case studies of 5 financial institutions with differing pasts. The aim of this is to ascertain the importance of risk management in financial institutions and the strategies that have been applied in the past. The case studies will be accomplished by looking at past institutional records and obtaining data from them. On the other hand, secondary data from relevant literature will be obtained to support theoretical concepts. In choosing the literature the content will be taken into consideration, narrowing down to the most relevant to the subject matter.

Ethical Issues

The major ethical issue that will be encountered in the research will be based on representation of institutional data. It will be necessary to refrain from disclosing confidential data as relates to current risk preparedness and management. Disclosure of such data has the potential of destroying the institution’s public image and reducing the customer confidence in the institution. The researcher will therefore try by all means to disclose only information pertinent to this research and favorable to the institution.

Measurement of Outcome

The effectiveness of the research study will be measured by its ability to answer all the research questions. It is hoped that this will help yield a good measure of the desired outcome, which is to provide additional information on the concept of risk management in financial institutions.

Data Analysis

After the data collection, the process of recursive abstraction will be used to analyze the data. In this process, the data is summarized iteratively until the most basic information that directly answers the research questions is obtained (Chenail, 2012).

References

Boateng, A., Boateng, G., & Acquah, H. (2014). A Literature Review of Fraud Risk Management in Micro Finance Institutions in Ghana. Research Journal of Finance and Accounting. Vol 5, No. 11.

Carey, M. & Stulz, R. (2005). The Risks of Financial Institutions. Working Paper Series, No. 11442.

Chenail, R. (2012). Conducting Qualitative Data Analysis: Qualitative Data Analysis as a Metaphoric Process. The Qualitative Report, Vol 17, (1): 248-253.

Directorate of Banking Supervision DBS (2010). Risk Management Guidelines for Banks and Financial Institutions, 2010. Bank of Tanzania.

Meyer, L. (2000). Why Risk Management is Important in Financial Institutions. BIS Review, Vol. 68.

Oldfield, G. & Santomero, A. (1997). The Place of Risk Management in Financial Institutions. Financial Institutions Center.

Word Count: 2395 (Excluding Abstract and References)