Financial Institutions .
THE FUTURE OF RISK MANAGEMENT IN FINANCIAL INSTITUTIONS
Instructions:
Research topic: Risk management in financial institutions in USA
Paper Outline
1.Introduction/background- 1 Page, Historical/recent information leading to research, specify objectives and scope of study
2. Source of data/methodology- 1 page, mention type of data used (primary or secondary), name a few sources (should be in reference section); Quantitative or qualitative data?
3. Findings- 8 pages, include relevant content only, describing them as you go along
4.Conclusion: 1 page,, summarising research findings and concluding remarks
5. References (if applicable Appendix)
Solution.
THE FUTURE OF RISK MANAGEMENT IN FINANCIAL INSTITUTIONS
Introduction
The financial industries are currently facing a significant challenge in creating reasonable value for the financial business that acts a hedge for developing economic uncertainties. The need for accurate and efficient planning that looks at the future of financial institution is crucial for the current market. The emerging difficulties pose a threat to many businesses. As such, innovative measures in maintaining the business while assessing factors that mitigate risks in financial institutions are inevitable. Every business today is increasingly facing stiff competition. The market cannot ignore the results of the drastically changing needs of the consumers. It is these factors that bring every global business to the same competitive platform that will require business acumen to survive.
Competition in the banking industry is a factor choked by a myriad of regulations presented in a non-exhaustive list of regulatory requirements (Ferguson & Laster 2007). Some of the rules include restrictions on pricing regarding interest rate, fees and price controls. Also, there are some new branch exit and entry restrictions. Ownership and line of business restrictions are also common regulations in financial institutions. As such, even though the financial institutions are unique regarding the nature of the business they represent, there is a need for the agencies to find a way in entangling itself from factors that stifle growth, development and uniform standards of competition with other business (Keeler 2009). This study examines how financial institutions in the United States can maximize their potential in the market to stay competitive and relevant to the future market. The study will highlight factors such as competition, institution efficiencies including other factors that act as determinant measures to maintaining the stability of the establishment in the existing and future markets.
Background
The commercial institutions in the Central and Eastern regions experience major commercial crises in the 1990s. Since then the economies have faced a threat from external shocks and the factor of institutional liberalization of commercial remodeling. Most confirmed studies critically analyze the Asian and South American situations of banking crises to find the actual issues that can explain the underlying matters that occasioned the problems. In many instances, the researchers tend to look at the issue based on the factors that affect the transitional process of the financial institutions. Studies on efficiencies of the system indicate that the financial institutions have are not close to achieving their maximum potential in serving the market (Semih & Philippatos, 2007).
The financial institution is the Central, and Eastern countries were examined to have multiple issues, they approached the market from a state bank that based on direct lending. The institutions were later pushed by circumstances in the industry to change to risk-based organizations that mainly exposed banks to the competitive environments. This factor caused the banking institutions and its management to quickly acquire the business expertise that was appropriate for survival in a competitive environment. After several years, due to the market forces, the institutions were rendered uncompetitive based on their current activities (Wallace, 2008).
There was an evident contraction in the economy after the banks revealed the strong nature of the non-performing loans. The current market faces drastic changes in the new regime of a competitive market. There is the need to analyze and introduce solutions that will assist in detecting problems and offering the necessary solutions. The institutions need the authorities to be prepared to help the system proactively prepare for the problems. Also, the banks require methods and concepts that will prepare them to counter the overwhelming nature of macroeconomic pressures and emerging customer needs (Akkizidis & Stagars 2016). Further, the experience that will ensure that the institutions have the appropriate experience to exists against the forces of the increasing number of new entrants that usually pose threats regarding external shocks.
Objective of Study
The objectives of the study include:
1. To examine the need and importance of studying signals of vulnerability in the financial industry.
2. To study the duty of financial sector regulations and their factor in providing appropriate commercial regulations that will help the financial institutions cope with existing and future challenges in the industry.
3. To study the need of having a proper measure of efficiency in the financial institution to ensure that the institutions are aware of their potential in the industry
4. To study the need of having a competitive business perspective for the progress of the financial institutions.
Scope of Study
This present research was focused on examining the future of risk management in financial institutions about the financial institutions in the United States. The study mainly highlights the banking institutions. The structure will primarily consider different ways in which the banking institutions can enhance the institutions towards growth and survival in future markets.
Source of Data and Methodology
This current study is based on both empirical and descriptive data. The primary and secondary information assisted in the analysis. The existing and expected future structure of the financial institution in United States will be assessed using the secondary data collected from published sources which include academic books, journals and peer-reviewed e-books. The Books used included John Hull, the fundamental of futures and options, Great Britain, the future regulations on derivatives and Semih and Phillipatos on efficiency of the banking industry.
The primary data was collected by the process of semi-structured interviews. The scheduled questions comprised of information concerning market challenges, influence and power of competition, customer emerging needs versus the structure of the financial industry, credit repayment and predictions of the future market structure.
Following the results of the financial crisis, persistent need for banking institutions dealing with the real-time economy is on the rise. Moreover, due to the occurrences, the banking institution is now more than ever faced with strict rules. These factors called for the need to access qualitative data which composed of banking inspector information, the internal governance, the existing and future risks in interest rates and the assessment of inefficiencies in the process of running a financial institution (Fraser & Simkins 2010).
Findings
The research paper shows that financial institutions are faced with the need to explore and demonstrate how the systems can enhance its potential to counter the challenges of the future market. Also, the study reviewed improvement needed and factors that the institutions may consider as activities that can be promoted to increase investments in order of the consumers to participate in contributing to the growth of the market.
Efficiency in Financial Institutions
Efficiency in financial institutions assists in realizing the potential of the institution regarding profit making. This element enhances the capabilities of the institution in meeting the future economic challenges. It is evident that many research findings agree that inefficiencies in financial institutions are significantly large. The results indicate that the banking industry has not optimized its potential.
The analysis in the sector shows that certain methods of measuring the efficiency in financial institutions may face challenges by the vast difference in the management and the structure of the institutions. The cost concept helps to determine the measure of the current position of the institution in relations to the best practice available in the market and the factor of optimizing the maximum potential in a financial institution that has exposure to similar conditions.
The standard profit measure of efficiency focuses on measuring the banks potential of making profits when provided with a specific ratio of price output and input costs. The alternative profit efficiency measured the closeness of a bank in maximizing the potential in its profit focusing on the degree of production compared to an emphasis on the output prices. The alternative benefits are primarily derived by measuring the customer’s willingness in paying for services targeted at making a financial institution unique compared to others due to the competition in the industry (Semih & Philippatos, 2007).
The findings of the research concluded that the three measures are determinants of performance. As such, using the three economic measures, the future financial institution may use the actions to determine the performance of the financial institution to establish how close or distant they are in achieving their profit potential in the financial industry.
Foreign Entry and Domestic Profits
Confirmed studies show that the entry of a foreign bank may be representation by an outlined graph indicating a significant of a U-Curve. This development suggests that the market may have a high or a low effect on domestic investments. The presence of foreign banks can play a significant role in promotion the local banking activities if the financial institution is considered to have a drastic expansion as well as contributing to a larger share of the domestic financial activities (Lensink & Murinde, 2006).
Signals of Financial Institutions Vulnerability
Macroeconomics as a variable offers original signals compared to economic variables. Problematic loans are a consideration of vital signs that the financial institution is in extreme distress. Moreover, the cost-income ratios are clear indicators that inefficiencies in the banking industries have a detrimental impact on the soundness of the bank.
The regulation of the banks is vital, being that the concerns are mainly raised questioning the ability of the creditors in monitoring signals that indicate risks on the factor of lending which may threaten the stability of the banking system. The advantage of regulations is that in their formal way they can assist the institution in realizing their outcomes in times of crisis. It is these rules that will help to make decisions such as to bail out insolvent banks or maintain acknowledged state ownership.
Competition
The advantage of competition is that the financial institutions will be able to find out their potential in withstanding the emerging and developing markets. Confirmed studies highlight that competitions may act as tools used to liberalize the financial institution. The competitive environment faces various elements of limitations: most of the rules are structured as enforcement practices, and they tend to stifle the competitive nature of the financial industry (Gambacorta & van Rixtel 2013). The restrictions restrict aspects such as ownership, entry and exit.
The banks would consider a competitive market to be a market that has integrated financial institutions with an international establishment. This way the banks will have a potential platform that ensures that there is regulated information to alert banks of the debt exposure promptly (Boot & Ratnovski 2012).
The developing markets will require a proper legal environment for the financial institution to ensure that they minimize the risk and maintain a competitive market that is also consistent. This way the institutions will be assisted to reduce the risks by aggregate liability lending.
The Derivatives Markets and Future Regulations
The derivatives have gathered a negative publicity due to their association with the recession in the American financial system. Findings indicate the increased regulations can assist in mitigating the risk factor of the derivatives. As such, there is a vast difference between over the counter derivatives and the traded derivatives. The actual difference is in the regulations, the over the counter derivatives are less regulated regarding having a structured legal framework. Hence pose a danger in attracting the risks of non-performance of contractual demands (Biggar and Heimler 2005) statute purely defines the exchange traded derivatives. The involvement of the Companies Act 1985 Part VII helps to identify the contracts. Also, the participation of the FSMA 2000 assists in planning for outlined investment exchange including a defined clearing house. Hence, the overall structure is not to allow clients to access the process of transfer directly but regulate under the contractual framework which collectively agrees within the confines of the financial institution. The four types of derivatives including the futures contracts, single and multi-period options, forward contracts and swaps are financial fundamental elements that when appropriately used will hedge speculation, threatening risk and arbitrage markets (Hull 2006).
The market rules assist in eliminating the risks related to bilateral contracts so that it is not associated with the contracts recognized on the exchange. The rules also support mutualization of market threats. Also, the regulations assist in separating the client’s position and the client’s collateral to ensure that the management is on different platforms (Barth, Lin, Ma, Seade, & Song 2013). Once the regulations are adopted, the client will be protected, from the exposure of risks in the market which will act as a hedge or investment. The market rules also provide an aspect of segregation which creates operational risks. These financial risks may work adversely to the financial institutions if not activated at the right time. The clients may be able to trace claims and request for compensation (Koenig 2006).
The provisions and regulations that will assist in reducing the risks associated with derivatives markets to formulate a structured future of financial markets will include: Legislations that ensures preference on derivative rules where applicable. Segregation f client’s margin should be structured to be enforceable. The European Union needs to conduct reforms that will align the contractual arrangements in the financial institutions relating to the clients (Thorogood, Reynolds & Yetton, 2010)
Research findings indicate that derivatives that are not efficient will not affect the economic needs of related derivatives. However, the effect will cause the derivative counterparts to seek for the most effective regime that will lead them to their objectives (Great Britain, 2010).
Risk Management and Interest Rate Hedging
The study by Rampini and Viswanathan (2015) revealed the significant correlation between net worth and interest rate hedging. The financial institutions that terms as better capitalized were examined to hedge more. A reduction in net worth will cause a drastic reduction in hedging. Further, most of the financial institutions are known to substitute the concept of financial hedging to operational risk management. Risk management is not limited by financial constraints rather; limited interest rates expose financial institutions to drastic changes in the interest rates which eventually signify the role played by the monetary macro-environmental elements attached to policies (Pathak 2011).
To achieve prospects the financial institutions need to begin transforming the frameworks that will include the risk functions by engaging initiatives that will cause the immediate impact. When the financial institutions approach another decade the financial planners are predicting a dramatic difference in risk management. The banks will be required to have continual improvement in the strategic planning as well as making de-biased decisions. The banks that will survive will have structures that will enhance the ability to sustain pressures from multiple risks as they prepare for regulations that will align to the current challenges (Prahalad & Ramaswamy 2013). Capacity to apply appropriate risk management will be a determining factor as well as a competitive determinant for survival in the future markets (Vargo & Lusch 2008). The financial institution’s role in satisfying customers experience throughout the market changes will be the underlying factor for success in future markets.
Conclusion
The future of risk management will determine the survival of the financial institutions in the United States. A clear understanding of past experiences in the financial institutions brings to surface the signals that are worth watching to prepare for future challenges. Financial institutions have undergone drastic changes in the industry. As a result, some of the banking systems and activities have been rendered obsolete. This factor has led to the termination of some financial institutions that worked efficiently in earlier markets. The emerging customer needs and changes in the markets due to globalization have caused major adjustments in the financial institutions. Most of the institutions have opted for mergers or assimilation by other organizations. Some of the banking institutions were initially nurtured under state regulations. After the exposure to market forces, the institutions needed to adopt the relevant muscles to overcome the challenges of the market. The recession proved that even with strict regulations the financial institutions were fragile and vulnerable to external forces.
Regulations in the financial institutions are necessary for protecting the consumers from the risks encountered in the past industries. On the same breath, regulations may pose strict measures that are likely to stifle the factor of competition in the commercial institution. The commercial sector, like the other bodies of the global market need to be flexible to attain their advantage of maximizing their potential in the markets. However, with strict regulations, some of the potentials are threatened and may not be realized shortly. A correct balance between protecting the consumers and liberating the banks to be competitive may serve as a way of structuring the institutions towards attaining the required framework to face future challenges in the financial industry.
References
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