Financial risk management and the Basel Accords
4000 words. Theme 3 ‘Financial risk management and the Basel Accords’ and Theme 4 ‘Required rates of return in the post-global financial crisis era’
Themes 3 and 4 have reviewed the risk faced by banks and the operation of financial institutions against a background of minimising risk through regulation. However, there is a potential conflict between these two areas. Consider these two statements:
Looking back at the Global Financial Crisis, specifically 2005 – 2009, changes in regulation were needed to ensure that banks had sufficient capital and liquidity to avoid failing as a result of too much risk. Regulators concentrated on these risks in order to protect customers, the financial system and avoid potential contagion.
We must remember that banks, like other firms, have as their primary objective the maximisation of shareholder wealth through profit. As regulators impose strict operating restrictions to minimise systemic risk, usually in the form of capital restrictions and credit risk through minimum capital requirements, banks’ ability to make profits decrease. However, regulators must be aware that every time we lend money, we are creating credit risk. We also face potential criticism if we don’t lend enough especially at time of recession when small and medium sized firms need extra funds and these may exhibit higher risk than under normal economic conditions.
Critically review these two statements outlining how banks can manage the risks that have been underlined. In addition, discuss how the tensions between the issues raised can be resolved by explaining how banks can attempt to maximise their profits within the constraints placed upon them by the regulators.
- Set out an introduction clearly outlining what it is you are looking at, why you are looking at it, and how you intend to set about looking at it.
- Critically evaluate the nature of regulation and the associated risks
iii. Discuss the ways in which banks can try and maximise their return on lending products given the regulatory system that currently is in place.
- Draw a conclusion based on the evidence that you have produced. Ensure that your conclusions are justified through the evidence you have provided.
- Proper referencing, no Wikipedia or Investopedia reference is permissible