Financial_Risk_Management

Financial Risk Management Assignment 2 0830200102 王翰涛 Table of contents 1. Part 1 …………………………………………………………..…3 2. Introduction…………………………………………………….…3 3. Risk factors identified………………………………………….…4 4. Conclusion………………………………………………………..4 5. Part 2……………………………………………………………...5 6. Citation and reference………………………………………….…7 Part one 1.Introduction Global offering become a popular way to raise money in current years. In China stock exchange, bank industry is the pioneer of this acting. Many banks listed on Hong Kong stock exchange to raise capital from global, not only from the Mainland China. However, international IPO involved many risk, therefore, we need to identify some risk factors for management. 2.Identified risk factors 2.1 A loan portfolio At first, we need to ensure and maintain the quality of our portfolio. If we fail to guarantee the quality of the portfolio, then the operations and financial situations would be influenced badly. Besides, allowance for impartment losses should be sufficient to cover the actual losses. Concentration on certain industries, regions and customers is necessary for a portfolio. Make sure the market value of collateral and guarantee can compensate loans, at least not loss too much. The classification and policy of loan should be suitable for certain region or country. Keep growing of our portfolio and prevent the deterioration in the debt payment. 2.2 Bank’s business For the banking business, we need to be careful about implementing operational reform initiatives. Being effective in risk management and internal controlling, also, introducing information technology to assist risk management. Do fully investigation before expanding range of products and services. Try to prevent fraud from employee and the third party. Maintain the growth of customers’ deposits, and enhance information technology system to reduce business risks. Further, obey the rules and regulations conducted by local government, and fully comply with their requirements. Getting away from illegal and improper activities, which would harm our business and reputation. 2.3 The banking industry in China Being highly competitive environment for banking industry, and the competition from other corporate financing and investment channels. Also, the banking industry expose to interest rate and other market risks those are difficult to hedge. There is a probability that the growth rate of banking industry might not sustainable. The effectiveness of credit risk management is highly depending on the information available. Some regulations of government may limit the ability to diversify risk, and a decrease in one specific asset may affect financial conditions adversely. 2.4 Risks related to China The business was affected by China’s economic, political and social conditions, as well as governmental policies. Pay attention to legal protections under PRC legal systems, because the existing legal system may not fully cover the risks. Besides, the taxation of PRC may deteriorate profits, and payments of dividends is restricted by PRC laws. Further, considering currency control and risks related to the fluctuation in exchange rates. In addition, the occurrence of any natural disasters may have adverse effect on business. 3.Conclusion As global offering is a common way to raise capital, so is Chinese bank. Banks can raise money more easily than before, and generate more business to boost profitability. However, it still has some risks that need to identify when doing banking business in China. Risk related to a loan portfolio, risks involved in banking business, risks with banking industry in China, and risks involved with China market. All of those factors should be taken into consideration when bankers operate their business. Part two From risk factors were identified, we can see that when we conduct a risk management by VAR. a loan portfolio should be taken into account. From banker’s perspective, loan should be classified as an asset. VAR is a probabilistic method of measuring the potential loss in portfolio value over a given time period and for a given distribution of historical returns. Furthermore, in a loan portfolio, there are four main factors should be considered when measuring risks by using VAR. firstly, asset concentration is the first factor in a loan portfolio to calculate VAR. because weights of different loan are different, and change in weight of some particular loan might affect the whole portfolio substantially. Secondly, asset volatility also affect the whole risk of portfolio, if the standard deviation of individual asset increase, then it would cause the overall portfolio’s standard deviation increase, which means that the risks of portfolio increase. Thirdly, the correlations among each asset within a portfolio need to consider carefully. For instance, if the correlation between assets is negative, then the risk can be reduced. However, if loans were positively correlated with each other, therefore, the risk would be higher. Finally, systematic risk can be considered within loan portfolio. Except for loan portfolio, the rest factors related to business, banking industry and China would be more appropriate to using stress testing to measure risks. Stress testing is procedures that attempt to gauge the vulnerability of portfolios to hypothetical events or testing of the impact of extreme market moves on the value of portfolio. Even though it is immature risk management tool, it is good for quantifying what we might lose in crisis situations. For business, industry, and China market, all of those can be classified as macroeconomic risks, stress testing is much better suited for gauging our exposure to macroeconomic factors, such as the state of the business cycle, the economic condition of a particular country. To measure the risks involved in banking business, both VAR and Stress testing can be applied, and stress testing is a natural complement to probability based risk measures like VAR. VAR can shows us that the business might loss some money at a certain probability, and Stress testing give us idea of the loss we might suffer in bad states where we could get a loss in excess of VAR. Being ineffective in risk management and internal controlling, fail to do fully investigation before expanding range of products and services. Fraud from employees or the third party. Fail to maintain the growth of customers’ deposits, moreover, break the rules and regulations conducted by local government. Getting in illegal and improper activities, which would harm our business and reputation. These entire bad situations happened in bank business, then we can figure out how bad the things can be, and find out the weakness in the banking business, and make alternatives and recommendations to fix the problem or make preparation to deal with emergency problems. For banking industry, stress testing would be much more appropriate than VAR. as a fact that banking industry is the whole environment for bank to do business, therefore measuring risk only by VAR may not sufficient. Stress testing would be suitable for risk management in banking industry. Scenario analyses are the method to working out information to guide managers for decision making. Provide modeling assumptions would assist to protect bad events to happen. Being highly competitive environment for banking industry, and the competition from other corporate financing and investment channels would adversely affect the banking industry. Also, the banking industry expose to interest rate and other market risks those are hard to hedge these risks. Growth rate of banking industry might not sustainable. The effectiveness of credit risk management is highly depending on the information available. Some regulations of government may limit the ability to diversify risk, and a decrease in one specific asset may affect financial conditions adversely. All those factors would render the banking industry in a really bad situation. After evaluating the effect of above each situation, then we get ideas of sensitivities of various positions to those hypothetical changes. China market is the most complicated environment not only for banking business, but also other business. China’s economic, political and social conditions, as well as governmental policies would affect doing business in China. Legal protections under PRC legal systems also would have negative effects on banking business, because the existing legal system may not fully cover the risks. Also, the taxation of PRC may deteriorate profits, and payments of dividends is restricted by PRC laws. Further, considering currency control and risks related to the fluctuation in exchange rates. In addition, the occurrence of any natural disasters may have adverse effect on business. Under this stress testing, we identify the risk factors such as interest rate, exchange rate, inflation rate, which related to banking business, and set up scenario that bad events like crisis happen, set up hypothesis, to see what is the weakness of banking business in China market. Reference Hamilton J. Oil and the Macro-economy since World War II[J]. Journal of Political Economy,1983,(91): 228-48. 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