With the changes in the financial market the risks companies are facing are high. Technological changes are also observed in the risk causing factors for the commercial banks. Risk taking is the engine that drives the business effectively. This is necessary to assess the vital components of the market success. Commercial banks are posed with different kinds of risks in the world. The risks are not only monetary in nature but there are certain environmental risks as well. Different kind of risks include the interest rate risk, deposits, loans, the delay in the return of the payments, default risks, regulations and opportunity cost. The risks faced by the commercial banks are solved using the tools and techniques. However, there are many bakers that follow the traditional methodologies. Traditional methodologies used by the bankers are however effective but there are loop holes in the techniques used. Traditional methodologies include economic capital and value at risk technique as well. This paper critically analyses all the risks and the tool used for this risk management and assessment. Besides this, gaps in the regulatory environment have been accessed in this paper. Since the international markets of the United States and Canada are highly established hence gas are analyzed especially in these countries. Regulations these days are uncertain and need more attention from the higher bodies.
IDENTIFY AND CRITICALLY EXAMINE THE TOOLS AND INSTRUMENTS OF RISK ASSESSMENT THAT COMMERCIAL BANKS USE AS WELL AS GAPS IN THE REGULATORY ENVIRONMENT IN YOUR COUNTRY/COUNTRIES OF YOUR CHOICE.
In the last decade it has been observed that the financial markets have undergone through various changes. These changes observed in the decades are due to the deregulation found in the past years. Besides this the instant liberalization and changes in communication have made the commercial banks to go through changes. Changes in communication are due to the innovation in the telecommunication. Commercial banks in some cases do not usually pay attention to the potential risks involved in these changes. The evolved mechanism, the idea of resolving the issues and making these things in line needs attention to be made better. Besides this, commercial banks need to get in line with the global standards of commercial banks after analyzing the potential risk associated with all the changes (Ingves, 2004). As the banks are no longer operating in imperative and protected environment, hence there is a need for all the commercial banks to utilize tools and instruments for risk assessment. These tools then help in managing the risk assessment as well. In this paper, critical examination of the tools and instruments used in commercial banks will be assessed. Besides this, the gaps in the regulatory environment specifically in the environment of the United States and Canada will be observed.
In this section risks associated with commercial banks, tools and instruments used in risk assessment and their critical analysis is mentioned.
Commercial banks are one of the important parts of the financial negotiators in the market place. Due to the prominent role of the commercial banks, there are certain exposed risks. These risks affect the security of the market and the economic conditions. These market and economic conditions are related to the consumers of the world. To understand the risks associated with commercial banks there are areas of banking operations that need to be understood.
2.1.1. Interest Rate Risk:
One of the most dominant risks observed in the commercial banks is the internet rate risk. In general it is observed that the commercial banks are good at enhancing the interest rate risk in their portfolio of their investments. Another fact that needs to be observed is that the interest rates fall out of the territory of the commercial bank operations. There is a considerable influence on the interest rates observed in the Federal Reserve which is the main bank of the United States. As a result of this, commercial banks are observing their loans and the changes in the general interest rate. The interest rate level of the economy is considerable fact that needs to be observed. If a bank makes a business loan and charges certain interest rate, profit will be made by the bank.
2.1.2 Default Risk:
The maximum amount of money made by commercial banks is in the form of loans. The process of borrowing is filled with the process of screening, analyzing the financial position of the borrower, the paying ability and any susceptible activity if found. In case of situation when the borrowers are unable to pay the default loan, the bank suffers from monetary loss. However, the general analyses of the commercial banks have shown a small margin of the default. The widespread default of the borrower risks the monetary benefits of the bank.
Subjection to the concept of regulation is also noticed in the commercial banks. The regulation mostly depends on the type of the bank they are operating in. Besides this, specialization and state in which the operations are being carried out is analyzed in the framework of legal regulation. Minor changes in the regulation come up with the changes in framework as well (Fuentes, 2010). This also impacts profitability of the bank as well. For instance, one of the main banks of the United States, the Federal Reserve, can increase the reserves with customer cash withdrawals. However, profit reduction may be observed when the bank decreases the capital available.
2.1.4 Opportunity Costs:
The fear of the widespread default in certain cases makes the banks to end the concept of taking loans. Diminished economic activity observed in the financial analysis of the bank makes the commercial bank to ask the borrowers to repay the payments.
Commercial banks depend on the deposits done by the customers to some extent. These deposits are beneficial for the bank funding available in the form of investments and loans (Fuentes, 2010). Other than offering traditional banking services, the bank offers certificates for deposit and checking as well. Savings and money market accounts are another bonus offer made by the commercial banks. Banks may tend to increase the interest rate payments.
Bankers share a unanimous approach related to the risk management techniques and the efficiency related to the risk management techniques. The performance and the success of the banks depend on the management of the risks. Many of the risk management techniques reduce cost and the expected losses (Moreno, 2014). This thought has been shared by the mangers as well. Below are some of the commonly used techniques for risk assessment:
2.2.1 Economic Capital:
All the risk adjusted performance is assessed using the Economic capital technique. Economic capital defines the actual risk profile of an organization (Abdelghani, 2018). In some organizations, the individual risk types are calculated separately while putting an emphasis on the idea of enterprise for the calculation of economic capital. Major risks types faced by the organizations of larger scale are understood with the association of economic capital. However there are some loopholes left by the organizations while using the technique of economic capital.
2.2.2 Traditional methodologies for credit risk management:
Measuring credit risk management in the Economics, finance and Business, most of the organizations rely on the traditional methods of measuring risks. The traditional methodologies are widely accepted and managed by the organizations. For assessing the credit risk management usually the organizations use the probability of default technique. This probability of default technique is the followed by the loss given by default. Other important things included in the conventional methods are exposure at default and the principal approach. In some cases the use of Friedman test has showed the differences in the ranking of the credit risk measurements are nearly negligible.
2.2.3 Value at risk for assessing market risk:
VAR stands for value at risk. Value at risk is the long accepted methodology. This methodology is used for assessing the market risk. For the trading profiles of the banks and the risk management purposes, the method VAR is widely used. There are three statistics components observed in the method of Value at risk. The time period for which the country is observing the risk, confidence level, and the loss of amount are the components of value at risk. Loss of amount is actually the loss percentage. There is certain value at risk questions which arises in the mind of the people using this technique. The questions related to maximum loss in the next month in dollars and the maximum percentage of loss. Value of risk is the new science of risk management. However, to use this technique it is not necessary that the person needs to be a scientist. Investors have mentioned that their odds for losing the money. The use of common sense is prevalent in the Value at risk technique (Will, 2018).
2.2.4 Friedman test for the progress of implementing operational risk management:
Friedman test is used for implementing operational risk management. The factors included in this test are the key risk indictors that is, the basis of the risk in the business, external loss event analysis and the casual even analysis as well (Maffini, Neltner and Vogel, 2018).
This part of the research analyses the tools and techniques for risk assessment. Risks are identified at first and arranged according to their priority. This priority list is managed according to the size of the threat the risk is posing. In his innovation are introduced. Innovations are a big way for creating enough opportunity. Then the techniques are implemented or an innovation is brought to the market.
3.1 Analysis of Economic Capital:
Many of the researchers believe that economic capital is one of the relevant methods for analyzing risks in the environment of the commercial bank risk assessment. The relevancy of the method can be analyzed from the fact that it provides key answers. The key answers are most of the times relevant to the businesses decision taken by the commercial banks. In other case the key answers are necessary for evaluating the financial units of the banks. An instrument is provided by the economic capital for comparing RC. Economic capital estimates can be effectively used by the banks to allocate capital. This capital is allocated across the business strategies and in the promotion of the units that provide profit according to the desire of the banks. The performance measure involving risk adjustment capital and giving economic capital in return is one of the examples of the effectiveness of the economic capital. Another point of effectiveness of the Economic capital can be analyzed from its utilization in comparison with RC. Besides this, measuring RC is an easy and less time taking process. This makes this process in high demand among all the bankers planning on measuring the credit risk management.
3.2 Analysis of Traditional methodologies for credit risk management:
Although the use of traditional methodologies for credit risk is widely observed but there are some loopholes to this technique of assessment used. Many researchers believe that If the traditional method are employed then the analysis so of the market, the debt and equity can never be estimated near to the reality. There is always a significant gap between the calculated value and the actual values existing in the credit risk for the commercial banks. Besides this, the banking system of the present time has the dominance of the people from the old times. No doubt there are new technologies and idea being implemented but the mindset has not changed yet since the old generation is comfortable with the traditional techniques. Besides the traditional techniques are an easy way of getting things done in credit risk management although there is a need of the
3.3 Analysis of Value at risk for assessing market risk:
Value at risk is considered to be one of the most reliable sources for the risk assessment in commercial banks. This method is not restricted to the financial transaction only there are many other dimensions on which this method is applied. The main focus of VAR lays importance on the downside. Downside mentions that the risk and the potential losses in posed risk. The posed risk to the commercial banks is mostly in the form of loans when the borrowers are unable to pay the default back. The utilization of this technique in banking system basically reflects the fear of the liquidity crisis. In this situation many widespread banks and the Nobel Prize winners have declared VAR as the reliable source for analyzing the demise of the long term capital management (Thamhain, 2013).
2.2.4 Analysis of Friedman test for the progress of implementing operational risk management:
Friedman test is one of the alternatives ways of measuring ANOVA with repeated measures being carried out in the atmosphere. The differences between the group and the original measured values are measured using the techniques of this test. The reason this test is not used in calculations is due to the limitation involved in this tests. Only when the deviations in the data are to observed then this test is applied.
Current regulatory environment is changing with an accelerating pace. The pace of regulations needs to be matched otherwise the wants of all such regulations will not be understood in time.
4.1 Gaps in the Regulatory Environment in the United States:
The intensity seen in the current regulatory environment due to the unbalance observed in the financial market. This unbalance has leaded the world near to the situation of collapse of the financial system. An acute economic downturn was observed six years ago. In this situation the regulation were believed to be the cure for the situation and acted as a preventive measure as well. This is how the business was intended to be changed. However, definite evidences are obtained about the latter being attained. Regulatory environment is the top issue that can impact most of the companies in the United States. Nearly 400 Chief executive officers of the United States presented that that they are spending more time on the regulators while some are paying consideration to complete this act.
Regulatory environment in the United States is mostly affecting the health sector and the financial services (Thamhain, 2013). As far as the financial sector is concerned, overall reduction on the market risk is being observed by regulatory mandates directed towards the idea of transparency. The quantity of regulations that is seen by the researchers coming on companies can be hard to handle. In the present time there is need for the companies to transform the data tracking methods. Besides this the companies need to focus on the data gathering systems, the functions being used for reporting and in some cases the organizational structures too need revision. Hence all the new regulation is expensive when it comes to compliance. Although these regulations are necessary but they come up with a cost since they can limit the generation of the revenue and profitability. This limitation can occur due to the increasing capital ratio necessities.
Besides this, limitations are applied on certain products ad activities as well. The current regulatory environment has been put into correct words by the CEO of prosperity bank. He mentioned that from the year of 1978 till now most of his time is sent in managing the regulatory environment and the consequences associated with it. The regulatory burden in the present time is a burden to the community especially the community that is traditional when it comes to banking environment. The biggest dilemma in regulations is that the want of such regulations are not known in every situation. The idea of Chief executive officers devoting higher amount of time to the regulation does not seem to be a good idea. In this case no special choice if left for the CEO’s to implement in the environment. The global pace of regulations is increasing every now and then. In this situation the major financial issues or gaps created by the regulatory environment for the commercial banks in United States have come in the form of six major issues:
- Corporate tax reform
- Global economic growth
4.2 Gaps in the Regulatory Environment in Canada:
Current regulations being observed in the country of Canada differ from the traditional consequences. Present time has shown that the regulations observed in Canada are not restricted to the specific needs. There is an uncertainty observed in the wants of the regulations. The regulations and its uncertainty add costs and risks faced by the banking associated people. New regulations are being observed in the framework by the department of the fiancé of the Canada. After the observation of this regulation, the country has decided to promote innovation and competition in the financial services. New payments plans are being observed and implemented in throughout the country. If interoperability between payment platforms is built into this system, it will spur competition and innovation. However, because a system with high interoperability requires significant collaboration, a strong governance framework is needed to prevent incumbent members and early entrants from strategically developing rules that exclude others from entering this sector in the future
To sum up, the research highlights the risk that are associated with the financial conditions of the commercial banks. Risk can be of different types. Starting from the main line and ending to the complex issues, there are many tools and techniques used by the owners and the ban executives in making the environment of the banks better. Now a day’s regulations are widely observed. The regulation are uncertain and do not come up with specific need and wants. In this case, specific examples of the United States and Canada are being observed in the present time. United States is having certain major issues due to regulation due to which CEO’s are giving more time. In Canada the regulations are of high complexity.
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