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Financial Markets and Risk

Introduction

According to the analysis done by the human resource management department of the bank, there are different risks that are evident in the commercial banking. There is a great need therefore to extend the already planned workshops so as to include using financial markets in managing the exposure of the bank to risks as well as the future implications that the changes in the regulations will have. There have been several suggestions to ensuring stability in the banking sector one of them being the return use of the narrow retail banking instead of depending on the investment banking as well as the financial market. The financial regulation may therefore require adjustment especially in the area of risk management.

Use of Financial Markets to Manage Risks

Financial markets can be used by commercial banks while managing interest rate as well as the credit risks. By using the financial market, the bank uses an approach that goes beyond the micro in not only the regulations but the supervision as well. There has been an increase in the focus on the macro approach to these financial regulations. The focus has especially been on the macro-prudential tools with their usage, how they relate to the monetary policy. In addition to all these, much attention has been paid not only to their implementation but their effectiveness as well (Briault 2009, p. 20).

By using the financial market, the banks are able to obtain data from several nations. This is facilitated by the member central banks. The data may significantly differ per country. The difference could for instance be in terms of the priced unit, property type, the covered areas, seasonal adjustments among others. The processes that are involved in the buying and selling of different property as well as the available data may vary from one nation to the other. There are no specific standards that are set which apply across all nations particularly when it comes to the pricing of commodity. There is need for the banks to collect information on price indices of various residential properties and come up the best price recommendations as per the user needs. Through this, there will be economic, financial as well as monetary stability and in the long run a financial crisis will be avoided. The commodity prices have to be updated regularly (Fuller 2009, p. 7).

Economic stability is not solely depended on the market efficiency, great moderation as well as on the macro-economic stability hence the need to involve countercyclical instruments. This will go hand in hand with systemic liquidity controlled variations as well as the central bank balance sheet control. The central banks may have to delegate their roles. The respective government-central bank relationships may have to be altered.

National and international monetary policies greatly influence the way banks manage their risks, be they the interest or the credit risks. Commercial banks have been yearning for price stability on the national or international platform. There is there a great need for a legitimate monetary policy-making process. Any economic or financial crisis has serous effects on the political economy and the central banks play a big role in the production of universalized price stability which is essential in the interpretation of the monetary policy. Most policy makers have been enacting and implementing financial regulations that have played a key role in making the world’s financial system to be unstable hence resulting to failure. There has been a demand for the adoption of a viable and dynamic financial system. The current system must therefore be redesigned and the financial regulations be modified where necessary (Goodhart 2009:40).

There has been a demand for most economic blocks to use one currency in the business transactions so as to manage credit and interest rate risks. The dollar has for instance been adopted by most nations and accepted as an international currency. The international currency status is therefore not solely depended on the market size. Most banks have opted to use the much accepted international currency in trying to put the risks under manageable levels (Heaney 2009, p. 43).

There is a need to alter the governance of central banks. Most central banks have maintained unviable policies despite going through enormous financial challenges. Most of these banks need to have their policies reexamined together with their governance structures and those that are unorthodox have to be scrapped off. Recurrence in capital inflow has been a big challenge particularly to the market economies that are emerging and are in dire need of financial stability. Increasing the interest rates with the intention of alleviating the problem of imbalances due to capital flows could be an attraction for more capital inflow and this would result in accentuated appreciation pressures. The relevant authorities have therefore taken different measures while attempting to eliminate the capital effect flows and stabilize the financial sector. Most banks have opted to use instruments like reverse requirements FOREX market intervention, strengthening the balance sheets for the respective banks, foreign reserve accumulation, and capital control and maintaining credit quality. These instruments must be used together with the policy that governs the interest rates so as to avoid the impairment of the financial system development (Lascelles 2010, p. 13).

The banks have to monitor cross-boarder lending as well as the capital flow. Strong macroeconomic fundamentals have to be observed strictly so as to manage the credit and interest rate risks. Financial intermediation is very vital for the banks in managing the mentioned risks and stabilizing their respective financial positions. There is a need to minimize the dependence on wholesale markets, stop new lending, avoid risky loans, shorten assets maturity and raise the government bond holdings.

Financial Markets and Systematic Risk Creation

Relying on the Financial Markets, while trying to manage the risks has its on shortfalls. The value of money is always varied across different countries and economies vary. Given the fact that different countries use different currencies could make it very difficult for a fixed price of a commodity to be determined. Different economies have different policies and regulations that govern financial activities and it may be very difficult for the bank to come up with a conclusive decision on the regulation that should govern the financial undertakings.

Some financial institutions may not be in a position to meet the most basic regulatory capital requirements while others may not even have adequate financial resources and hence pose a challenge to the management of the risks that come about. In some cases, the financial market may be prone to financial crime, whereby most of those involved take part in activities that flout the market rules like money laundering, abuse of market, fraud activities, and dishonesty.

Some of the financial markets are greatly fragmented into smaller yet numerous blocks that with each block having its own rules and regulations and pricing systems. It may therefore be very difficult for the respective banks to come up with a conclusive remedy to any financial crisis. There could also be conflict of interest where various financial institutions have different objectives, they have conflicting policies and very different approaches while dealing with financial crisis and this could be a significant hindrance to the intuition’s success in dealing with the respective risks.

A bank may do inadequate market or consumer research. Given the fact that search research is vital for the comprehension of consumer behavior in the retail market, it may be difficult to come up with policies that are based on evidence. A bank may not consult other firms concerning their service delivery. This could lead to underperformance of such the bank and hence pose a risk to the banking system. Given the numerous variations in the financial markets, it may not be easy to carry out an economic research and analysis. With no market failure coupled with the cost benefit analysis, it may be s very difficult endeavor to try and evaluate where an intervention is needed as well as the type of the intervention measure to be undertaken. It therefore becomes impossible to make sound judgment concerning agenda for any financial regulation (Watts 2006).

The financial market is always prone to systemic failures particularly when it comes to the financial regulations. The policies that are enacted could destabilize the financial system. Most of the banks engage in unorthodox policies and they therefore risk their governance structures being examined and this could jeopardize the independence of their monetary policy. Financial markets are prone to currency denomination reversal. The US dollar has for instance been of a greater attraction as while the euro has been sidelined and this has detrimental effects on those economies that rely on the euro.

Recurrence in the capital inflow is a significant challenge particularly when it comes to the upcoming market economies and want maintain their financial stability. Fluctuations in the interest rates aggravate the imbalance that comes about due to capital flows hence causing market instability. The banks’ financial system development could be impaired in the long run. This becomes problematic when as the banks cannot fully rely on the financial market while doing the risk management. In fact the bank’s financial system may not be resilient to enormous financial crisis as in the case of the world economic recession which his all the sectors of the economy across the globe. Emerging market economies are particularly the ones that are enormously affected (Nison 2006).

Capital flows coupled with cross boarder lending have been fluctuating significantly and this has enormously affected the financial markets and the end result has been risky to the banking system. Currency mismatches can adversely affect the financial markets. They lead to a reduction in the domestic interbank participation or the credit market. The relevant authorities may have to not only lengthen the maturity of the purchased securities but also widen their range so as to fund local currency. Reverse requirements and policy rates may allowed counter-cyclically.

Banking System Stability

For a banking system to be stable, it should meet the standards that are set and monitor its observance of set rules and regulation. Through supervisions, the banks are able to monitor and regulate their activities to ensure their compliance with the required regulations. It has been said that stability in the banking system can only be achieved if these institutions will not undertake investment banking businesses, which includes propriety trading and mainly deal with the traditional narrow banking. This is due to several factors, for instance, narrow banking is less prone to financial crime. By focusing on the narrow banking, the problem of money laundering and fraud is minimized.

Focusing on narrow banking makes monitoring to be manageable as opposed to the something like investment banking which may not be easy to monitor. Narrow banking is less costly and is less risky as compared to the investment banking. It is easy to collect and analyze the data while dealing with narrow banking as in the case of small business firms which are easy to supervise. Risk assessment becomes easier when banks limit their operations to involve narrow banking and this helps in ensuring stability particularly in the banking system. Wholesale banks and other financial investment institutions are able to supervise most of the smaller firms due their size, number of clients and their activities. Casework supervision could be employed on those firms that do not have the relationship management. Information from them could be gathered from their contact centers or even the police/security personnel.

It is easier to deal with the cases that involve such firms over the phone as opposed to the investment banking case which may require very complicated forms in trying to resolve their issues. The firms may have multiple ways of solving an issue at the given time. Coordination for the banks with such firms become easier and any issue can be resolved promptly. The banks are able to regulate the industry by using project work that is themed. This could be done by comparing firm issues and the directives. Firms can be supervised regularly through the officers’ compliance. Risk assessment can therefore be done periodically.

Such firms significantly benefit the community directly. In the event that small businesses and firms are not viable, it becomes easy to move to another business without incurring much loss and this greatly differs with investment banking. Investment banking is highly prone to the bad debt risk. The whole process requires so much administration hence increasing the administration expenses. Investment banking is known for enticing people to buy more than they can really afford and this could plunge them to big dept and become bankrupt in the long run, this will in the end destabilize the banking system. Investment banking requires more working capital (Robert 2006).

Narrow banking ensures reduction in bad debts as it become easier to spot the defaulter and make the necessary follow up. There is increased customer loyalty due to the fact that the customers receive more attention. This kind of banking helps in building confidence and stability in the financial sector. It is easy to set credit limits and there is a better management. It is cost effective.

Propriety trading involves the trading in currency, stocks, the bond market, as well as commodities among other financial instruments. The firm uses its money and not necessarily the customers’ money with the intention of making its own profit. Global macro trading is particularly common in this kind of trading. Whenever banks are involved in propriety trading, they stand a high chance of risk as this kind of trading is riskier, and the profits are volatile. The risk involved in propriety trading may in most cases prove difficult to manage. Through arbitrage, banks usually take advantage of price discrepancies by purchasing and selling various securities with the intention of locking in a profit.

Propriety trading is known for creating a conflict of interest between the customer and the trader. Some of the banks’ propriety traders are usually involved in under-deals to the detriment of the banks. This causes the backs to loose a large amount of money and hence run at a loss. Investment traders are known for actively purchasing different financial instruments using their own funds whenever the market profits are high. In some cases those profits are usually very volatile and in such a case, markets are prone to credit crises and this could easily cause the banking system to collapse.

It is very easy for customers to be tricked into investing in the stocks that are not performing well. This is done by the employees of the propriety firms whereby they hide the real facts about any form of decline with the intention of selling those stocks whose performance is poor. In the event of a global financial crisis, propriety traders are usually the ones that receive the shock first and they are the ones who receive the largest impact. This becomes riskier for the banks as they are bound to loose huge amounts of money that they invest in the propriety trading (Lindstrom 2007).

Reference List

Briault, C., 2009. Rebuilding regulation. Financial World, Vol. 3, No. 2, pp. 20-25

Fuller, J., 2009. Now, re-regulation. Financial World Vol. 2, No. 3, pp.7-11

Goodhart, C., 2009. The case against narrow banking. Financial World, Vol. 4, No. 5, pp. 33-40

Heaney, V., 2009. Past perfect. Financial World, Vol. 3, No. 3, pp. 40-45

Lascelles, D., 2010. The CIFI’s Latest Banking Banana Skins survey Slipping on Politics. Financial World, Vol. 2, No. 2, pp.10-15

Lindstrom, D., 2007, History of United States Business. Redmond: Microsoft Corporation

Roberts, K., & Ricardo, J.,1996, Financial Markets. Texas: Wiley

Steven, N., 2006, Technical Analysis of the Financial Markets. New York: New York Institute of Finance

Watts, M., 2006, United States Economy. Redmond: Microsoft Corporation

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