Financial Risk Management Final Project

Submitted to: - Salman Ali Badami

Submitted by: - Adil Anwar Ali 46322
Hunaid Ahmed 46500
Acknowledgment :

First of all, I would like to express my deep gratitude to Almighty Allah, who
enabled me to undertake such an important task to study about Financial Risk
Management Final Project
I would like to express my sincere gratitude to several individuals and
organizations for supporting me throughout my research. I wish to express my
sincere gratitude to my supervisor, Salman Ali Badami, for his enthusiasm,
patience, insightful comments, helpful information, practical advice, and unceasing
ideas that have helped me tremendously at all times in my project and writing of
this project.
His immense knowledge, profound experience, and professional expertise in
Financial Risk Management have enabled me to complete this project successfully.
Without his support and guidance, this project would not have been possible. I
could not have imagined having a better supervisor in my study.
Abstract :

Financial Institutions work in a world full of risk and uncertainty. Financial

organizations operate in environments where the future is insecure and uncertain.
Risk management is all about managing successfully in the capricious and
speculative world. It gets substantial responses due to the recent financial
catastrophe. Therefore, managing risk persists as a momentous and challenging
corporate function. This project aimed to investigate the relationship between risk
management and the profitability of financial institutions working in Pakistan. it
became clear that risk management affects the profitability of all financial
institutions. The impact of credit risk (NPLR) and Liquidity risk (LDR) revealed
significant, but negative, returns on assets. It was found that the relationships
between Liquidity risk (cash & cash equivalent to total assets) and profitability
indicator (ROA) were ascertained insignificant. The relationship between
Operational risk (CAR) and profitability indicator (ROA) was found significant
and positive. The overall finding of the analysis shows the significant impact of
risk management on profitability at a reasonable level. The study result indicates
that inadequate risk management practices hurt the financial institution's
performance, leading to failure and bankruptcy. Thus, it is concluded that there is a
strong correlation between a well-managed business and an efficient risk
management system. Therefore, it is suggested for financial institutions working in
Pakistan carefully manage risks and increase revenue levels.
Objectives of the study:

● To analyze the effect of credit risk on the performance of financial

institutions working in worldwide.
● To analyse the effect of liquidity risk on the performance of financial
institutions working in worldwide.
● To analyse the effect of operational risk on the performance of financial
institutions working in worldwide.
Q: What will be the effect of risk management on the business performance of
financial institutions?

Financial Institutions work in a world full of risk and uncertainty. Financial

organizations operate in environments where the future is insecure and uncertain.
Risk management is all about managing successfully in the capricious and
speculative world. It gets substantial responses due to recent financial catastrophes
there is a strong correlation between a well-managed business and an efficient risk
management system. Therefore, it is suggested for financial institutions working in
Pakistan carefully manage risks and increase revenue levels.
Credit risk, liquidity risk and market risk as constituents of the financial risk
together affect financial performance and volatility Bank performance overall is
highly affected by credit risk since the latter leads to the possibility that the total
value of assets may change in value because some counterparty has failed to meet
its commitments under the contracted liability.
For financial institutions market risk is a primary cause of profit volatility. Market
risk generally consists of three types of risks:
1. stock price risk
2. interest-rate risk
3. exchange risk
Financial institutions are bestowed with an imperative responsibility to execute in
the economy by acting as intermediaries between the surplus and deficit units,
making their job as mediators of critical significance for the efficient allocation of
resources in the modern economy. The sturdiness of the financial institutions is of
vital significance as observed during the most modern US financial crisis of 2008.
The IMF (2008) anticipated total losses to reach $945 billion globally by April
2008. The world's largest banks announced write-downs of $274 billion in total on
the first anniversary of the credit crunch. While US subprime mortgages and
leveraged loans may reach $1 trillion according to some estimates of July 2008
The stability of the entire economy is affected by a crumple of the financial
institutions, as a result, a robust risk management system is mandatory to keep the
financial institutions up and running. Risk management is the total process of
identifying, controlling, and minimizing the impact of uncertain events. Since the
banks carry the bigger and ultimate burden in the cost of these losses, they should
therefore be at the forefront in managing the risks. Risk management if successful,
avoids or mitigates costly risks while increasing the payoff by managing the risks
effectively. Risk management is an issue that needs to be stressed and investigated,
especially in the banking industry, where the need for a good risk management
structure is extremely important. The recent global financial crisis served as a
reminder that risk management and how the same is practiced is fundamental if
performance objectives are to be consistently achieved. Every bank is faced with
several types of risks key among them being strategic risk and financial risk. Risk
management is a key factor that determines the level of progress of the banks. In
most cases, banks had adopted a proactive and enterprise-wide approach to their
risk management practices by having a risk department with a manager and had a
documented risk management policy that was fairly well communicated
throughout all levels of the organization from the Board to Staff. Risk management
practices do have a significant effect on financial performance more than others i.e.
the existence of a risk management policy and 10 the integration of risk
management in the setting of organizational objectives were considered to be the
key risk management practices that had a direct effect on financial performance.
Effective risk management can bring far-reaching benefits to all organizations,
whether large or small, public or private sector. These benefits include superior
financial performance, a better basis for strategy setting, improved service
delivery, greater competitive advantage, less time spent firefighting and fewer
unwelcome surprises, increased likelihood of change initiative being achieved, and
closer internal focus on doing the right things properly, more efficient use of
resources, reduced waste and fraud, and better value for money, improved
innovation and better management of contingent and maintenance activities.
Effective risk management structure supports better decision-making through a
good understanding of the risks and their likely impact. In practicing Risk
Management (RM), if risks are left unmanaged, they can hurt stake holder’s value.
It, therefore, means that good risk management enhances shareholders' value.
Creating a good discipline in risk management helps improve the governance
process and therefore improves effectiveness. An organization makes cost-
effective use of risk management first involves creating an approach built up of
well-defined risk management and then embedding them. These risk management
include financial risk management, operational risk management, governance risk
management, and strategic risk management.
Conclusion:

Risk management practices hurt the financial institution's performance, leading to

failure and bankruptcy. An organization that cannot manage the risk effectively
does not make constant progress. Thus, it is concluded that there is a strong
correlation between well-managed businesses and an efficient risk management
system. On-performing loans (NPL) are the major cause of credit risk in financial
institutions. Poor quality risk management practices increase the bad quality loans.
Sound management of credit risk reduces the amount of NPL. A Higher value of
NPLR indicates more risk involved in investment and operations activities of the
financial institutions. The result of the study endorses the claim that bad quality
loans and poor loan management in banking organizations reduce the efficiency of
the banking organization. The impact of liquidity risk on the financial institution's
performance is measured by taking the ratio of Loan to Deposit ratio. It has been
found that LDR is an influencing factor that determines the performance of
financial institutions. The overall result of the analysis proves that the performance
of selected financial institutions in Pakistan has been influenced by risk
management. NPLR, LDR, and CAR have shown significant predictors. Therefore,
the study results conclude that risk is a major threat to financial institutions. Based
on analysis and observation, it would be advisable for financial institutions to focus
on and apply cautious risk management practices to maximize bank revenue and
protect institutions against potential losses. This can be achieved through the
development of effective internal control systems, sound assessment procedures,
diversification with hard work to improve assets, retaining profitability is a
challenge, innovative cost-cutting techniques, and minimizing the events of risk.