Financial Risk Management Final Project

Submitted to: - Salman Ali Badami

Submitted by: - Sagar Kumar (50024)
Asad Ahmed (43920)
Shahnil Ali (51564)
Q: What will be the effect of risk management on business
performance of financial institutions?
Ans: 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 catastrophe
there is a strong correlation between well-managed business and efficient risk
management system. Therefore, it is suggested for financial institutions working in
Pakistan to 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 the three types of risks:
- stock price risk
- interest-rate risk
- 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 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. 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 fore front in managing the risks. Risk management if successful, avoids or
mitigate 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 which 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 have a risk department with a manager, and had a
documented risk management policy which was fairly well communicated
throughout all levels of the organization from the Board to Staff. Risk management
practices do have 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 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, 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, 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 cause a negative impact on stake holder’s value. It therefore
means that good risk management enhances shareholders value. By creating a good
discipline in risk management it helps improve 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
risks management, operational risk management, governance risk management,
and strategic risk management.

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Conclusion:
Risk management practices have a negative impact on the financial institution's
performance, leading to failure and bankruptcy. The 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 business and 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 organization reduce
the efficiency of the banking organization. The impact of liquidity risk on the
financial institutions performance measure as 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.

References:
http://erepository.uonbi.ac.ke/bitstream/handle/11295/75037/Mwangi_The effect of risk management
on financial performance.pdf?sequence=1