K.K.

VIGYAN AVAM VYAVSAIK ADHYAYAN MAHAVIDYALAYA

DEVI
AHILYA VISHWAVIDYALAYA , INDORE
(Affiliated to Devi Ahilya Vishwavidyalaya (DAVV) ,Indore)

MAJOR REASEARCH PROJECT

On
“ A Study of Risk management in investment banking”

( In the partial Fulfilment of the Requirement for

the award of the Degree of Devi Ahilya
Vishwavidyalaya, indore )

MASTER OF BUSINESS ADMINISTRATION (FT)

2022-2023

Guided by : Submitted by :

Prof. Namrata Sharma Ritika Shere

K.K.VIGYAN AVAM VYAVSAIK ADHYAYAN MAHAVIDYALAYA
DEVI
AHILYA VISHWAVIDYALAYA , INDORE
(Affiliated to Devi Ahilya Vishwavidyalaya (DAVV) ,Indore)

MAJOR REASEARCH PROJECT

On
“ A Study of Risk management in investment banking”

( In the partial Fulfilment of the Requirement for

the award of the Degree of Devi Ahilya
Vishwavidyalaya, indore )

MASTER OF BUSINESS ADMINISTRATION (FT)

2022-2023

Guided by : Submitted by :

Prof. Namrata Sharma Ritika Shere

 CERTIFICATE

This is certify that Ritika Shere is a student of Master of Business

Administration ( HR+Finance / Full Time ) 3rd Semester of K.K. College,
Indore, M.P. She had prepared the Major Research Project under my
guidence, on the topic “ A Study Of Risk Management In Investment
Banking ”.

Namrata Sharma

Professor
 DECLARATION
I do here by declare that this project report “A Study Of Risk
Management In Investment Banking” submitted to the K.K. College,
Indore, M.P. in partial fulfillment for degree of Master of Business
Administration.

Place: Indore Ritika Shere

Date:
 ACKNOWLEDGEMENTS

It was a matter of great privilege and pride for us to commence and

complete our major project at "A Study Of Risk Management In
Investment Banking". I am highly grateful to our instructor "Prof.
Narmata Sharma" who guided us at each and every step and patiently
provided us the solution to each and every problem and queries, we
came across. I am also thankful to the people who made this project a
success. I am also thankful who have helped directly or indirectly in
completing our project.

Ritika Shere

CONTENTS
 No. Chapter Name
CHAPTER 1 INTRODUCTION
CHAPTER 2 REVIEW OF LITERATURE.
CHAPTER 3 RESEARCH MEDATOLOGY AND OBJECTIVES
CHAPTER 4 RESULTS
CHAPTER 5 CONCLUSION
CHAPTER 6 REFERENCES
CHAPTER 7 APPENDIX

INTRODUCTION

Corporate risk embodies a multitude of policy decisions that are made

separately as a This dissertation analyzes the antecedents of corporate
risk-taking and answers the question:
What factors contribute to corporate risk-taking? Specifically it looks at
how four sets of factors, including:

(1) Institutional and industry variables,

(2) Company’s aspirations,

(3) Firm’s knowledge, and

(4) Corporate governance, contribute to corporate risk-taking

(Please see Appendix A).

The connection between regulations and corporate risk was established

not only in the United States, but across the world, including in Central
and Eastern European countries (Agoraki, Delis, & Pasiouras, 2009).

Regulations such as capital requirements, bank activity restrictions, and

boundaries of supervisory power have an independent influence on

risk-taking in the banking sector, and that influence is separate from

any market power effects of regulatory changes (Agoraki et al., 2009).

Therefore, institutional environment clearly influences corporate

risktaking, and that is why it is selected as one of the main factors in the
analysis. The difference between aspirations and actual performance is
called attainment discrepancy (Lant, 1992).The higher this discrepancy
is, the larger the company’s pressure to take risk (Bromiley, 1991).

Aspirations can be measured in two ways:

(1) As company’s past performance, and

(2) As company’s peer groups’ performance (Cyert & March, 1963), and
both of those will be measured in this dissertation.

The resource-based view argues that a valuable, rare, inimitable and

nonsubstitutable set of resources provides a sustained competitive
advantage for a company (Barney, 1986b, 1991, 2001).

Resources not only provide competitive advantage, but also influence

corporate risk-taking (Wang, Barney, & Reuer, 2003).

In turn, particular corporate risk-taking practices send a positive signal

to the market and can attract more resources in the form o f
investment to the company (Wang et al., 2003).

Corporate resources consist of various productive systems, including

physical capital, legal capital, intangible assets and human talent
(Mahoney & Pandian, 1992). In human talent Mahoney and Pandian
(1992) include top management teams as a crucial resource that
generates rent. Das and Teng (1998) divided resources into four
categories, including: financial, technological, physical and managerial,
and showed an interactive effect of resources with risk (Das & Teng,
1998).

Managerial resources include knowledge and expertise, and they will

be analyzed using knowledge-based view o f the firm, which is an
extension of resource-based view (Felin & Hesterly, 2007).

Knowledge based view argues that the key to any company’s success
lies in its ability to integrate various types of knowledge and apply it to
new problems, products and services (Grant, 1996b). Knowledge-based
view puts forward the idea that a company’s success and survival
depend on its ability to combine, generate and apply relevant
knowledge (Conner & Prahalad, 1996; Kogut & Zander, 1993, 1996).

Hierarchical organizations are particularly good at combining, sorting

and applying knowledge, thus developing “path dependent” capabilities
and intellectual assets (Athanassiades, 1973).

The relationship between corporate governance and corporate

risktaking is well established (Eloign & Marek, 2011; John, Litov, &
Yeung, 2008). Variations o f corporate governance systems across
countries, like the market-based corporate governance system of the
U.K. and the control-based corporate governance system o f Germany,
produce variations in corporate risk-taking, and evidence of this is well
established (Eling & Marek, 2011).

All this evidence suggests that differences in corporate governance

systems between companies and across nations clearly influence
corporate risk-taking.

In this dissertation, additional factors such as interlocking directorships

and the number o f independent directors on the board will be
examined.

Four sets of factors contribute to corporate risk-taking, Including:

(1) Institutional and industry variables,

(2) Firm aspirations that are based on past performance and industry
average,

(3) Specific resources and a particular type of resource - knowledge, and

(4) Corporate governance.

The strength of these factors could vary across situations, but in order
to have a clear picture of how to stimulate effective risk management
systems in corporations it is crucial to look at all four sets o f factors
simultaneously. This simultaneous view allows us to see the
interactions, and the analysis of factors related to agency theory
permits us to rank board of director’s parameters by their strength of
influence.

Government and regulatory bodies can benefit from this research

because their role as rule setters is covered under the institutional and
industry levels of analysis.

Review of Literature

Banks like any other organization also inclined towards taking risk,
which is inherent in any business. Higher the risk taken higher would be
the gain. But higher risks may also result into higher losses. However,
banks are quick enough to identify measure and price risk, and
maintain appropriate capital to handle any contingency.

The major risks in banking business or ‘banking risks’, as commonly

referred, are listed below –

Liquidity Risk

Interest Rate Risk

Market Risk

Credit or Default Risk

Operational Risk
1. Liquidity Risk

Liquidity is a bank’s capacity to fund increase in assets and meet both

expected and unexpected cash and collateral obligations at reasonable
cost and without incurring unacceptable losses(Manish Kumar &
Ghanshyam Chand Yadav, 2013).

Liquidity management becomes a very important part in financial

management decisions, where the liquidity management efficiency
could be achieved by firms that manage a trade-off between liquidity
and profitability (Bhunia and Khan 2011).

2. Interest Rate Risk

The effect of interest rate movements on the financial condition of a

bank is called interest rate risk. Since, it has a direct impact on the
profitability of a bank, it becomes an important area for the
management of a bank to focus on the methods to manage and
mitigate this risk (V N Prakash Sharma, 2016)
3. Market Risk

Market risk is the risk of losses in liquid portfolio arising from the
movements in market prices and consisting of interest rate, currency,
equity and commodity risks (Aykut Ekinci, 2016).

4. Credit or Default Risk

Credit risk is the possibility of loss due to a borrower's defaulting on a

loan or not meeting contractual obligations (Investopedia) .

Credit risk is the most important risk exposure for banks due to strong
connection with bank profitability and economic growth.

For banks, a proper investment decision means the greatest return on

investment at the lowest credit risk (Aykut Ekinci, 2016).

5. Operational Risk

The Basel Committee defines the operational risk as the "risk of loss
resulting from inadequate or failed internal processes, people and
systems or from external events”.

6. Strategic Risk

It can be defined as the system of future opportunities and threats that

are so significant that they could materially impact the enterprise’s
achievement of its main purpose or even its survival (Neil Allan, Patrick
Godfrey, 2007).
All organisations are vulnerable to strategic threats to varying degrees
despite their best efforts to manage them.

Strategic Risk need a risk-management system designed to reduce the

probability that the assumed risks actually materialize and to improve
the company’s ability to manage or contain the risk events should they
occur(Robert S. Kaplan and Anette Mikes, June 2012 Harvard Business
Review)

7. Reputational Risk

Reputational risk refers to the potential for negative publicity, public

perception or uncontrollable events to have an adverse impact on a
company's reputation, thereby affecting its revenue
Risk Management Investment Banking
RESEARCH METHODOLOGY & OBJECTIVE

Sample The sample of financial institutions was obtained

The sample of financial institutions was obtained from Thomson One

Financial database.

The three subset of Diversified Financial

The set Diversified Financials, in turn, consists of three subsets:

(1) A subset of 50 corresponding to Diversified Financial Services with

code 402010;

(2) A subset of 63 corresponding to Consumer Finance with code

402020

(3) A subset of 135 companies corresponding to Capital Markets with

database code 402030.

GIC codes

GIC codes, due to being a later development, are generally more logical
(Boni & Womack, 2006), have more consistent ways in naming
categories, and, therefore, analysis proceeded with the set produced by
applying GIC codes.

Investment banks are set their data

The final data set included 135 publicly traded investment banks that
operate in the United States (please see Appendix C).

Variables and Measures

Strategic management

Research in strategic management was criticized for poor construct

measurement (Boyd, Gove, & Hitt, 2005), and, for this reason, for every
theoretical perspective more than one indicator variable was used; the
smallest number is two and the largest is five.

Independent variable

Independent variables include:

(1) A deregulation dummy, which was coded as 0 before deregulation

and 1 after deregulation,

(2) Corporate aspirations as industry average, i.e. arithmetic mean;

(3) Diversification as measured with entropy measure;

(4) Knowledge of real estate with a dummy,

(5) Clock variable o f time in the real estate, as number of years in that
industry;

Data Analysis

Risk management in investment banking

Risk management occurs when an investor or fund manager
analyzes and attempts to quantify the potential for losses in an
investment, such as a moral hazard, and then takes the
appropriate action (or inaction) given the fund's investment
objectives and risk tolerance.

.
 The 4 types of risk management
There are four main risk management strategies, or risk treatment
options:
• Risk acceptance.
• Risk transference.
• Risk avoidance.
• Risk reduction.
The study of risk management
Risk management is an important process because it empowers a
business with the necessary tools so that it can adequately
identify and deal with potential risks. Once a risk has been
identified, it is then easy to mitigate it
 The 6 categories of risk
6 Types of Risks To Be Managed With Enterprise Risk
Intelligence...
• Health and safety risk. General health and safety risks can be
presented in a variety of forms, regardless of whether the
workplace is an office or construction site. ...
• Reputational risk. ...
• Operational risk. ...
• Strategic risk. ...
• Compliance risk. ...
• Financial risk.
 The 5 benefits of risk management
5 Hidden Benefits of Risk Management Planning
• More efficient, consistent operations. ...
• Increased focus on security. ...
• More confident, successful initiatives. ...
• More satisfied customers. ...
• A healthier bottom line.
 RESULTS

Results of this study indicate that deregulation by itself might not have
had an impact on the corporate risk-taking, however, it created
opportunities to take bigger corporate-risks which many banks started
to exploit.

Those banks that were taking more risk were performing better and
that created peer pressure, which was measured as aspirations based
on industry. Those aspirations had statistically significant results
however, in year 2010 the sign of the relationship changed.

Results of full model suggest that in years 2008 and 2009 it was
imitative behavior that led to high corporate risktaking. Evidence of this
comes from aspirations based on peers’ variable, called Aspirations
Industry Average, was significant. In year 2010, aspirations based on
industry average variable again was significant but it reversed the sign.

This finding suggests that during times of crisis and market decline,
years 2008 and 2009 in the model, aspirations based on peer pressure
push companies to act in established ways, those who have positive
aspirations, i.e. perform worse than average are prone to take more
risk. In fact, as performance deviates from the average, the propensity
to increase corporate risk-taking goes up. At the same time, companies
with negative aspirations, i.e.
companies that are outperforming the industry are not inclined to
pursue strategies with higher corporate risk-taking. However, when
market decline stopped and recovery started, that is years 2010 and
2011 in the model, companies that were performing better than the
industry before, and thus were exhibiting low levels of corporate
risktaking changed their strategies and started to demonstrate more
aggressive corporate risk-taking.

Data suggests that after the crisis, better performing companies, push
the limits of corporate risk-taking, while companies that struggled
through the crisis, pursue very safe strategies with low corporate
risktaking. Another explanation may be the fact that government was
involved with many investment banks that were on the verge of going
bankrupt and thus forced them to play safe.

Also, TARP money was offered to many banks, including the ones that
performed well during the crisis, thus encouraging management to use
low cost capital and take more risk.

An interesting finding o f the full model was that diversification

argument was partially supported and showed that more diversified
investment banks had lower corporate risk-taking levels. An
explanation for this might be that highly diversified banks operate in
many lines of business outside of investment banking, while the
dependent variable, standard deviation of free cash flow, was
measuring free cash flow for the bank as a whole and not distinguishing
across different businesses. Portfolio effect of large number of
businesses has a smoothing effect on income streams, free cash flows
and reported earnings (Skinner & Sloan, 2002).

Size of the board was negatively related to the corporate risk-taking,

which is a finding that goes against the conventional wisdom that large
boards have weaker communication (Herman, 1981), worse
participation of the members (Gladstein, 1984), Ionger decision-making
speeds (Kovner, 1985), worse board involvement levels (Judge &
Zeithaml, 1992b), decrease levels of monitoring and advising (Linck et
al., 2008), and provide weaker growth opportunities (Lehn et al., 2009).

Data suggests that large boards lead to lower corporate risk-taking. One
reason for this finding may be the fact that larger boards take longer to
make decisions; so many risky decisions are postponed or never made.
One person with a low risk-tolerance level in the group can block risky
decisions and thus lead to lower corporate risk-taking.

Ownership of the stock by the board members did not yield significant
results in the model.
Ratio of insiders on the board was negatively correlated throughout
board of directors model and full model.

The relationship was significant and negative for years 2008, 2009 and
2010. This finding suggests that larger number of insiders actually
reduces corporate risk-taking. One possible explanation may be the fact
that insider possess more knowledge about the company and so are
able to make better decisions that lead to reduction in corporate
risktaking. Another explanation may be the nature of the job security of
insiders.

Job security of insiders depends on the risk-level of the corporation

where they work, so there is a direct incentive to make company safer,
and thus reduce corporate risk-taking.

CONCLUSION

This study adds to the discussion of corporate risk-taking behavior and

asserts that risk-taking by firms is due to multiple factors and we need
to develop more complex models to capture effects of all the factors.
Comprehensive approach used in this study with different levels of
analysis, covering institutional environment or macro level, and firm
environment or micro level showed that variables from both levels play
into corporate risk-taking and at different times effects Of those
variables might have different magnitude or change the directions.

Theoretical contributions of this work include analyzing corporate

risktaking phenomena with multiple prisms and methods. This study
provides empirical evidence against the conventional notion
established in the media that current financial crisis was solely due to
deregulation of investment banking.

In fact, findings suggest that deregulation had no immediate effect on

corporate risk-taking, but rather created an environment with many
opportunities. That environment full of opportunities also had peer
pressure.

It was peer pressure of other investment banks and imitative behavior

after “high status” banks that lead to aspirations and eventually to
excessive corporate risk-taking. Interestingly, aspirations based on
banks own past, were not contributing to the levels of corporate
risktaking.

Counterintuitive results were found for the size of the boards of

directors, which, while bring many inefficiencies in decision making acts
as a reducing factor for corporate risktaking.
Path dependent knowledge of a particular industry or type of security,
like CDOs, according to the data had no effect on corporate risk-taking,
while size o f the board of directors had a pronounced effect.

Results suggest that, while larger boards may be ineffective and

expensive to run, they lead to lower corporate risk-taking.

This dissertation also combined two types of aspirations into one

model, and empirical evidence suggested that aspirations based on
peers are more powerful predictors of corporate risk-taking behavior
than aspirations based on past performance.

According to data, both presence and duration of the presence of

specific knowledge of real estate securities that accumulates over time
did not have effect on corporate risk-taking. Overall, results support the
idea that corporate risk-taking is a multidimensional concept and needs
to be studied from several perspectives.

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 Appendix

Q. 1 What is risk management in investment banking?

❖ Credit risk
❖ Bank risk
Q. 2 What are the 4 types of risk management?

❖ Accept, avoid, transfer, reduce

❖ Identification, analysis, tracking, mitigation planning
Q. 3 What is the study of risk management?

❖ Assess, manage
❖ Measure risk

Q. 4 What are the 5 pillars of risk management?

Q. 5 What are the 5 benefits of risk management?

.

Q. 6 What are 6 basic principal of risk management?

Q. 7 What are 8 risk management process?

Q. 8 What are 8 risk categories?

Q. 9 What is the most important risk in banking?

❖ Credit risk
❖ Operation risk
Q. 10 What are 3 risk profiles?