Gfc and the Risk Management

Abstract

It is evident that the poor investment decisions yielded substantial losses for financial institutions in the credit market thus triggering the Global Financial Crisis (GFC). The liquidity crisis that led to the GFC traces its origin to personal ethics, organisation ethics and the social context of ethics. It suffices to state that the excessive desire of individuals to obtain more money from assets in the credit market contributed towards the onset of the GFC. However, organisations also played a substantial role towards the crisis. Poor governance and leadership among financial institutions resulted in the implementation of ineffective hedging techniques that subjected the organisations to liquidity risk. The decision of organisation managers to rely on optimistic assumptions subjected the financial institutions to excessive credit risks. The managers assumed that the Credit Default Swaps had eliminated the firms' risks because there were other mechanisms that could re-introduce the risks.

The difference between the anticipated risk context and the actual context led to the crisis. The perverse incentives offered by the institutions led to the emergence of the risks. Even though the firms had expected positive results from the incentives, the eventual turnout of events was unexpected. In the case of the rating agencies, inadequacy of the models and the inexperience in handling the parameters of the models compelled them to conflict with their clients during the GFC. Controlling the global economy is a challenging endeavour. Regulatory arbitrage also contributed towards the occurrence of the GFC. Different countries have different economic control systems. In fact, some countries have designed specific operations that circumvent the universal controls for a global economy. Consequently, the lack of transparency emanating from information concealment and opacity of activities on the part of shareholders, regulators and customers makes it difficult to control the global economy.

                                                                   CONTENTS

1. Introduction……………………………………………………………………………...1

1. Risk Principles in the Global Financial Crisis………………………………………....2

1. Case Studies……………………………………………………………………………....3

1. The Failure of Derivative Products in Risk Management…………………………….4

1. The Interconnectivity between operational risk, liquidity risk, credit risk and systemic risk………………………………………………………………………….......5

1. The Role of Governance and Non-Regulatory Compliance…………………………..6

1. The Role of ISO31000: 2009 in Global Risk Management……………………………7

1. References………………………………………………………………………………...8

1. Introduction

The global financial markets succumbed to significant fear following the downfall of the Lehman Brothers in 2008. The resultant impact was evident. The collapse paralysed the lending system of banks since they could no longer issue credit funds to one another. The risk premium that banks and other financial institutions attached to the loan process underwent a significant increase from almost 0% to 5%. Trade credit for manufacturing products and investment commodities stopped. The occurrence of the events resulted in the suppression of the global economic activity. It is evident that the GFC caused a major economic recession in the majority of the developed economies. The decision of governments to ease the fiscal and monetary policy was a response to the crisis. The states wanted to reduce the trend of the rapidly declining trade volumes since it impacted negatively on the global economy. The unemployment rate rose sharply following the decline in the trading activity. The battle towards a stabilised economy compelled governments to protect their domestic economies and prevent the further deterioration of trading activities.

The essay contains six parts. The first part discusses the risk principles in the GFC. Secondly, the essay analyses three case studies that triggered the onset of the crisis. The third part constitutes an analysis of the role of financial engineering in the emergence of the GFC. It focuses on the use of derivative type products, collateralised debt products and contracts for differences in the crisis. The fourth part discusses the interconnectivity between operational risk, liquidity risk, credit risk and systemic risk. Moreover, the essay discusses the role of governance and non-regulatory compliance in risk management. Finally, the essay provides the ISO31000:2009 recommendation on the practical global risk management standards.