Risk Of Financial Institutions Research Articles

Best execution compliance automation: towards an equities compliance workstation

PurposeForthcoming requirements in MiFID and RegNMS mean that buy‐side and sell‐side firms need to find ways of showing regulators that they are sifting through their trading volumes in a justifiable, methodical manner looking for anomalous trades and investigating them, in order to prove “best execution”. The objective was to see if a SVM/DAPR approach could help identify equity trade anomalies for compliance investigation.Design/methodology/approachA major stock exchange, a computer systems supplier, four brokers and a statistical firm undertook a cooperative research project to determine whether automated statistical processing of trade and order information could provide a tighter focus on the most likely trades for best execution compliance investigation.FindingsThe support vector machine approach worked on UK equities and has significant potential for other markets such as foreign exchange, fixed income and commodities.Research limitations/implicationsThe research has implications for risk professionals as a generic approach to trading anomaly detection. The prototype compliance workstation can be trialed.Originality/valueAutomated anomaly detection could transform the role of compliance and risk in financial institutions.

The Risks of Financial Institutions

Over the last twenty years, the consensus view of systemic risk in the financial system that emerged in response to the banking crises of the 1930s and before has lost much of its relevance. This view held that the main systemic problem is runs on solvent banks leading to bank panics. But financial crises of the last two decades have not fit the mold. A new consensus has yet to emerge, but financial institutions and regulators have considerably broadened their assessment of the risks facing financial institutions. The dramatic rise of modern risk management has changed how the risks of financial institutions are measured and how these institutions are managed. However, modern risk management is not without weaknesses that will have to be addressed.

Measuring Operational Risk in Financial Institutions: Contribution of Credit Risk Modeling

The new Basel II Capital Accord incorporates an explicit capital requirement for operational risk into its proposed capital framework. Unfortunately, although the advanced approaches for the measurement of operational risk evolve rapidly, the absence of reliable internal operational loss databases in many financial institutions is likely to hinder the use of these models. As there is a much greater variety in credit risk modeling approaches, this paper explores the possibility of applying a properly modified version of CreditRisk+, one of the most popular credit risk models, to operational loss data. To assess its usefulness, our this paper investigates the fitting quality of an adapted version of CreditRisk+ on simulated databases generated from three known distributions with thin, medium and fat tails. Our results show that our adapted model, OpRisk+, is able to work out very satisfying Values-at-Risk at 95% level as compared with a lower bound issued from the IMA approach of Alexander (2003), and with the sophisticated approach advocated by Chapelle, Crama, Huebner and Peters (2005). The OpRisk+ approach proves to be extremely worthy in the case of small samples, where more complex methods cannot be applied. This suggests that OpRisk+ can be used in many instances to fit the body of the distribution of operational losses up to the 95% percentile, and Extreme Value Theory or external databases should be used beyond this quantile.

Risks of Water Scarcity Report: A Business Risk for Financial Institutions

Risks of Water Scarcity Report: A Business Risk for Financial Institutions

Default Risk Sharing Between Banks and Markets: The Contribution of Collateralized Debt Obligations

This paper contributes to the economics of financial institutions risk management by exploring how loan securitization a.ects their default risk, their systematic risk, and their stock prices. In a typical CDO transaction a bank retains through a first loss piece a very high proportion of the expected default losses, and transfers only the extreme losses to other market participants. The size of the first loss piece is largely driven by the average default probability of the securitized assets. If the bank sells loans in a true sale transaction, it may use the proceeds to to expand its loan business, thereby incurring more systematic risk. We find an increase of the banks' betas, but no significant stock price e.ect around the announcement of a CDO issue. Our results suggest a role for supervisory requirements in stabilizing the financial system, related to transparency of tranche allocation, and to regulatory treatment of senior tranches.

Re‐assessing 21st century risk: assessing risk in financial institutions – facing up to the banana skins

Every year the think‐tank, the Centre for the Study of Financial Innovation, produces a survey which highlights the major areas of risk which financial institutions are worried about. This article charts the findings of the latest survey and finds, amongst other things, that regulation is now seen as a risk.

Accounting for Value at Risk in Financial Institutions' Portfolios

One of the most important developments in portfolio risk management in the 1990s was the increased use of Value at Risk (VaR). VaR has enjoyed a spectacular rise, from being largely unknown at the beginning of the 1990s, to prominence among financial institutions and, more recently, also in the corporate world. VaR is particularly useful because it measures aggregate portfolio risk by accounting for correlations between the individual risk factors in a portfolio.

A Comprehensive Model for Managing Credit Risk on Home Mortgage Portfolios

Managing credit risk in financial institutions requires the ability to forecast aggregate losses on existing loans, predict the length of time that loans will be on the books before prepayment or default, analyze the expected performance of particular segments in the existing portfolio, and project payment patterns of new loans. Described in this paper are tools created for these functions in a large California financial institution. A forecasting model with Markovian structure and nonstationary transition probabilities is used to model the life of a mortgage. Logistic and regression models are used to estimate severity of losses. These models are integrated into a system that allows analysts and managers to depict the expected performance of individual loans and portfolio segments under different economic scenarios. With this information, analysts and managers can establish appropriate loss reserves, suggest pricing differentials to compensate for risk, and make strategic lending decisions.

Valuation effects of the FDIC Improvement Act

The FDIC Improvement Act mandated key provisions that affect the potential performance and risk of financial institutions. Our study measures how the signals pertaining to the FDIC Improvement Act affect the share prices of financial institutions. We find that the Treasury's proposal for bank reform favourably affected small and medium banks, but negatively affected large banks. The differential effects are likely attributed to the relatively lower capital ratio of large banks. A cross-sectional analysis confirms that the commercial banks with a relatively high capital ratio experienced a more favourable share price response to the Treasury's proposal.

Rethinking Risk Management

The purpose of this paper is to bring together the ideas of those who currently practice the many different forms of risk management on a global basis. These forms include guidance of public policy on macro risks, risk financing and insurance for many larger commercial organizations, managing credit, currency and interest rate risks for financial institutions, plus other extensions of risk management including security, quality control, and quality assurance in a health-care environment.

Operational Approaches to Risk Management in Financial Institutions: A Technique for Commercial Banks

This article provides an overview of operational approaches to risk in financial institutions along with a more specific look at risk in banking. The coverage includes traditional approaches to the subject and more recent developments such as the use of computer simulation models.

Capital adequacy and the regulation of financial intermediaries

This paper investigates the impact of capital requirements and market power on the risk of financial institutions in the Middle East and North Africa (MENA) region. We test the hypothesis that capital requirements have a significant effect on risk behavior of both Islamic and conventional banks in the MENA region. We also investigate the moderating effect of market power on the relationship between capital requirements and bank risk. Our analysis indicates that capital ratio has a strong positive impact on the credit risk of conventional banks, whereas this effect is insignificant in the sample of Islamic banks. For the conventional banking sector, the increase in the capitalization level imposed by the regulators is negatively linked to the credit risk level only for banks with high market power. Regarding the IBs behavior, that the relationship between capital ratio and credit risk is not moderated by market competitive conditions. This means that Islamic banks are less sensitive to the conditions of market competition in the MENA countries but strongly depend on the regulatory authorities’ initiatives. Our findings inform the policymakers and regulators concerned with improving the banking sector’s stability in the MENA region to set their policy differently depending on the level of banking market competition.