Risk Management and Value Creation in ... - Arabictrader.com

Introduction 3
in financial assets 18 and are, therefore, by definition in the financial risk
business. 19
Additionally, risk management is also perceived in practice to be necessary
and critically important to ensure the long-term survival of banks. Not
only is a regulatory minimum capital-structure and risk-management approach
required, 20 but also the customers, 21 who are also liability holders,
should and want to be protected against default risk, because they deposit
substantial stakes of their personal wealth, for the most part with only
one bank. The same argument is used from an economy-wide perspective to
avoid bank runs and systemic repercussions of a globally intertwined and
fragile banking system.
Therefore, we find plenty of evidence that banks do run sophisticated 22
risk-management functions 23 in practice (positive theory for risk management).
They perceive risk management to be a critical (success) factor that
is both used with the intention to create value and because of the bank’s
concern with “lower tail outcomes”, 24 that is, the concern with bankruptcy
risk.
Moreover, banks evaluate (new) transactions and projects in the light
of their existing portfolio 25 rather than (only) in the light of the covariance
risk with an overall market portfolio. In practice, banks care about the
contribution of these transactions to the total risk of the bank when they
make capital-budgeting decisions, because of their concern with lower tail
outcomes. Additionally, we can also observe in practice that banks do care
18 In order to offer products that are tailored to their clients’ needs, banks need to
transform their “resources” along the following dimensions: term, scale, location,
liquidity, and/or risk itself by originating, trading, or servicing financial assets; see
Allen and Santomero (1996), p. 19.
19 They enable most of the market participants to cope with economic uncertainty by
hedging, pooling, sharing, transferring, and pricing risks. See Harker and Stavros
(1998), p. 2.
20 See, for example, the Basle Accord from 1988 (Basle I), the European Capital
Adequacy Directive (CAD), and the recent discussion on the newly proposed Basle
Accord (Basle II).
21 And many other stakeholders.
22 Over the last ten years, we have seen dramatic improvements in risk measurement
tools to make the risk management in banks more effective.
23 Managing risks has been one of the hottest topics in banking and finance over the
last decade. For instance, Risk Magazine devoted a whole special issue, under the
topic “The Decade of Risk,” to this phenomenon; see Risk Magazine (1997).
24 See Stulz (1996), p. 8.
25 For instance, the concern with credit concentrations to one borrower, region, or
industry is a well-established banking guideline and is also reflected in regulatory
rules (e.g., the “Grosskredit-Richtlinie” in Germany).