For the financial institutions, risks are the events that can adversely affect the performance or reputation of the institutions. Risks are dangerous in that in a worst case situation, it can bring businesses to closure. The paper seeks to understand how the banks and other financial institutions manage the risks to ensure that they do not adversely affect business operations. It also seeks to understand the need for regulating financial institutions locally as well as in the international market.
The first approach to risk management is risk avoidance. This involves financial institutions failing to engage in business activities that expose them to certain risks. They make an effort to evaluate creditors and ensure that they have the ability to repay loans, or ensure that they have securities to recover loans. Other assets that are viewed to be risky are eliminated in the financial institutions to ensure that the risks that the institutions face are the ones that cannot be avoided only.
The second approach to management of risks is risk transfer. This involves transferring risks to a third party, such that in the case of occurrence of the peril, the losses incurred are born by the third party, or the losses are shared with the third party. An example is where the financial institutions insure their loans with insurance companies to ensure that if there is loan default, then the insurance companies can be responsible. Additionally, the insurance companies can re-insure to share their risks with a bigger financial company. This encourages financial institutions to engage in risky business activities without the fear that certain transactions can make them leave the market.
The third approach the companies use is acceptance and actively managing the risks. The financial institutions cannot avoid all the risks, and insuring them or transferring them to other parties is more expensive. They have to deal with the risks on a daily basis ensuring that the losses resulting from the risks are taken care of accordingly. An example of such risks includes the chances that the employees will make mistakes or steal from the financial institutions. Such risks are handled in a daily basis since insuring them is not a reasonable approach.
Finances in a nation are an important issue since they can affect the economy of a country as it occurred in the US in the financial crisis. As such, the control of financial institutions ensures that companies engage in activities that are not very risky for the company and the customers. In the global market, the flow of funds has become easy, meaning that a financial crisis in one country affects other nations a country trades with. As such, there is a need to have an international financial regulator to regulate international transactions. This may be a difficult and challenging task but is necessary in the modern world.
Based on the analysis, it can be seen that risk management is an important activity in financial institutions. The three basic approaches are risk avoidance, risk transfer and risk acceptance and management. The financial institution has to be creative to develop products that are less risky and profitable for the businesses. In the global market, the financial institutions have to e controlled from the national and international level because the financial activities in a certain country affect people in various countries. From the policy perspective, the implications of the findings are that governments are expected to collaborate to regulate international transactions because it affects all countries in the global market.
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