Risk Management Banking

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Date Submitted: 02/22/2011 11:14 AM

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Risk Management in Banking

Elmer Funke Kupper *

1. Introduction

The Asian financial crisis is yet to run its full course, but is already one of the largest crises in the post-war era. It severely affected the performance of the region and created an economic downturn that impacted on financial institutions worldwide. At the same time, the failure of Russia to deal with its deteriorating conditions led some hedge funds and leading international banks to announce substantial losses. Moreover, these events occurred at a time when financial markets were still trying to cope with the contagion effects that shook the economies of Latin America. Clearly, recent events have unfolded in a way that most institutions and governments did not expect. Yet, while the specific circumstances of the crises are certainly unique, the reactions of financial institutions were somewhat predictable. Immediately following the outbreak of the Asian crisis, credit standards were tightened and lending growth was curtailed. Some banks seemed to withdraw to their home markets, which looked more stable and attractive in the short term. These measures are very similar to the ones taken during the Latin American debt crisis in the 1980s or the global property downturn in the early 1990s. Banks in countries like France, Sweden and Australia were hit hard by the latter and imposed tight credit controls while they worked through their portfolios of bad loans. Figure 1 presents some of the key events that have impacted on the way financial institutions do business. Australian GDP growth is used simply to


Figure 2: Breaking the Vicious Cycle of Risk

Take uneconomic risks

Drive marketing aggressively

Incur large losses

Lose market share Forego economic risks

Clamp down on lending/ trading

highlight the cyclical nature of these occurrences. Looking back at these events, the behaviour of banks seems countercyclical. Banks are happy to participate in excessive growth under the...