Risk Management Case Summary

This study is the primary research on the markets for bank equity to analyze the dynamics of market discipline in a post reform period. A significant relationship between the risk factors and cost of fund has been developed in this paper. The concept of market discipline was introduced by the Pillar III of Basel Accord II in order to provide transparent information to the investors to evaluate the bank. It comprises of two mutually independent aspects which are:

Discipline of imposing Higher Cost of Funds: The first aspect is related to the ability of stakeholders to monitor and identify any changes in the banks fundamentals

Penalizing bad banks by Deposit Switching: The second aspect is concerned with the power of these stakeholders to influence actions of bank management by manipulating their required rate of return.

Since, the focus of the research is on banks equity that is why if we look at the financial system of developing countries then we can see that in these countries indirect financing is done through banks mainly because the banks are regarded as more expert in minimizing the transaction costs, adverse selection and moral hazards. But a main disadvantage also arises from tendency of excessive risk taking behavior of these financial intermediaries. To avoid various types of risks in the financial sector various instruments of control are used to ensure adequate risk absorption capacity which includes capital adequacy, statuary reserve requirements and minimum paid-up capital. Also, the need for development of a strong stock market cannot be ignored with this all because the stock price formation process is reflected in the perspective of the investor about the future of a firm. Stock prices reveal important risk related information and banks offer compensation when they are perceived risky. Analysis of the market activity shows that there was where a huge failure to raise capital and due to this market discipline cannot be expected to be into its...