Risk Management, Strategic Thinking and Leadership in the Financial Services Industry

As it is well known the international economic landscape has undergone a change and individual countries have slackened by virtue of economic recession after 2008 global financial crisis. In spite of declination in business activities in many industrial countries since 2008, the global economic recovery is developing and it is estimated to be sustained for keeping up with the international trade. In contravention of many years that passed after economic turmoil which has cost millions of jobs, the economists have been still preoccupying with crisis effects on global economic outlook. This chapter draws attention to some of the economic reports that should be taken into consideration for financial services industry. Moreover the current and expected economic situation is discussed by reviewing reports.

For strong and sustainable growth finance must be inclusive. Individuals and companies should have equal opportunity on accessing markets and resources. Financial inclusion does not mean pushing access for the sake of access, and it certainly does not mean making everybody borrow. For inclusive economic development, inclusive finance is a necessary criteria. Growth becomes inclusive if it is supported by structural reforms. The main purpose of this chapter is to explore the terms of sustainable and inclusive finance and assess the underlying role in the developing countries especially in Turkey and to reveal the current situation and further possibilities.

After the Great Recession of 2008–2009, advanced economies of the West predominantly went by the Keynesian expansionary policies. Nowadays, though, the monetary policies are diverging. Central banks are diverging on their policies as the global economies continue their significant downward convergence trend. More than 40 central banks have eased their monetary policy in 2015. The ECB, the PBOC and the BOJ are expected to ease further looking forward. Central Banks of many other emerging markets and those of advanced economies such as the USA and the UK are expected to tighten. Uncertainties about the future decrease risk appetite. Capital outflows from emerging markets and fall in trade volumes follow.

Businesses that trade internationally or have undertaken ventures overseas are likely to be exposed to foreign exchange risk on account of unpredictability in the currency markets. The usual source of exposure to foreign exchange risk arises from having to make overseas payments for your imports priced in a foreign currency or receiving foreign currency receipts for your exports. If the sum that a company expects to receive falls because of a change in the exchange rate, then it will find that its profits are squeezed even if costs remain unchanged. This paper basically deals with the measurement and management of the financial impact of international operations, particularly with reference to exchange rate risks. Exchange rate risks are classified under the broad headings : economic, transaction, and translation risks. Section 3 takes up the issue of measurement of economic, transaction and translation exposure. Control of the impact is assumed to operate through the application of hedging techniques, the most important of which are described in some detail in Section 4. A recent chronicle of foreign exchange risk management in the Indian context has been discussed in Section 5. This paper ends with a conclusion.

Dollarization which is mostly observed in developing countries has been a widely disputed topic in the literature. It occurs due to high inflation and macroeconomic instabilities. In the previous studies the effects, causes and determinants of dollarization were analyzed using the econometric techniques such as co-integration, vector error correction model and vector autoregressive models for multivariate time series methods. We investigate the relationship between dollarization and its determinants such as interest rate differential, Istanbul stock exchange index, central bank reserve ratio, expected inflation, expected depreciation and volatility index using data between 2001 and 2014 for Turkish economy using Geweke linear feedback, causality tests in frequency domain and the wavelet comovement analysis.

This chapter reviews capital allocation in the banking sector. Capital is crucial if banks are to be protected from banking risks. In order to ensure financial stability in the banking sector, banking regulators demand that banks hold sufficient capital to support their risks. The Basel Capital Accords, which aim to enhance the risk management functions of banks and to strengthen the stability of the international banking system, have introduced a common regulation framework for the capital allocation. They are international guidelines to encourage convergence toward common standards in the banking sector. The Basel Capital Accords have evolved over time because of the growth of international risks.

This study explores the calibration of market risk measures during period of economic downturn. This calibration is done in two frameworks: firstly individual profit and loss distribution is modelled using two different types of extreme value distribution namely: the generalized extreme value (GEV) distribution, and the generalized Pareto distribution (GPD). The resulting shape parameters are all positive indicating that these distributions can in fact capture the negative skewness and excess kurtosis of the profit and loss (P&L) distribution during period of economic downturn. We show that the presence of such positive shape parameters indicates the existence of large probabilities of extreme price drops in the left tail of the P&L distribution. Based on these results the second framework used in this study builds two multivariate copula distributions with GEV and GPD marginals. This procedure captures the dependence structure of stock markets during periods of financial crisis. To illustrate the computation of market risk measures; we consider one elliptical copula (student t copula) and one Archimedean copula (Gumbel copula). Using two stock market indices we compute what we refer to as EVT based mark risk measures and the copula based market risk measures for both the left and right tails of the P&L distribution. Our results suggest that copula based risk measures are more reliable in predicting the behavior of market risks during period of economic downturn.

Under Basel III the minimum capital requirement due to operational risk is computed as the 99th quantile of the annual total loss distribution. This annual loss distribution is a result of the convolution between the loss frequency and the loss severity distributions. The estimation of parameters of these two distributions i.e. frequency and severity distributions is not only essential but crucial to obtaining reliable estimates of operational risk measures. In practical applications, Poisson and lognormal distributions are used to fit these two distributions respective. The maximum likelihood method, the method of moments as well as the probability-weighted moments used to obtain the parameters of these distributions can sometimes produce nonsensical estimates due to estimation risk and sample bias. This paper proposes a different calibration of the frequency and the severity distributions based on Bayesian method with Gibbs sampler. Further to that, the paper models the severity distribution by making use of the lognormal and the generalised Pareto distribution simultaneously. Simulated results suggest that computed operational value at risk estimates based of this new method are unbiased with minimum variance.

We consider a risk-averse investor whose investable assets are held in a perfectly liquid asset (a portfolio of cash and liquid assets or a mutual fund) and another investment that has liquidity restrictions. The illiquidity could be due to restrictions on the investments (such as hedge funds) or due to nature of the asset held (such as real estate). The investor’s objective is to maximize the utility he derives from his terminal wealth at a future end date of his investment horizon. Furthermore the investor wants to hold his liquid wealth above a certain subsistence level, below which he incurs hefty borrowing costs or shortfall penalty. We consider the optimal conditions under which the investor must liquidate his illiquid assets. The redemption notification problem for hedge fund investors has certain affinity with the optimal control methods used in widely studied inventory management problems. We find that the optimal policy has a monotone structure similar in nature to inventory management problems.

Derivatives are financial instruments that derive its value from underlying asset such as bond, loan or credit. Credit derivatives are a subgroup of derivatives and mainly consist of credit default swaps, credit linked note, credit swap options and collateralized debt obligations. Credit derivatives market has experienced an exponential growth in recent years. From almost nothing in 1990s, approached to $60 trillion in 2008. Growth was particularly strong in credit default swaps. Force behind this fast growth is rising demand for hedging and transferring the credit risk. After the credit crisis, misuse of credit derivatives and insufficient regulations are come into light and mostly argued. Many claimed to ban these instruments whereas many other tried to find alternative solutions. The purpose of this paper is to explain the issue of credit derivatives, their mechanism and their role in financial system and global credit crisis.

The number of insurance companies in Indonesia has been increasing over the years. This is a good indicator of the society’s awareness ofthe importance of insurance. In order to ensure the sustainability of acompany as well as its customers’ safety, the insurance companies have to maintain the quality of their performance. To deal with this, the Financial Service Authority (OJK) of Indonesia needs to monitor the risk level of each insurance company. For the company, financial risk analysis is required to formulate strategies for reducing its risk. Financial risk analysis is also important for prospective investors or creditors as one of the considerations to formulate a business plan with the company. This chapter introduces an approach to measure financial risk through financial performance data as reported in the company’s annual report. In this case, the risk variables in the balance sheet are available only on a yearly basis, and hence, a time series based approach for measuring risk, such as Value at Risk (VaR), cannot be applied. The limited number of series will explode the variance estimate of the parameter distribution used to calculate VaR. As an alternative, the risk can be measured by an index showing the financial risk of a company relative to the others. The fact that financial risk is a latent variable, which can be measured only through its indicators, leads to the idea of calculating the index by using the concept of the Confirmatory Factor Analysis (CFA). This chapter applies that idea to calculate the financial risk relative indices of life insurance companies in Indonesia. This approach offers another benefit, the ability to investigate variables which significantly contributes to increase the risk. The analysis shows that a company is said to have a high financial risk relative to the others if the index is below 0.29.

EVT works on extreme affairs and those affairs are generally classified as outliers. Although in some analyses it is preferred to exclude extreme events, oppositely EVT directly focuses on extreme events and analyze them. Financial data also contain outliers due to crashes, breaks and peaks. Since extremal events are more commonly seen in financial data than many other data types and excluding of those results in under or overestimation, academicians and financial institutions utilize EVT especially in risk management as a contributing function to Value-at-Risk. Additionally, distribution characteristics of financial data which do not fit normal distribution are other major points to use EVT. The finance literature on EVT indicates the EVT does the best especially in fat-tail modeling and extremal event analysis.

This paper investigates the issue of market risk quantification for twelve emerging market equity portfolios during the FED tapering period. The performance of most popular VaR methods, namely Variance-Covariance, Classical and Weighted Historical Simulation Methods are compared. The results indicate that Classical and Weighted Historical Simulation outperform Variance-Covariance VaR. Kupiec back testing is supporting this argument. In the second stage of analysis, VaR performance of equally weighted equity index and US Government Bond portfolios are analysed. We obtain lower VaR values than equity portfolios. Russia, Turkey and Brazil are the worst performers out of 12 countries. The performance of portfolios are measured by Sharpe ratio and VaR adjusted Sharpe Ratios and found parallel rankings.

This chapter aims to measure the company-level informational shocks based on the jump dynamics of stock price around earnings announcement in emerging economy using high frequency data. Besides, it intends to show the profitability of earnings announcement strategy that uses jumps as trading signal. For this, the chapter divides earnings announcements as “Good” and “Bad” news and tests how jump behavior changes in accordance to “Good” or “Bad” earnings news. In another words, the chapter tests the presence of the post earnings announcement drift anomaly in Turkish Stock Market through characterizing the jumps and cumulative abnormal returns of individual stocks around the announcement days. The results show that there is a discrete jump in the stock price around both “Good” and “Bad” earnings announcement in emerging economy. The cumulative abnormal returns response significantly to “Bad” earnings news for the event window which support the validation of post earnings announcement drift anomaly in Turkish Stock Market. It can be conclude that investor can take short position in Bad earnings news to make a profit.

Hedging without giving regard to what competitors are doing may actually increase the variance of profits as opposed to decreasing it. In this study, a market maker and an individual firm are taken as the players of a simultaneous game. We explore the impact of competitors’ hedging practices on the optimal hedging policy of an individual firm by explicitly considering the other factors such as the level of pass-through of cost shocks and the level of profitability in the industry. Computational results are based on the simulations of an analytical model which incorporates a Nash equilibrium strategy.

Development of options markets has been rapid and constant development has led to innovations in the financial sector in recent decades. Despite the fact that innovations are far from complete, this chapter aims to address the prominent options strategies and exotic options. The way they are priced is questioned and behavioral approaches are addressed. Speculative nature of exotic options and financial instability relationship is discussed.

The audit has become an integral part of many activities in various fields related to business life from the past to present. Fundamental changes have been experienced in the concept of audit due to several reasons such as accounting scandals, changes in management mentality, technological developments and legal regulations experienced especially in recent years. Along with these changes, risk-based audit approach focusing on uncovering the risks of business and how to manage these risks has developed beyond the issue of benefiting from the previous period data envisaged by the traditional audit approach.

The risk-based audit is a process containing important stages such as identification, classification, and measurement of risks and determination of their weights. At the end of this process, it is possible to have considerable knowledge to what extent stress should be laid on which risks by ranging the risks identified for business according to their probability of realization.

Structured finance techniques, especially synthetic structuring, were applied intensively to ensure sustainable growth of credit mechanism via developing high rated hybrid instruments before recent global shock. The system created a loop that caused systematic risk maximization derived from undesirable default correlation between collaterals. Therefore structured products were seen as the reason for financial crisis and their popularity has begun to fall. On the other side, discussions have started to take place within accounting dimension in recent years. The fundamental point of this perspective was constructed on the efficiency of accounting techniques to provide signals on future hitches and to make market participants properly informed about the values of collaterals. In this study, the tradeoff for applying fair value versus historical cost accounting is discussed in the frame of the connection between recent global shock and structured finance.

The digital age, with decreasing barriers to entry, paving the way for low-cost competition, saw an influx of new financial products and services globally. Soon the increasingly technology-driven financial landscape transformed itself with the democratization of finance diffusing to all levels of society. The standing rules and regulations of financial markets were confronted with an epitome of complexities marked by higher transparency, increased efficiencies, a wide range of substitutes, abundant information, a huge number of stakeholders and a bulk of aspiring entrepreneurs. However, a new game necessitates new rules, and a considerable disruption in old ways of doing is sure to witness unorthodox problems that need to be dealt with, and preferably foreseen, through a different lens. Sooner or later, these new digitally enhanced financial markets are destined to break down, dragging down everyone who once had faith in them, if not supported by proper compliance and corporate social performance and reporting standards. This chapter explores newly emerging trends in compliance and reporting standards for financial institutions.

Risks in the rapidly increasing global business environment began to receive more attention among both researchers and practitioners illuminating the delicate balance between enterprise efficiencies and risk economies. However, Risk Management, in recent years, are becoming more complex to analyze and more challenging to manage and optimize.

Besides that, risk and uncertainty concept have always been a significant concern not only for private sectors and public sectors but also for non-profit organizations (NPOs) sector. In this chapter, the potential risks and their drivers are identified, assessed and ranked for a wide spread and most effective for a non-profit organization which aims to bring together native and foreign students for creating a bridge of humanity and education. After investigating the key control measures of major sources of risk, risk management processes and strategies were developed. To provide analytical results, Analytic Hierarchy Process (AHP) used by utilizing the questionnaire technique.

Strategically planned and implemented risk management paves the way for competitive advantage and a decisive edge for global financial institutions. The importance of risk management becomes more evident in financial instability periods. The failure of global financial institutions in the recent financial crisis revealed that firms with strong risk management and culture were more prepared and economically less damaged. As financial institutions have been criticized severely about risk management practices, it also becomes clear that most financial institutions have difficulties in developing a risk management culture. To have a clear understanding of risk management culture, the chapter aims to highlight a need to extend our understanding of risk management culture and how it can find a voice in the strategic planning of global financial institutions.

As a result of the economic, social and cultural reflections of the rapidly developing information and communication technologies, a new social reference was developed based on information society which is a an intellectual reformist domain paradigm which can also be called as the information age. In this radical transformation process, where information becomes a strategic resource including information and communication technologies in its center, economic, social, political and cultural lives were deeply affected. The changes and developments in social dynamics also affected the structure of the organizations, their management understanding, the technologies used and the employees while the organizations had to re-design their functions and the managers had to re-design their roles. More importance was given to the intrapreneurship and leadership qualities of the managers who can adapt to the changing competition conditions in the organizational sense in the information society. This destructive change in the operation and management techniques also affected the economy theories and was affective in the development of endogenous growth approach. In this section, we draw a conceptual framework between leadership and managership, discuss personal characteristics of the chief officers and financial managers, the leadership of the time while looking for a place for these concepts within Schumpeter’s approaches and endogenous growth theories.

The financial services industry is one of the most critical pillars of economic growth and sustainable development in any country. As such, the findings of the 2016 Edelman Trust Barometer, that measures trust in institutions with more than 33,000 respondents in 28 countries over the last 15 years, are highly alarming. Accordingly, the financial services industry is ranked among the lowest with a mere 51 % on a global basis. Despite this darkened outlook, areas exist that seem to be promising: Sustainability management, responsible innovation and the organized and systemic efforts to increase transparency, comparability, accountability and reliability. Although the recent crises in financial markets have led regulators to come to a general agreement that a mutual effort is needed to develop procedures for increased compliance standards, and increase the pace of harmonization in accounting and financial reporting standards, the industry is faced with an imminent challenge: The low levels of trust in financial services. In this chapter, the author discusses how to re-build trust and reputation of the industry.

Recently, studies on the effects of cultural factors on corporate financial decision-making have emerged in the finance literature. Culture shapes behaviors of people and distinguishes members of one group or category from another. The decision-making process depends greatly on cultural background. Executives’ financial decisions show variance from society to society as a result of their cultural differences. The objective of this study is to point out the effects of national culture on financial decision-making. We examined Hofstede’s cultural dimensions among 20 countries around the world to explain the variation of financial decisions based on cultural differences. According to our results, power-distance has an effect on all financial decisions included in the study, except for the capital structure. Individualism also has an influence on all the financial decisions we analyzed, except for Research & Development (R&D) expenditures. Uncertainty avoidance is found to have an effect on all of the financial decision parameters included here, except for discretionary accruals, which are an indication of a firm’s earnings-management decisions and can be considered as a clue for manipulation of earnings. Masculinity is found to have an effect only on capital structure and working capital level.

Together with the globalizing economy, it is no more possible for any system to survive by ignoring the market changes and transformations. A change taking place anyhow in any place of the world triggers complex processes and affects everyone by growing in waves. Successful ways of business conduct of today is based on predicting the growth speed of these waves and on the ability to carry out strategic cooperations and manoeuvres accordingly. Sometimes these fluctuations also trigger serious crises. Apart from the shocks created in organizational structures, periods of crisis have complex effects on people. Some people approach to these events in hesitation, while other people or organizations happen to have skills to turn these processes into opportunity. The practical examples show that the organizations that adapt to new condition by getting simpler and getting rid of burdens in the constriction process are able to come out in a better condition before the crisis. This section discusses the way of organizations to become human oriented when acting strategically during strategic alliances, cooperations and manoeuvrings.