Lecture4 - 9/10/2010 MGMT 4370 / MGMT 7760 Risk Management...

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9/10/2010 1 MGMT 4370 / MGMT 7760 Risk Management Aparna Gupta Lally School of Management and Technology Office: PITTS 2104 Email: guptaa@rpi.edu Phone: x2757 A Look into the Past • Crash of 1929 and ensuing economic crisis led to major changes in bank regulations in the US • The focus was on ‘ systemic risk • Systemic risk is the risk of collapse of the banking industry at a regional, national or international level. • The concern was to prevent a ‘ Domino Effect • 1933 establishment of FDIC (Federal Deposit Insurance Corporation) improved the safety of bank deposits
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9/10/2010 2 A Look into the Past • 1933 Glass-Steagall Act separated commercial banking from investment banking activities – commercial banks were barred from dealing in equity and from underwriting securities • These above steps reduced risk in banking operations, but also reduced competition • The 1956 Bank Holding Company Act and 1970 Amendment restricted non-banking activities of commercial banks – motivation was to protect banks from idiosyncratic risk , or specific risk , which may then affect the entire banking system A Look into the Past • In 1951, interest rates were no longer pegged and did start to be used as a tool in the monetary policy of the Federal Reserves – They became more volatile ! – The volatility intensified in 1970s and 80s. And hence began a new era. • In the late 1960s, the regime of fixed exchange rates broke down due to global economic forces broke down due to global economic forces. – Hence the exchange rates became volatile. • These were major steps of liberalization of the financial markets.
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9/10/2010 3 A Look into the Past • These shifts precipitated in a string of novel financial contracts , also by banks. • Creation of Markets for the new contracts by Exchanges. • This process has only intensified since! • In 1995 BIS (based in Basel, Switzerland) did the first major survey of derivative markets – The global market of OTC derivatives amounted to $47 trillion, of which $12 trillion was booked in the US! – It has increased at a rapid pace since. A Look into the Past • Non-financial firms also engage in large daily volumes in Foreign currency ($168 billion) and – Foreign currency ($168 billion) and – Interest rate ($27 billion) products • The exposure for foreign currency risk is higher than interest-rates. • Entry of foreign banks and the trend of mergers and globalization leads to greater exposures to risks.
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9/10/2010 4 How the Risk Management environment has evolved? • Significant structural changes in the international banking system in the last 25 years: – Major bank mergers – Institutions have become global – Emergence of large multinational corporations – Technological advancements in computerized information systems – Mergers and alliances with insurance companies Competition has increased
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Lecture4 - 9/10/2010 MGMT 4370 / MGMT 7760 Risk Management...

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