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Lecture4 - MGMT 4370 MGMT 7760 Risk Management Aparna Gupta...

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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: [email protected] 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 l b li ti l d t t t i k 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 Corporations are finding it easier to raise money from
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