A CRITICAL POST-GLOBAL-CRISIS ASSESSMENT OF THE CREDIT RISKS OF INVESTMENT BANKING AND TO WHAT EXTENT DOES IT AFFECT THE BANKS LIQUIDITY? A CASE OF DEUTSCHE BANK AG.
A CRITICAL POST-GLOBAL-CRISIS ASSESSMENT OF THE CREDIT RISKS OF INVESTMENT BANKING AND TO WHAT EXTENT DOES IT AFFECT THE BANKS LIQUIDITY? A CASE OF DEUTSCHE BANK AG.
1.0 Introduction
Investment banking can be defined as a specific division of banking that is associated to the making of funds for other companies. This task is normally executed by Investment banks through the underwriting of new debts and equity securities for various types of corporations. Stock placements by issuers are also provided with guidance by investment banks. In some instances, Investment banks also aid in the sale of other companies’ securities and at times their own. Mergers and acquisitions are sometimes facilitated by investment banks. In the execution of the above stated tasks, risks are bound to be experienced. These risks are thus referred to as credit risks of investment banking. They are normally in the form of defaults of any type of debt by a borrower of funds. In the recent past, there has been a global-crisis with regards to investment banking. His warrants a critical post-global-crisis assessment of credit risk of investment banking.
1.1 Action plan
Due to the 2007/2008 global-crisis in regards to investment banking, a keen assessment will reveal the contributors to the said state. This will see the adoption and implementation of the said strategies hence enhancing a reduction or elimination of some of the credit risks in investment banking. Through the above action plan, banks’ that deal with investment banking will have their liquidity status on check. They will always have cash or assets to meet instantaneous and short-term liabilities. Investment banks thus need to support the noble course of research geared towards unearthing the credit risks that threaten their daily business operations.
1.2 Rationale of credit risk assessment
When Investment banks assess the risks associated with credit lending, it eliminates various unseen and unnecessary risks. It also increases a bank’s profitability based on their credit portfolio. Banks will also manage to significantly reduce most of their operational costs. The main reason for the assessment will also be the enhancement of efficient client prospecting. This is very crucial because, finding the right clients to lend means a great reduction in the default rate. Client prescreening takes the banking business to its next level. Defaulters will be easily eliminated even before lending begins. This saves the bank losses in the long run since both a capital is not released, and administrative costs are avoided.
1.3 Research Objectives
This research targets the below stated objectives:
• To critically analyze the major credit risks of investment banking.
• To propose strategies for investment banks to adopt to minimize their credit risks.
1.4 Research questions
The research aims at clearly addressing the following critical questions:
• What are the major risks involved in investment banking?
• What was the role of investment banking in the global financial crisis?
• What impact does investment banking have on a bank’s liquidity status?
• How has the financial aspects of the European Union stability and growth pact influenced investment banks/ Referenced on the Deutsche Bank AG?
2.0 Literature Review
According to NIB website, credit risk is NIB’s major financial risk. The Nordic Investment Bank defines credit risk as the risk that is associated with the Bank’s borrowers and other stakeholders who fail to accomplish their contractual requirements, and that the security provided does not coat the Bank’s claims. It is a risk that occurs from the lending operations of a bank According to NIB’s credit policy, it ensures that it has formed a basis for the lending and aims at maintaining the highest quality of loan-portfolio and ensures proper threat diversification. The credit policy is used to set the basic criterion for satisfactory risks and distinguishes risk sections that need extraordinary concentration. In the year 2007 and 2008, a serious financial crisis put into task the business model used by most of the investment banks. Robert Rubin, who was a former co-chairperson of Goldman Sachs, deregulated banks when he became part of Clinton’s administration. This then saw a change from underwriting the established companies and those seeking long-term benefits to low standards and short-term margins. In the previous guidelines, the taking of company public required it to be profitably engaged in its business for a period of at least five years. Three years consecutive profitability was previously vital. Deregulation eroded the said standards. Similarly, small investors never grasped the total impact of the transformation. Investment banks Bear Stearnsand Lehman Brothers which was foundedin 1923 collapsed; Bank of America acquired Merrill Lynch, but continued to remain in trouble, similarly to Goldman Sachs & Morgan Stanley. The two companies Goldman Sachs and Morgan Stanley left their status as investment banks in the year 2008 because of the 2007/2008 financial challenges caused by an economic crisis. They converted themselves into companies that execute traditional bank holdings. Having done this, each qualified for billions of dollars as an emergency assistance from the tax-payer funds. The policy changes saw banks get more regulated by tight measures. Initially, the Troubled Asset Relief Program (TARP) was intended to stabilize the economy by thawing the credit markets that were already frozen. In the long run, taxpayer assistance targeted at banks almost clocked $13 trillion US dollars. Lending, therefore, did not rise, and because there was no scrutiny, credit markets were rendered frozen. When a number of former Goldman-Sachs managers and directors such as Henry Paulson & Ed Liddy joined the government for various high end positions,the contentious bank bailouts that were taxpayer-funded were amended to suit the situations at hand. This was because according to TARP Oversight Report, disclosed by Congressional Oversight Panel, found out that the bailout encouraged a very risky behavior and cripples the vitalmarket economy tenets.
TARP has succeeded in laying down an enduring legacy of a notion that some financial institutions and even non financial institutions are too networked to fail. It also further addresses that suppose a reverse version of the status of such companies is experienced, the government of the day will find it wise to quickly act in response to their misfortune. The unintended output has, however, been witnessed with the introduction of safety nets. Potential recipients of the said safety nets have been noticed to engage in risky behaviors with a lean on the fact that any misfortunes will be shouldered by the taxpayers.
3.0 Research Methodology
3.1 Research Philosophy/Strategy
In general terms, risk assessment is arisk management step that aims at determining the quantitative and/or qualitative cost of risk. Quantitative risk evaluation involves the computation of two components of risk. The two risk components are involved the magnitude of the possible loss and its probability of occurrence. In the case of an asset, the single loss expectancy (SLE) is computed. This is normally the loss of an asset based on a single security occurrence. TheAnnualized Rate of Occurrence (ARO) is then calculated based on the threat posed by the asset. From the above information, Annualized Loss Expectancy (ALE) can easily be computed. The annualized loss expectancy is a product of single loss expectancy multiplied by the annual rate of occurrence. Through the above said method, it then becomes very possible for a fiscal justification of expenditures to be made. When losses are foreseen, counter measures will be implemented to cushion against them early enough. Qualitative risk assessment does not assign any financial values to assets, losses expected, and control cost.Relative values are calculated instead. In qualitative assessment, precise financial value/cost is not of importance. The main advantage of a qualitative risk assessment is that, the challenges of calculating the accurate figures of an asset are overcome. It is, therefore, true to say that, easy to work with than quantitative risk assessment. However, for financial institutions, qualitative assessment has some drawbacks, the resulting figures are indistinct, and managers may not be at home with relative values generated during a qualitative risk assessment. However, since it is a cheap method, qualitative risk assessment will be used in this research.
Research Design
The research will use co-relational analysis. Various identified independent variables will be weighed against a dependent variable known as ‘risk value’
Data Collection Methods
Data collection will be conducted through a twin combination of collaborative workshops and questionnaires. People from different groups in the same organization will be subjected to questioning .Questionnaires will be distributedahead of the first workshop. This means a few days-few weeks before the workshop is conducted. The design of the questionnaires will target at discovering the assets and controls that are already in use. During the workshops that follow, information gathered will be very useful. Relative values of assets are estimated, followed by the threats faced by each asset. The final step is to forecast on the types of possibility of the said threats exploiting in future.
Data Analysis
Data will be analyzed based on a graduated scale of relative figures to determine the threat level of a risk. If the relative figures are too, the risk factor is considered fatal and warrants a quick action to curb the possible negative consequences. Low relative figures means that the risk factor is negligible and may not pose any major threat to the investment bank.
Project Plan including timescale and resources
The Gantt chart below shows the how the project’s life span will be utilized overtime.
Time in Months
| JAN | FEB | MAR | AP | MAY | JUNE | JULY | AUGUST | SEPT | OCT | NOV | DEC | ACTIVITIES |
| General preparation of dissertation materials and resources. | ||||||||||||
| Formulation of the problem statement and Literature Review | ||||||||||||
| Documentation of the dissertation. | ||||||||||||
| Data Collection, analysis, and presentation. | ||||||||||||
| Report writing. |
References
Congressional Oversight Panel, TARP Oversight Report (2008)
NIB-Nordic Investment Bank (2012), Retrieved from http://www.nib.int/about_nib/risk_management/credit_risk on 27th December 2012.
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