Financial Innovation & Risk Management of Goldman Sachs - Essay Example

? Goldman Sachs Here of Goldman Sachs Introduction Over the recent years, commercial banks in the banking industry have recorded dramatic losses because of risks it faces due to global crisis. This is because, in the financial perspective, risk is assessed as the tendency whereby the actual return does not match with the expected return. As a commercial bank, Goldman Sachs faces market risk, financial risk and operation risk that arise from either external or internal activities (Goldman Sachs, 2012). With banks facing a crisis as a result, of risks that arise from credit exposure and interest rate position among other risks they have resolved to upgrade the risk management strategies and theories they use. Goldman Sachs is one of the banks using risk management strategies that either eliminates or mitigates some risks. In other instances, Goldman Sachs management decides to shift the risks to other parties (Goldman Sachs, 2012). The risk management strategies comprise of liquidity risk management, operations risk management, credit risk management and market risk management that has over the years, seen the bank remain stable during both the financial and economic crisis. More significantly, banks carry out risky business, as it provides financial services to its clients. In the banking industry, Goldman Sachs is well known as the leading securities and global investment-banking firm. It has three main business lines that it operates comprising of investment banking, asset management and securities services and trading and principal investments. Goldman Sachs is an international corporation that provides services to a substantial and diversified client base that is widely distributed worldwide. With banking institutions in over twenty-three countries, it has diversified its operations outside the United States and grown globally (Goldman Sachs, 2012). Its wide base of clients includes other financial institutions, governments, corporations, and high net worth individuals. As a result, the management of Goldman Sachs focuses on being the leading member in worldwide financial markets besides being a leading advisor of choice to its wider clients’ base. Goldman Sachs just like other financial institutions faces business and operational risks that originates from its internal activities apart from financial risk that arise from outside activities (Goldman Sachs, 2012). As a result, liquidity, market and credit risks fall under liquidity risk because it relates to the outside clients of the bank. On the other hand, legal, people, system, equity investment and external risks relate to day-to-day operational risks of the bank. At Goldman Sachs, the management and strategic risks are more likely associated with business risks within the banking institution. More than often, institutions face a financial crisis, and economic crisis that have affected Goldman Sachs bank operations just like any other banks in the industry. Nonetheless, the impact of the crisis depends on the level of risk management an organization has been implemented (Goldman Sachs, 2012). With the high level of competition that exists in the banking industry today, besides the existence of an open economic system that is followed by sensitive market players and other strong external influences it is more challenging for institutions to carry out efficient liquidity management plans. Goldman Sachs, as one of the strong banking institution with branches in different countries faces competition from non-banking financial institutions that has recently seen banks declining reliance on the levels of deposits because of the immense competition. In addition, the competition in the banking industry has become immense thus, affecting the global position of Goldman Sachs in the financial market. With pressure mounting up for accountability to the shareholders based on risk management, Goldman Sachs just as, many banks have resorted to ensure that it mitigates risks while efficiently managing its liquidity levels to remain competitive in the industry (Goldman Sachs, 2012). It is more notable that unlike other banking institutions, Goldman Sachs management value most strategic risk management. This initiative begins with the topmost manager that is, as the chief executive officer puts himself into task to provide the best risk management strategies that ensures smooth running of the organizations daily activities. With a wider prospective market to serve globally, Goldman Sachs relies upon proper risk management planning, as a way of mitigating risks that it is more likely to face in the dynamically changing global financial institution (Goldman Sachs, 2012). As a result, Goldman Sachs does not venture on traditional models of banking that are related to retail business like other large investment banks. This is evident, because the bank fails to administer retail brokers and advisors on even the low-level amounts of investors who seek to help their clients in investing cash in asset management products that relate with the bank and other products that arise from external sources (Goldman Sachs, 2012). Witcher and Chau (2010) asserts to the fact that many financial institutions focus on chasing financial deals that lead to more profits in its business venture, as they neglect the most vital issue of risk management. As a result, many financial institutions are facing financial crisis due to poor management of the risks its faces. Without doubt, financial institutions like, Goldman Sachs has managed to survive the hard financial crisis because of its main value on value management outshines that of other larger financial institutions (Goldman Sachs, 2012). This is because, the management of Goldman Sachs put more emphasis on placing their clients' interests first besides maintaining high levels of integrity, and commitment to excellence and innovations, while focusing on working with the employees as a team. According to the chief executive officer of Goldman Sachs the idea of risk management does not fall under the risk manager or the management only but everyone who works in the institution is held responsible (Goldman Sachs, 2012). It is more attributable that culture within an organization plays a critical role in its performance in the industry. With this in mind, the chief executive officer of Goldman Sachs takes personal accountability in the establishment and maintenance of a strong risk culture. This ensures that the firm remains stable away from suffering financial break down during times of crisis. Analysts believe that Goldman Sachs full rigour in its risk management ensures that it stands out from the other financial institutions. More so, they point out to its survival during the global crisis unlike other financial institutions that closed down or suffered immense loss (Witcher & Chau, 2010). Indeed, the management of Goldman Sachs focus on their clients and risk management is what makes it all the different in its performance through the crisis (Goldman Sachs, 2012). There are several risk management strategies that Goldman Sachs, as a financial institution applies ranging from liquidity risk management, operations risk management, credit risk management and market risk management. Liquidity risk management Liquidity risk arises from the losses a financial institution incurs as a result, of poor liquidity position. Depending on the management of the transactions that the financial institutions undertakes it is easier for it to run short of cash that enhances its operations. As a result, banks need to manage properly its liquidity levels in order for it to run its operations smoothly. In addition, Goldman Sachs maintains a suitable liquidity levels ensure that they not only uphold a good relation with the borrowers, but also the clients and investors who believe that there investments are secure with the banking institutions (Goldman Sachs, 2012). In Goldman Sachs, the management and employees believe in undertaking a corporate responsibility for everything they undertake, as a financial institution. The enhanced liquidity risk management ensures that Goldman Sachs bank creates liquidity risk management policy, build an effective information system with strong internal controls, establish a special purpose committee and come up with ways upon which it can mitigate liquidity risks (Goldman Sachs, 2012). At Goldman Sachs, a well-established finance committee is responsible for the proper management of the company’s liquidity at all times. As a result, it helps in Goldman Sachs bank avoidance from the failure due to poor liquidity situations. More significantly, the finance committee at Goldman Sachs is primarily responsible for that preparation of liquidity and comprehensive funding policies (Goldman Sachs, 2012). These policies are more beneficial to the banks because it guarantees the justification of Goldman Sachs from facing liquidity risks. With one of the most important objective of the bank being to maintain enough liquidity that will ensure that there exists enough cash flow within the institution to carry out its operations (Goldman Sachs, 2012). The financial committee found it essential to use the funding model to establish a policy that conserves excess liquidity levels within the bank’s branches. As a result, Goldman Sachs bank not only maintains excess liquidity that meets the expected cash flow needs from its diversified clientele field, but also its collateral needs, as a financial institution. In addition, the financial committee came up with a second policy that assisted the management of Goldman Sachs, in the management of liquidity risks. Through the implementation of the policy, the management of Goldman Sachs bank have been able to efficiently maintain a reliable contingency fund. This is because in some instances, the depositors could more likely withdraw more funds than what the bank holds in the form of cash at hand within a given time period (Goldman Sachs, 2012). As a result, the bank suffers from a shortage in liquid cash that it uses for its transactions. Therefore, the main purpose of maintaining the contingency fund is to allow the bank to timely respond to a liquidity crisis besides unexpected difficult market situations that are more prone in the banking industry (Goldman Sachs, 2012). As a result, the funds act, as reserves that assist the bank in situations like the current global crisis that oversaw Goldman Sachs stand strong with its operations despite the failures that faced most financial institutions in the banking industry. More significantly, the finance committee advocate for the use of divesture, as a strategy that focuses on the management of the company’s liquidity through capital management models. In most cases, the bank can more likely suffer from adverse losses of earnings or sometimes cannot meet its business objectives as a result, of liquidity shortfalls. The committee therefore, ensures that the bank does not concentrate its resources in one particular portfolio, but diversify it to ensure proper management of liquidity risk (Goldman Sachs, 2012). This is because the bank offers many liquid liabilities while it also has to invest in illiquid assets that cannot be easily changed into liquid assets. In addition, the financial committee analyses the banks new business initiatives ventures besides the products it is expected to offer in order to assess the levels of liquidity risks associated with it and the funding requirements. The management also ensures that the entire Goldman Sachs entity holds adequate capital to sustain its activities. This is to ensure that Goldman Sachs protects itself against the risks of losses while it also meets the regulatory requirements for it to remain fully operational at all times (Goldman Sachs, 2012). More significantly, Goldman Sachs is widely known for the use of its own capital in both the long-term and short-term investments that it makes to increase its financial base. In addition, the team involved in liquidity risk management uses the capital management model to repurchase firm’s shares and for dividends policy. Credit Risk Management As a financial institution, Goldman Sachs focuses on maintaining good levels of credit with its clients. This ensures that it protects its capital base and functions, as an effective financial intermediary. As a result, the management of Goldman Sachs not only focuses on the credit quality of corporations, but also that of government and other financial institutions globally that make up its broad base of clientele. Goldman Sachs has a well-established credit department that focuses on gaining an in-depth knowledge of clients and its market niches for the vast trading products it offers (Goldman Sachs, 2012). Therefore, the department focus on the crucial levels of risk tolerance the institution can maintain and operate efficiently. Over the years, Goldman Sachs has become famous as one of the few banks that operate both the rating agency advisory and the counterparty credit risk management, which focuses on investment banking clients. As a financial institution, the management of Goldman Sachs ensures that the credit department works closely with the other departments to ensure smooth running of the entity (Goldman Sachs, 2012). As a result, the employees who work in the credit department gain various financial experiences besides acquiring a broad perspective on how the bank functions to ensure customer satisfaction, as they serve them. The credit risk management strategies carried out by Goldman Sachs involves the assessment of credit and financial strength that the clients uphold. This ensures that the department assesses acceptable levels of credit exposure for it to offer suitable credit terms that will not put the bank at risk (Goldman Sachs, 2012). In addition, the department ensures that it analyses the risks that are integral to the products the bank trades in, this include coming up with ways upon which there is increasingly complex derivative transactions. Operational Risk Management At Goldman Sachs, the management business leaders work closely together with the operational risk department to provide the leadership required around risk management. The main goal is to align the risk profile of the bank in order to give suitable measures on handling risks. With a broad financial experience, the department undertakes scenario analyses, risk analysis, and capital calculations (Goldman Sachs, 2012). This ensures that the company can easily determine an efficient and risk-sensitive capital levels that can allow the smooth monitoring of internal risk management and assist in decision-making purposes. Over the recent years, the management of Goldman Sachs have identified the presence of operational risks in the following regions London, Tokyo, New York, and Hong Kong. The management strategies comprise of operations management team responsibility in the maintenance of a close relationship that gives them a deeper understanding of the banks functions (Goldman Sachs, 2012). This enhances, the identification of business developments plans that are more likely to have a potential impact on the banks operational risk profile. In addition, the department carries out an evaluation of internal losses, as well as trending analysis of industry firms that compete with Goldman Sachs in the market. In addition, the team involved in risk management operations focuses on the development of knowledge based on banks operational risk regulatory requirements. These requirements are outlined by several regulatory agencies that financial institutions operate under this include the Financial Services Authority (FSA) and the Securities and Exchange Commission (SEC) (Goldman Sachs, 2012). At Goldman Sachs, the operations risk assessment team take part in operational risk industry events where they focus on strategies that will foresee the proper management of the banks operations (Goldman Sachs, 2012). More than that, the Goldman Sachs operations risk management team carry out a careful operational risk assessment of new products. The team also participates in scenario analysis process that involves the senior business leaders of the entity. As a result, they determine data elements that are more likely to support capital determination process for the banks business activities (Goldman Sachs, 2012). In addition, the team works together with the management controls department, in sharing and evaluation of information. This enhances a thorough assessment of Goldman Sachs business environment besides its internal control factors associated with its business lines. Market Risk Management The management of Goldman Sachs focuses on the maintenance of a good position in the banking industry. This is because, Goldman Sachs mainly deals with advising powerful corporations on mergers and acquisitions, while offering trading services for its clients (Goldman Sachs, 2012). In addition, Goldman Sachs ventures into a wider market that not only manages the assets of large institutions, but also that of governments, and wealthy individuals. Therefore, the management establishes a team whose main responsibility is to continuously carry out market risk management and analysis. This involves taking necessary controls over the bank’s market risk globally (Goldman Sachs, 2012). The team involved remains responsible for verification and approval of the pricing models to be used in risk management and analysis. In addition, the team gives advice on the undertakings of Goldman Sachs in areas with complex trade models in order to achieve success. Moreover, the team undertake the measurement of losses the firm is more likely to experience in cases where it is exposed to normal and extreme market conditions that exist in the banking industry. It also carries out the reporting of market risk information that the bank faces to external bodies (Goldman Sachs, 2012). Finally, the team carries out an evaluation and engages itself in the introduction of new products and businesses, as it is aware of the markets the bank operates in within in the industry (Goldman Sachs, 2012). At Goldman Sachs, the team involved with risk management and analysis are divided into three groups that are represented in London, New York, Hong Kong, Tokyo, Singapore, Seoul, and Bangalore. The team under the market risk analysis is more centred in the banks daily activities responsible, as it carries out trading activities globally (Goldman Sachs, 2012). It not only focuses on measuring and analysing of market risk but also on reporting market risk limits. The team uses a variety of quantitative measures that comprise of Value at Risk (VaR) and stress tests. On the other hand, the group also carries out a survey on market risk strategies that are responsible for designing and implementing models (Goldman Sachs, 2012). These models comprise of approving pricing models besides the market risk measurement models that are used by Goldman Sachs. More significantly, the group involves of two teams involved in risk modelling and derivatives analysis. The derivative analysis team is made up of derivatives modelling experts who focus on the use of exotic derivatives in risk management. As a result, the group carries out an assessment and approves all pricing models to be used in risk management (Goldman Sachs, 2012). In addition, the team advises the senior management on risks that the bank could be more likely exposed to as a result, of undertaking large and complex transactions. The other team is involved with risk modelling. Its main activity is to design and implement all risk models that are more likely to occur in the trading portfolio. The risk models designed include stress testing, Value at Risk (VaR) models and hedging analysis. As a result, the team is made up of individuals with strong quantitative and technological training (Goldman Sachs, 2012). Conclusion Without a doubt, Goldman Sachs is one of the largest bank holding companies in the United States. It is majorly known for its strong investment in the bank's division and is widely acknowledged for its outstanding risk management strategies. The focus that the management of Goldman Sachs has on risk management through its strategies ensures that it remains one of the most admirable financial institutions especially because it remained firm after the global financial and economic crisis. The use of liquidity risk management, operations risk management, credit risk management and market risk management strategies has led to the company’s growth worldwide as the leading financial institution. There exists no doubt, Goldman Sachs stands out as an entity that undertakes risk with a comprehensive and fully designed perspective that reflects on client focused strategies within a single and flexible stress test. Indeed, Goldman Sachs bank will remain a strong financial institution as it remains prepared for the unexpected outcome in the global financial and economic market. Bibliography Goldman Sachs, 2012, Finance business units. Retrieved February 29, 2012, from http://www.goldmansachs.com/careers/choose-your-path/our- divisions/finance/finance-subdivisions.html Witcher, B. & Chau, V., 2010, Strategic management : principles and practice, New York: Cengage.Learning. Read More