Investigation into Credit Risk Management Practices in Hong Kong and Shanghai Banking Corporation - Research Proposal Example

Investigation into credit risk management practices in Hong Kong and Shanghai Banking Corporation (HSBC This is a paper that considers aninvestigation into the credit risk management practices in Hong Kong and Shanghai Banking Corporation Limited (HSBC) in UK. It also includes the functions and credit policies in HSBC with respect to the credit risk management, the problems faced by the organization in managing credit risk and the overall performance of the bank and how it could “Take advantage of a wealth of information, support and resources to help you make the most of international business opportunities.” (International business tools and information, 2010). 2. Background of study: Financial institutions are facing many problems in the area of credit risk management. Credit risk is not only oriented towards the banks but it also occurs in all enterprises in the business world. Credit risk usually arises, when any of the trading partner fails to meet his full obligation on due date. This will seriously affect the trading practices of other partner who is associated with him. There must be proper balance maintained between the credit risk and other risks that influence the credit practices of the firm. The issue of credit risk is having a greater concern in banks because of the higher level risk associated. It also includes the changing business conditions and characteristics of the clients. The major causes for these problems are failure of banks in meeting the credit standards which are framed for the borrowers, failure in changing the policies with respect to the economic changes, under-graded portfolio risk management and the situations that lead to decline in credit standings of borrowers of the bank. Credit risk arises when the borrower fails to the terms and conditions mentioned in the credit agreement. “The goal of credit risk management is to maximise a banks risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters.” (Principles for the management of credit risk, 1999, para.2). The bank selected for the study is HSBC in UK. “The HSBC Group is one of the largest banking and financial services organisations in the world.” (Gokarn app as head of credit risk management of HSBC, 2006, para.6). It is headquartered in London and has its offices in more than 86 countries and has 8,500 offices all around the world. “HSBC provides a comprehensive range of financial services: personal financial services; commercial banking; corporate, investment banking and markets; private banking; and other activities.” (About HSBC: who is HSBC?, 2009, para.4). Research Hypothesis: Credit Risks Management Practices invoked by Hong Kong and Shanghai Banking Corporation, United Kingdom. This research hypothesis is sought to be gained through examination of appropriate credit risk management tools gained as a result of survey through personal interviews and questionnaire based investigations into the risk management segment of commercial banking pursued by HSBC. Among the financial services, this study is conducted on the credit risk management associated with the commercial banking of HSBC. The hinge of this study is to have a clear cut idea of how HSBC manages its credit risk. 3. Aims and objectives: • To identify the credit risks that are faced by HSBC in UK in the current economic climate • To review the credit policies framed by the bank. • To examine the credit standings of the bank’s borrowers • To investigate about the credit risk management practices in HSBC 4. Research question  To be successful, any scholarly research requires a proper structure and clearly stated research questions, research objectives, and methodological approach. The research questions of the proposed work will include the following points (these might be modified in the course of research work): How the credit risk management operations are practised in HSBC and what are the tools used to measure risk? What makes HSBC different from other banks in terms of credit risk management? To what extent the credit risk policy helps the bank in facing the arising problems related to risk management? What are the credit facilities provided by the bank? 5. Literature Review: “Managing risk is nothing but managing the change before the risk manages.” (Raghavan, R.S., 2003, p.842). Risk management includes the design, functions and roles of a risk management system. “More specifically, it provides a framework for viewing the policies, methodologies, data collection and technical infrastructure used to support risk management.” (Dahen & Dionne, 2002, p.1). “Credit Risk is the risk of loss to the Bank in the event of Default.” (Dhaulta, 2007, para.4). Credit risk management is an approach which is structured in a systematic way to meet and manage uncertainties through the process of risk assessment by developing appropriate strategies that enable in maximum utilization of managerial and non-managerial resources. The nature of banking is very sensitive because it involves deposits from depositors that contribute more than 85% of their liability (Saunders, Cornett, 2005). Banks use these deposits to generate credit for their borrower which is a method for generating income for the banks. “Credit risk is a combined outcome of Default Risk and Exposure Risk.” (Raghavan, R.S., 2003, p.842). Default risk is “The risk that companies or individuals will be unable to pay the contractual interest or principal on their debt obligations.” (Default risk, 2009, para.1). HSBC “sets policies and guidelines inclusive of credit and others policies to address environmental, ethical, and reputation issues in credit business.” (More than banking: credit risk management, 2009, para.3). “Managing international cashflow and exchange rates can be complicated. We can help reduce the risks or simply make life easier.” ((International business tools and information, 2010). Updating the credit policies based on the changes in the economic cycle and marketing regulation is the primary responsibility of the teams within the bank. The credit policies are designed in such a way that they lead the bank to earn its maximum return and growth by creating a good position among its competitors. “With effect from 1 January 2008, with the FSA’s approval, HSBC has adopted the internal ratings-based (‘IRB’) advanced approach for the majority of its businesses, with the remainder of its credit risks assessed using either the IRB foundation or standardised approaches.” (2008 HSBC holdings plc, n.d., p.3). “HSBC Holdings Plc, Europe’s biggest bank, said 2009 will be a “tough” year as bad loans increase and the economy deteriorates.” (Menon, 2009, para.1). For identifying the risk within HSBC, a filter system is used by the responsible authority. “Risk Identification Managers give early warning to Relationship Managers regarding credit concerns so that remedial actions can be taken to protect the Bank from provisioning.” (More than banking: credit risk management, 2009, para.15). “An electronic credit application process for banks is operational throughout the Group and a similar corporate credit application system covers almost all Group corporate business by value.” (The Hong Kong and shanghai banking corporation limited, n.d., p.4). There are certain tools that are used to measure credit risk. The two most important tools used for measuring credit risk are balance score card designer and financial analysis. Balance score card designer (BSC) arranges all the activities in the business and transform them into vision. An appropriate strategy is designed based on the list of activities mentioned in the score card. “It has four key perspectives for instance business, customer, financial, learning and growth perspectives.” (Managing the credit risks efficiently, 2009, para.5). HSBC involves External Credit Assessment Institutions (ECAIs) for rating the credit risk of the bank in foreign countries. The credit ratings are done on the basis of “Foreign Banks, Foreign Sovereigns, Foreign Public Sector Entities and Non-Resident Corporates: a) Fitch b) Moody’s c) Standard & Poor’s.” (The Hong Kong and shanghai banking corporation limited, n.d., p.10). This study proposes to speak about HSBC, one of the largest banking and financial services organizations in the world. This institution is headquartered at London and has 8500 offices in 86 countries in Europe, Asia-Pacific, America, Middle-East and Africa. It is listed in the London, Hong Kong, New York, Paris and Bermuda stock exchanges and has 220,000 shareholders in 119 countries. Perhaps one of the major aspects about this bank is that “The shares are traded on the New York Stock Exchange in the form of American Depositary Receipts.” (About HSBC: who is HSBC?, 2009, para.3). The main risks that the bank would have to bear would be in terms of competition, bad and doubtful returns of loans and advanced made and other kinds of commercial risks that occur during the course of banking business, including “Principal Investments, consolidating HSBCs principal investing activities, including private equity, real estate and hedge funds.” (About global banking and markets, n.d.). It is also seen that HSBC provides “a range of services tailored for the needs of larger businesses, including a Relationship Manager, a wealth of specialist expertise and complimented by our Telephone and Business Internet Banking services.” (International business tools and information, 2010). Methodology: The research approach that this study would follow would be in terms of interviews with the top managers of this bank, conducted with prior appointments. During the course of face-to-face interviews with top managers, the risks regarding commercial banking would be laid down threadbare and ways and means to counter these risks using modern, state-of-the-art schemes and strategic tools would be expounded. Research Approaches: There are normally several approaches that could be taken depending upon the genre of study and which approach could be best appropriately suited to achieve research objectives with maximum advantage and optimum data gain. In this case, the market research group were unanimous that the following approach be pursued. Positivist, Qualitative, Inductive and objective Research paradigm: In this study the main paradigm that would be examined would be that of a positivist, qualitative, inductive and objective type study in order to determine the aspect of risk management on commercial banking, especially with respect to HSBC. Through this use of paradigms, it is possible to gainfully employ techniques that could address the situation peculiar to HSBC, especially in the context of commercial banking on a global scale, with culture, language, legal environment and government regulations differing from country to country. Being the kind of local global bank that HSBC is, it is perhaps possible for it to reach out to different country-specific objectives in their pursuit of creating new paradigms in banking and also excelling in it. Positivism Theory: Again this would be the positivist type in that it would deal with the positive aspects of HSBC’s risk management systems and how these could be improved in later time. Thus, positivism is more concerned about laying emphasis on “observable facts and excludes metaphysical speculation about origins or ultimate causes.” (Noun: positivist, n.d., para.1). Perhaps, one of the major factors that impact upon the risk worthiness of banks is their debt equity ratio, the extent to which banks are in a position to pay off their equity shareholders, in the event of liquidation, or dissolution of business. If net assets are well utilised and appreciating, it would be in a better position to pay off the equity shareholders, if deemed necessary. However, too high a debt equity rate is also unwise, since it shows that assets are not being invested productively and for the benefit of the bank. Thus, it could be said that the bank needs to strike a right chord between safe loans and liquidity in order to maximise its profits and yields. “This segment provides loan and deposit products to small businesses and middle-market corporations including specialized products such as real estate financing. Various credit and trade related products such as standby facilities, performance guarantees and acceptances are also offered. These products and services are offered through multiple delivery systems, including the branch banking network.” (United States securities and exchange commission, n.d., p. 7). Research Approaches and strategies: Data collection reference to the method in which underlying data and information for the topic under study is gained, in keeping with the typical needs of the survey under study. Data Collection: The main paradigms would be that of a positivist, qualitative, inductive and objective type study in order to determine the aspect of risk management on commercial banking, especially with respect to HSBC. In order to achieve these paradigm goals, it would be necessary to conduct face-to-face interviews along with questionnaires (view Appendix 1 at the end) in order to assess the present risk management techniques. “The phrase "grounded theory" refers to theory that is developed inductively from a corpus of data.” (Borgatti, S., n.d.). In this case the ground theory would be in terms of data collected from the bank officials and respondents in questionnaires consisting of open ended queries regarding the topic under survey. A two pronged approach of personal interviews along with Questionnaire method through use of open ended questions would be the modus operandi of the study. The outcome of the study in terms of its results would largely depend upon the feedbacks received from the interviews and the answers to the questionnaires. Other alternative approaches instead of interview/questionnaire methods: Besides the standard questionnaire/ interview methods, 3-4 other approaches could be in terms of: 1. Surfing banks’ web pages for secondary sourcing on which to base the survey 2. Internet Library searches previously conducted regarding credit risk management in HSBC on which to underpin the study 3. Online Internet interviewing of current global customers of HSBC to ascertain their views on HSBC risk management techniques and how it could help this study. 4. Market Survey of HSBC branches in and around the UK to garner material for research and basing this study on this door- to- door survey Data Collections: The data collection would be in the form of interview questions put forward to respondents and officials of the bank along with their responses to questionnaire. The researchers would have a standard set of questions that would be asked from the top managers of HSBC. The answers to these queries would constitute the matter and materials for data collections. It could consist of ten well formed, open ended questions (viewed Appendix 1 ) regarding the current issues faced by HSBC in particular and commercial banks in general in terms of their opinions and strategies on the issues and benefits impacting commercial banking and how they prefer to solve them. Perhaps, one of the major factors that have impacted is the low interest rates that have led to deposits being lowered during 2008. However, in as far as commercial lending is concerned, it is seen that there has been increases in lending and deposits during 2008. The inclement investment climate, falling interest rates, and lowered rate of consumer spending has led to a somewhat depressive investment climate in as far as commercial banking in HSBC is concerned. However, it is seen that this is neutralized by increases in other segments that have helped to reduce its impact on its bottom line, although it is seen that there has been an underlying reduction of net income in 2008 from $297 Million in 2007 to $120 Million in 2008, a reduction of nearly 60% between 2007and 2008. (United States securities and exchange commission, n.d., p. 60). It is seen that the methodology that would be used for this would be positivist, empirical, inductive and qualitative. The main aspects would be the various reports, including the SEC Filings 10 K that would give a clear idea about its risk management regarding commercial banking segment and how it would try to tackle the main issues that surround commercial banking. Again, it could also be seen that this may be a passing phase in the history of banking, especially one of the premier banks in the world, HSBC and once the general economic scenario in the US and Europe betters, it is also bound to its “Private Banking segment provides client services, including advisory portfolio management; discretionary asset management; tax, trust, and estate planning; mutual funds; and currency and securities transactions to high net worth customers.” (Commercial banks: HSBC bank plc, 2009, para.1). Despite the fact that it is facing reverses in commercial banking due to competitive elements, low interest rates and general lethargy by investors to invest in HSBC, it is believed that through the commitment of its employees and dynamism and dedication of its top management, it would not be long before HSBC’s commercial bank segment tops the chart again. “The Commercial Banking segment offers banking products to corporate, mid-market, small, and micro businesses. These products include financing, cash management, international trade, and investment banking.” (HSBC holdings (HBC), 2009, para.5). The fact remains that it would not be until 2010 that the US economy would be able to stage some kind of recovery and it would, therefore, be necessary for HSBC to undertake some kind of commercial strategies in order to become more competitive and offer an array of attractive options to investors and depositors that could address profitability and deposit issues. For one thing, it is necessary to increase the rate of deposits and also offer mortgage loan takers some kind of incentives that are not provided in other banks and financial institutions. Coming to HSBC commercial loans, we need to think in terms of mortgage loans. These could be in terms of having “a broad selection of mortgage products tailored to meet individual requirements and budgetary needs.” (Mortgage central, 2009, para.1). Data analysis and ethical considerations: From the results of the face-to-face survey it is found that risk management constitutes a major facet of modern banking business, especially in one of the largest banks in the world, HSBC. Although appropriate risk management techniques are being taken up including hedging, entering strategic alliances with like minded banks, etc, the fact remains that the economic climate needs to improve for the benefits of these strategies to manifest. For one thing, there needs to be injection of large dozes of investments into the economy, and for another, investments needs to be given a boost for further money inflow into the economy. These were some of the ground theories that were discussed during the survey. Another aspect was the need to maintain confidentiality and secrecy in these discussions which were necessary for competitive reasons. The researchers had assured the respondents that the research findings would be used only by authorised personnel and only for the purpose of this research and not for commercial use. Moreover, the results were well secured and used only by authorised and officials of the research team and the respondents. Considering the fact that a lot of this material could form the premise for further research on this topic, the permission of the respondents were also sought and gained. Results and conclusion: The results of this survey seem to concur with the fact that the commercial risks that have been the main issue with HSBC, although this have been well hedged through derivatives and other instruments. Moreover, it is also seen that with the improvement of the world economy post 2010, it could be envisaged that the efforts and business strategies taken by HSBC could bear fruit after this period. Till such time, HSBC could try to maximize its business prospects in other segments of business, and try to consolidate and strengthen its overall competitive position in future. According to most of the respondents, the global functioning of HSBC, especially with regard to currency fluctuations, payments against export business and high commercial risks in lending without proper securitization are some of the major issues confronting HSBC’s business. The impact of mortgage lending and interest rate depletions are also other adverse conditions that have lend credelence to the present scenario, which it is widely believed, would definitely improve over time. Besides, it is also seen that remedial measures could be in improving customer servicing, verifying all credentials of prospective loanees and loan debtors, having standard audit practices and conformance to regulatory rules and laws laid down by governments besides becoming more competitive through internal reorganisation of business techniques and commercial banking practices. Debts need to be thoroughly scrutinised and reported to higher management for follow up and legal action as need be. An overall investigation into the deficiencies in the present system with suggestions for remedial actions needs to be made for progressive action. “HSBC understand that knowledge of the local social and cultural differences is key to international business.” (International business tools and information, 2010). APPENDIX 1 Questionnaire (Senior managers of HSBC, UK) 1. What are the impacts of the main credit risks confronting HSBC, UK in the light of the current economic scenario? 2. What, according to you, are the main kinds of risks in credit policies framed by the bank and how could these be countered? 3. What the benchmarks by which the present credit standings of the bank’s borrowings are assessed and identified? 4. How and what are the major credit management operations practiced in HSBC, UK ? 5. What are the main kinds of tools that are used to manage risks in HSBC? 6. What are the main kinds of credit facilities provided by this bank? 7. What difference does HSBC make in terms of credit risks management as compared to other banks? 8. What are the proposed remedial measures for overcoming risk deficiencies? 9. How are these to be enforced? 10. How far would these strategies help HSBC, UK, in facing up to current and future issues in credit risk management? Reference List About global banking and markets, n.d. HSBC. [Online] Available at: http://www.hsbcnet.com/solutions/about-gbm [Accessed 29 December 2009]. About HSBC: who is HSBC?, 2009. HSBC: The World’s Local Bank. [Online] Available at: http://www.hsbc.com/1/2/about [Accessed 29 December 2009]. Borgatti, S., n.d. Introduction to grounded theory. [Online]. Available at: http://www.analytictech.com/mb870/introtoGT.htm [Accessed 29 December 2009]. Commercial banks: HSBC bank plc: company overview, 2009. Bloomberg.com, Business Week. 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