Financial Risk Management - Literature review Example

Literature Review, Finance and Accounting Introduction According to (Mulz pg. 4) risk management refers to the process of identifying, analyzing, and then opting whether to accept or take mitigation steps when it comes to investment decision-making. (Allen 2013, pg. 1) shares this ideology as he defines risk management as the process through which investors and fund managers identify potential risks of their businesses and act in such a way that their business interests are safeguarded. Allen goes ahead to assert that the decision on whether to accept or take mitigation steps towards the potential risks is based on both the investment objectives and risk tolerance of the specific investor. Similarly, Allen warns that investors who fail to adopt the correct strategies in handling the identified risks always face severe consequences. To support his ideology, he says that the economic depletion of 2008 came out because of the then major financial firms failing to adopt the correct strategies of managing loose credit. Mulz 2011 (pg. 7) defines financial risk management as the aspect of evaluating and managing current or possible financial risks within the firm. He says that even though financial risk management practices cannot always prevent firms from all possible risks, they are beneficial in a way as they decrease the level at which firms are exposed to the risk. According to (pg. 9), risk management has some similarity to financial risk management. The similarity arises from the fact that in both cases, investors and firm managers are required to identify potential risks, evaluate possible remedies that they can embrace, and finally implement the most appropriate strategies in such a way that the objectives of the business are handled satisfactorily. Historically, various economies of the world have different mechanisms of controlling their markets. This is to mean that a strategy can be ideal for implementation in the United States but not in China, Brazil, Australia or South Africa for that matter. This essay aims to provide more insight on both risk management and financial risk management, but by comparing the most applicable strategies in China with those in Western nations notably, the United States of America. Similarly, this essay aims to discuss how differently bigger companies as well as small and medium-sized enterprises in China manage risks. On the same note, the essay briefly covers some of the financial risk problems that SME’s face in their attempt to compete with the already established corporates. Comparing Risk Management Practices in the United States and China Chance 2010 (pg. 47) argues that the economy of the United States has proved its strength to the entire world. This is because it has managed to compete favorably with other top nations amidst all the challenges it has faced in the recent past, which includes the large amount of debt that it owes other development partners. He asserts that in as much as that is true about the United States, we should not turn blind to the fact that the Chinese economy has made significant strides within the past few years. His reasoning originates from two facts, the first being that the Chinese economy has undergone sufficient deregulation and has been subjected to a thorough reform process (pg. 49). In like manner, he mentions the fact that the Chinese economy has emerged uninterfered with from most of the global challenges that have faced other mightier economies as one of the reasons. Allen (2013, pg. 60) shares the same ideology as Chance, attesting to the fact that indeed the Chinese economy has registered significant growth in the recent past. His only concern is the fact that a considerable section of the global population still has doubts on the strength of the Chinese economy judging by the volume of recent academic and professional papers that have shown some element of concern as to whether the economy is safe enough to face continuous competition originating from other leading economies. As observed during the 2008 economic depletion, both risk management and financial risk management are critical in ensuring that the economy of any given nation remains vibrant. Going through the process of risk management in both the United States and China, one will not fail to realize the fact that both nations share the same practice, though slightly different when it comes to principles. This is according to (Tarantino et.al 2012, pg. 164). Tarantino argues that though investors and organizations within the United States have their mechanisms of risk management, most of their strategies are well documented with the Centre for Strategic and International Studies, located in Washington D.C and deals majorly with policy initiatives. Similarly, he asserts that the Hong Kong Institute of Monetary Research provides Chinese investors and corporations, which include banks with the most applicable strategies of risk and financial risk management. Tarantino et.al (2012, pg. 167) argues that in both the United States of America and the People’s Republic of China, risk management processes begin with assessment. He goes ahead to explain that assessment is broad and extensive within the United States. This is because it looks at the risks that may originate internally within any specific organization or investment as well as external risks that may arise from the environment within which the investment or corporation operates. According to Tarantino et.al (2012, pg. 168), the process of assessing potential risks within the United States is never complete without looking at the global environment. This is because assessing the global environment helps in ensuring that organizations and investments within the country are prevented from unexpected risks. Weighing this to the risk management process in China, (Tarantino et.al, 2012) attests to the fact that the process applies the same strategies as those within the United States, except for the ideology that the Chinese mechanisms are slightly specific. Of more interest is the fact that Chinese corporations not only look at the factors that may inhibit them from meeting their objectives, but those that enhance their chances as well and work towards ensuring that such mechanisms are adequately kept in check. The process of risk management in both the United States and China is also similar in that in both cases, the likelihood and the consequences of the risk factors are identified. This is according to Christoffersen 2010 (pg. 18). In as much as the United States is known for its ideal strategies of finding solutions to problems that arise, Christoffersen reports that several agencies within the States normally acknowledge the uncertainty variance. This is to imply that during the risk assessment process, they make it clear that surprises may come up during the implementation. This therefore makes them be on high alert during the implementation process, so that they do not expose themselves too much to the surprise risks. On the other hand, Christoffersen attests to the fact that several agencies within China do not consider the aspect of uncertainty and variance. A trend that has often worked to their disadvantage, and has left them highly exposed whenever the unexpected risks emerge (Christoffersen 2010, pg. 20). Christoffersen goes ahead to explain that by analyzing potential of risks emerging from the internal, external as well as the global environments, United States agencies are always able to identify crosscutting risks. This refers to types of risks, which cut across functions of various departments or different geographies (Christoffersen 2010, pg. 27). Moreover, in as much as the risk assessment process within Chinese agencies always looks at the probable causes of the risks, it is different from that of the United States. The differences come up in that it does not assess the potential of crosscutting risks, a factor that has always resulted in most of their investments being unable to weather interference from the global markets. Just as in the case in almost all the economies within the world, both the Chinese and United States Agencies normally identify all the strategies that they can employ to avert the assessed risks. In doing this, both economies normally assess some of the strategies that if employed will reduce the likelihood of the risks taking place. At the same time, they assess the worst case scenario, that just in case they happen, what measures should be in place to ensure that the consequences do not take a toll on the objectives of the business. To prove his point, Christoffersen provides the example of a job environment, where after potential risks have been identified, the management should ensure that it provides a friendly environment for their team of employees to deliver. Similarly, they should ensure that they have a team of multi-skilled employees at their disposal to reduce the potential of over relying on only one individual whenever such problems arise (Christoffersen 2010, pg. 28-33). Another strategy that can be employed in a job environment by the management is to ensure that they make clear to the employees what is normally required of them at all times. In return, the employees should supply the management with the required information before they are asked to do so. Once the potential control measures have already been identified comes the implementation phase. Christoffersen argues that in both the United States and China, the process of settling on the most applicable mechanism and the implementation process are similar. In the United States, the implementation process takes the decentralized mechanism in that all the available leadership roles are normally divided based on the individual threats as well as the missions available. Christoffersen holds the opinion that this is the same process that is always carried out by the Chinese agencies. With the only difference being that in as much as some of the roles are always divided across various departments, leadership is normally left specifically to the risk managers, who are always educated on the best possible mechanisms to handle different situations. In both economies, the available alternatives are normally compared before deciding which one is ideal for the prevailing situation. In the process of doing the comparisons, the fund managers, investors as well as the risk managers always analyze the risks that might come up with the various existing alternatives. Emphasis on transparency is one of the most far-reaching aspects of the implementation process witnessed within the two economies. This is according to Christoffersen 2010 (pg. 41). This is to mean that in both economies all the implementation strategies are subjected to documentation at each stage. The documents are then availed to the public, or to any party who is interested in knowing how the risks or their consequences were averted. In as much as that is the current situation, Christoffersen acknowledges the fact that occasions exist where documentation of the implementation process is not availed to the public. He says that such only exist where the national interests need to be safeguarded, he gives an example of the U.S Nuclear Agency wherein as much as documents are availed to the public, and not all are let out for the fear of them falling in the hands of enemies of the nation. In as much as documentation of the implementation process should always be carried out, (Poitras 2002, pg.62) introduces a different concept when he says that it is also of great significance to communicate all the stages of the implementation process to all the concerned stakeholders. The major reason for doing so is to ensure that in an organizational set-up for example, everyone should always understand the factors that are associated with risk so that they work as a team. Another main aspect that should always be taken into consideration according to Poitras is the assumption factor. This is to imply that in as much as risk assessment is to be done; the team carrying out the analysis should not be quick to assume issues. This is because a frequent assumption leaves both the investment and the corporates highly exposed to risks that often spring up surprisingly. Poitras similarly mentions the need to embrace organizational culture. Arguing that it is of great significance, to ensure that risk management principles and practices are embedded on the day-to-day operations of the organization instead of being left only to a few individuals. Comparing Risk Management between SME’s in China and the Bank of China According to Chong 2004 (pg. 163) risks are part of the daily lives of both SME’s and large corporations in China. He goes ahead to say that there are various types of risks with some having minimal effects on the business while others threaten the existence of the businesses. To this effect therefore, Chong advices that it is imperative for investors both large and small to ensure that they understand the process and principles of risk management, so that they make the most suitable decisions thereby preserving the interests of their businesses. Small and Medium sized Enterprises commonly known as SME’s refer to investments across all industries that employ fewer than twenty people. This is according to Henschel 2008 (pg. 362). In addition, he says that in an economy like China, close to half of SME’s are managed by one person who in most instances is a partner or the sole owner of the business. Even though SME’s employ a small number of people, their process of risk management is quite inclusive. This is because most of the SME’s in China usually follow the normal risk management process, which includes establishing the context, identifying, analyzing, evaluating and working on mechanisms through which such risks can be averted (Henschel 2008, pg. 365). Just as discussed under the above section that compares the risk management processes between China, and the United States, the processes mentioned above are aimed at assessing the potential risks, and working on ways and mechanisms to prevent the risks or reduce the consequences of their impact. The difference according to Henschel only exists because different SME’s trade in a variety of products and services, and for that reason, they communicate and consult people in various fields. This is to imply that some will maintain frequent communication with the community while others will consult the suppliers and contractors. Similarly, some will deal with their customers, staff, and even the owner depending on the type of product or service they trade in. Comparing the risk management process adopted by SME’s across China with those that employed by the Bank of China, which is the oldest and one of the largest banks in Chinese history, one realizes that larger corporations normally adopt tighter strategies to avert risks than SME’s. According to Henschel, this is partly because SME’s do not deal with a large group of clients or customers as compared to the larger corporations that need to be on the look out and safeguard not only their interest, but also their position within the market as well as their reputation. Chong goes ahead to explain that unlike SME’s, which always assess the internal and external environment, larger corporations assess risks across their various departments. The Bank of China for example assesses risk that arises from credit, the broader market, the interest rates being charged, liquidity, operations, strategies, reputation as well as legality and compliance. Under the Credit Risk Management section for example, the Bank of China takes into consideration the fact that in as much as some customers normally honor the agreement that exists between them and the bank, some of them fail to meet the obligations. This implies that not all the customers who are lent by the banks repay the loans. Wu 2011 (pg. 96) argues that in order to avert such instances, the bank normally ensures that it limits the level at which it is exposed to the customers. In that, the Risk Management Department, the Board of Directors as well as any other concerned parties normally review and update the conditions upon which individuals or different entities apply for loans from the Bank (Wu 2011, pg. 99). This contrasts the trend that is practiced by SME’s where the owners assess the potential risks personally without consulting any parties. When it comes to Market risk Management, the bank acknowledges the fact that interest rates, foreign exchange as well as commodity and equity prices normally fluctuate depending on the demands of the market. Wu therefore explains that the Bank of China has established a Market Risk Division, which is tasked with the responsibility of keenly studying the day-to-day trends of the market positions as well as the demands of the customers. From carrying out such surveys, the Bank puts up a measure that ensures that it stays above its competitors (Wu 2011, pg. 103). Due to the advancement in technology, the Bank has come up with a technique that identifies potential loses and develops strategies that can be used to reduce the consequences that arise from such loses if total prevention cannot be achieved. This sharply contrasts the trend witnessed within the SME’s where the owner is the sole decision maker and makes market related decisions on his own without relying on advice from any task force. Wu 2011 (pg. 108) similarly holds the opinion that in assessing some of the potential risks, the Bank of China has to consider those that come up due to legal and compliance issues. The legal aspects arises when the Bank finds itself in the middle of unforeseeable contracts or lawsuits, some of which if not amicably negotiated can result in harsh judgments, which may completely destabilize the objectives of the business or put it in bad books with the society. In like manner, Wu advises that the bank should be on the lookout for compliance issues that may arise from regulatory sanctions that can as well result in huge financial loses, or affect the reputation of the bank thereby interfering with its position within the market. In order to avert issues that arise due to compliance and legality, the bank has established a compliance and legality department. The compliance department always ensures that all the policies and guidelines placed forward by the regulatory body are duly followed. Similarly, the legal department is always on standby to ensure that it explores the most suitable mechanisms of handling the unforeseen lawsuits, such that the rights and privileges of the client are respected and that the business objectives and ideals of the bank are safely guarded. Legal and Compliance risk management methods practiced by SME’s contrasts those employed by the Bank of China in that, the managers of SME’s do not have a legal team in place, but they hire the services of a lawyer when called upon. In regard to Compliance risks, the owners often make an attempt of ensuring that they abide by all the regulations of doing business as outlined by the mandated organizations. In as much as both the legal and compliance departments have been established within the bank to deal with matters legality and the regulatory standards as discussed in the section above, the Bank of China does not take reputation related risks lightly. Zsidisn 2008 (pg.49) explains that the bank still believes that negative publicity be it factual or otherwise can either result in the bank losing grounds to its major competitors or litigation that can prove costly to the business of the bank (Zsidisn 2008, pg. 51). To avert such, the bank has established a Reputation Risk Management Policy that looks at the standards upon which the bank is to operate, thereby preventing such risks. Chong further elaborates that such departments normally perform continuous monitoring exercises to ensure that it does not fall into bad books with the public, which forms a large base of its customers. Zsidisn argues that in as much as the bank always assesses all the available alternatives at its disposal before implementing the ideal one, it has taken into account the fact that certain situations are unforeseen. To this effect, it has created a Strategic Risk Management Team, which ensures that all the decisions settled on are the most suitable and that there is proper implementation of the strategies agreed upon. In order to ensure that both the financial and the market positions of the bank are also kept in check, the team also looks into the demands of the market and responds to them, so that other competitors do not get any chance of exploitation. An Operation Risk Management team has similarly been assembled by the bank to ensure that all the operations of the bank, be it internal or external is perfectly done. The assembling of such a team according to Sharma 2009 (pg. 347) ensures that all the potential loses that might have arisen from failed people or systems are prevented. Moreover, in the worst-case scenario that such events take place, the loses do not destabilize the operations of the bank. This trend is divergent from that of SME’s in that their managers do not rely on opinion collected by a strategic risk management team to make decisions, but rather arrives at a strategic conclusion based on his or her own ideologies. Given that asset, funding and growth are some of the major objectives of the Bank of China; it has established a liquidity team that is tasked with several responsibilities, including ascertaining that all the payments are made on time once they have matured. At the same time, the team is to ensure that growth is evident within the business and that all the assets are funded. According to Sharma, the team is also tasked with the responsibility of ensuring that all the opportunities that are arise are funded without having to liquidate forcefully. Sharma further argues that given that lending to clients is one of the major responsibilities of the Bank of China, it has established a team that ensures that the interest rates that customers are being charged are favorable enough. This is because economies are normally subject to fluctuate, implying that organizations that do not take heed of the market trends may find itself misplaced within the market. One aspect of great significance is the fact that departments that deal with weighty issues such as interests assess the market trends daily, and reports directly to the Board of Directors of the Bank of China, which normally decides on the best solutions to be implemented. Sharma argues that access to finance is no doubt the largest challenge facing small and medium-sized enterprises in China. Though the government of China has in the past put in place several mechanisms aimed at averting such trends, problems with access to capital continue to be a challenge to developing a vibrant SME sector. Unlike larger corporations that have in place a liquidity management team, small and medium-sized enterprises do not have such frameworks within their organization; instead, they rely on loans provided by various agencies. According to Das (2006), such loans help SME’s in expanding their asset base, embracing technology as well as in their daily workings. Similarly, such funds help SME’s capture a considerable share of the market from their competitors and extend their production facilities. Another mechanism through which SME’s solve their lack of sufficient funds is to bring on board other partners. According to Das, such a move does not only inject a considerable amount of funds into the market, but also brings in fresh ideologies into the business, and ensures that it remains relevant for a long duration. Challenges facing SME’s in China Small and Medium Enterprises in China are always faced with several challenges in their attempt to grow and establish their position within the market. Lim 2010 (pg. 67) argues that most of the problems that are faced by SME’s are uncommon within the larger corporations. The first challenge facing SME’s is lack of sufficient funds for growth. The main reason this is so is the fact that many a times, SME’s opts for cheaper solutions to their problems, which includes some of the risks that they are facing. Lim argues that whenever SME’s attempt to implement these cheaper mechanisms of risk management, they end up using a larger amount of their budget than they imagined. The cheaper solutions also result in the problems not being properly handled, a trend that negatively affects the performance of SME’s. To drive his point home, Lim asserts that the financial challenges being faced by SME’s hardly affect the multinational corporations within China. This is because the multinational corporations normally go for the best strategies that do not affect their reputation, and ensure that their problems are solved amicably. The lack of documented formal procedures of doing business is similarly one of the great problems facing SME’s in China. Das 2006 (pg. 116) argues that this is majorly because most of the SME’s are owned and managed by a few individuals who negotiate on the be best way of doing business. Lim further asserts that the problem is heightened by the fact that the decisions might always change depending on the trends of the market. the overall complication being brought about by this is the fact that the lack of documentation and formal way of doing business makes it difficult for third parties who are interested in doing business with the SME’s to come in. Lim therefore suggests that the lack of formal way of doing business, makes it default for the SME’s to grow and exert their positions within the market (Das 2006, pg. 117). Multinational corporations normally have skilled employees within each department. The knowledge held by such employees normally come in handy when problems related to their relative departments arise. Moreover, the multinational corporations normally call on consultants in various fields when the problems become too complex. The SME’s in China nevertheless are forced to go through their problems without the input from professionals in various fields and even the consultants (Das 2006, pg. 123). The main reason why this is so, is the fact that most of those who work within SME’s are not trained. On the same note, even when complications arise that need the input of consultants, they are not invited because they charge too highly, and the SME’s cannot afford the amount that they charge. According to Freeman 2013 (pg. 214), SME’s in China re also faced by the challenge of leadership. This is majorly because as mentioned above, their owners act as managers and make decisions that pertain to their businesses on their own, a trend that often proves costly in the end. Freeman argues that most of the SME’s within China have not embraced IT within their system of doing business irrespective of the opinion that China is one of the nations that have fully embraced it. He says that the main reason this is so is the fact that high quality It experts are always hard to come by. In addition, they are expensive and opt for the larger corporations. Conclusion To this point, we can agree on one fact, that risk is inherent in life. This is because everything we lay our hands on may prove costly for us in the end. Investors and fund managers normally take risks every day. In as much as they are exposed to risky situations, they rely on their experience as well as the expertise of their employees and consultants to ensure that that the potential risks are averted or that the consequences that come with such risks are reduced. Investors also find comfort in the fact that there is a risk management process, which they can turn to during tough times. Of more interest is the fact that the process of risk management is the same in all economies. This is evident from the above section that compares risk management process in United States and China. It is imperative however that in the course of carrying out an assessment of risk, and implementing the best decisions to avert all the challenges that come with risk, those tasked with taking full control of the process should avoid arriving at too many assumptions. This is because such may result in surprising and unforeseen risks during the Implementation process. On the same note, they should ensure that the implementation process is carried out within the shortest duration possible and that proper documentation is done and availed to all parties who are interested in knowing how the whole process turned up. From the above discussion, we also learnt that multinational corporations always leave nothing to chance and that they have established different departments to deal with various kinds of risks. Similarly, we have learnt that in as much as SME’s contribute to the growth of our economies, they operate with minimal resources. References (2012). IJBF: Jahrgang 33: 2012. 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