Goldman Sachs' Risk Management Strategy - Case Study Example

Goldman Sachs Introduction Goldman Sachs is a global investment banking and securities firm which engages in financial services like investment banking, securities, investment management etc. Founded in 1869 and headquartered in the Lower Manhattan area of New York City, Goldman Sachs has lot of international offices across the world. Apart from financial services, it provides mergers and acquisitions advices, asset management and prime brokerage to its clients. Its clients include corporations, governments and individuals. Goldman Sachs has recently caught the attention of the investment world because of the innovative risk management strategies implemented by them. According to J.P. Morgan analysts Kian Abouhossein and Delphine Lee, “Goldman Sachs risk management was "best in class" and could act "as a benchmark for investment banking peers” (Kennedy). This paper briefly analyses Goldman Sachs risk management strategy, its advantages and the risks faced by Goldman Sachs Goldman Sachs Risk Management Strategy The key elements of Goldman Sachs risk management strategy can be summarized as follows; Playing a key role in the risk/reward decision making process of the Firmwide Risk Committee; Measuring the losses that the firm would experience under a variety of normal and extreme market conditions, across asset classes, for all our trading desks globally; Verifying and approving pricing models; Advising on the modeling of complex trades; Reporting market risk information to external bodies and Participating in evaluating and introducing new products and business (Market Risk Management and Analysis). Market risk analysis is taken as the core of Goldman Sachs risk management strategy. Market is always fluctuating and the recent financial crisis is the best example for how unexpectedly the market can collapse. Constant monitoring of the market is essential for minimizing risks. Apart from the market monitoring, Goldman Sachs was able to devise strategies suitable for countering the expected and unexpected risks. Why did risk management strategies place the bank in an advantageous position? Kennedy (2010) has argued that in general, most of the U.S. investment banks are conservative in their measurement of risk than European firms. But the industry as a whole cannot expect shares to re-rate significantly without giving full risk disclosures and improving the consistency between banks globally (Kennedy). Goldman Sachs has taken a different approach in their risk management strategy which put them in an advantageous position in American investment industry. While most of the share values of the American banks were dropped, Goldman Sachs was able to maintain a steady growth in their share value which created more faith among the investors. Goldman Sachs have used different measures of risk for a long period and the competitors were able to adopt such techniques only recently. They have established good working relationships between the risk departments and trading desks. Most of the competitors failed to realize the importance of an association between the risk departments and trading desks. Investors are always keen in knowing the risks associated with their investments made on share trading and for that purpose close relationships between the risk department and the trade department are essential. Goldman Sachs realized the above principle early enough and they established facilities for investors to communicate with the risk department which increased their business potentials in American stock market. First, Goldman Sachs puts a number on the size of losses it could face on any given trading day. Whereas most banks typically run the data series back one or two years to come up with the figure, Goldman Sachs goes back to about five years in its models. As well as providing regulators with a VaR calculation that purports to capture 99% of the range of its losses, the bank uses a more conservative 95% VaR model. Another way the bank measures risk is through the use of stress tests and scenario analyses – otherwise known as “worst-of-worst correlations” – to complement VaR. Stress tests are scenario analyses to map out how much it could lose in more extreme market conditions, such as in September 1998 or 2008 when credit spreads (Elliot) People, capital and ideas are the major elements of Goldman Sachs risk management strategy. Employees of Goldman Sachs know the importance of relationship building and they are keen in putting the bank ahead by constantly interacting with the customers in a positive manner. Huge capital and innovative ideas further stabilized the position of Goldman Sachs in America. Current risks faced by Goldman Sachs According to Dhawan (2010), “Goldmans franchise and market position are potentially vulnerable to scrutiny by stakeholders, and like peers, may be affected by the industrys regulatory evolution. It considered that the regulatory challenges faced by the company may hurt Goldmans revenue stream (Dhawan). Financial industry is undergoing many regulations at present. The recent global financial crisis taught America a lesson. America already started to enforce regulations on financial institutions because of their recent experiences. Earlier America adopted a much liberal approaches towards its financial institutions which were exploited by them. The increased restrictions will prevent the freedom of Goldman Sachs like financial companies and it is difficult for them to reap the profit before. Goldman’s "value at risk," (VAR), a measure of how much money it could lose on any particular trading day, jumped 15%, to $92 million, in the first quarter of 2010 (Goldman Sachs White-hot, and streaking ahead). The risks associated with a company may increase as the company grows. Even though Goldman Sachs has a well defined risk management policy at present, it does not mean that they are capable of managing any type of risks. In fact risks mostly come from unexpected corners, in an unexpected manner and at unexpected time. Because of the uncertainty in the occurrence and nature of the risks, it is difficult even for big organizations like Goldman Sachs to manage risks when it actually occurs. Conclusions Goldman Sachs was able to escape from the recent financial crisis because of their highly innovative risk management strategies. They were able to implement risk management strategies which other may not even think of. When most of the financial institutions struggled to survive because of the recent financial crisis, Goldman Sachs was able to improve its market position because of their well defined risk management strategies. Works Cited 1. Dhawan, Harish. 2010. “Goldman Sachs: Fitch downgrades Goldman’s rating outlook”. 05 August 2010. 2. Elliot, Dominic. 2010. “Inside Goldman Sachs risk management”. Financial News. 05 August 2010. 3. “Goldman Sachs White-hot, and streaking ahead”. 2006. Businessweek. 05 August 2010. 4. Kennedy, Simon. 2010. “Goldman upgraded for best in class risk management”. 05 August 2010. 5. “Market Risk Management and Analysis”. n. d. 05 August 2010. Read More