Risk Management at Wellfleet Bank - Case Study Example

Risk Management at Wellfleet Bank By student’s name Course code +name Professor’s name University name City, state Date of submission Risk Management at Wellfleet Bank Question 1 The strategic intention of Wellfleet bank was aimed at pursuing deals from a large scale transformation platform. These deals were to be undertaken through the corporate banking segments. The management of the bank undertook such strategies having in mind that if such deals failed they would “sink a ship”. The ship, in this case, is the bank if the deals failed the bank might end up collapsing (Mikes, 2011). The bank is facing a number of risks according to the information given in the case. Some of these risks include the following: According to banks strategy, it lacks a risk appetite statement. In such a case, Wellfleet bank finds it hard to define its risk tolerance level. It is unable to show how it is prepared and ready to accept the risk before they come up with a way of reducing it. Therefore, there is no clear representation of a balance that exists between the bank potential benefits from the strategy innovations and threats that have inevitable changes. For example, the default risk in the case of leveraged loans that the bank aggressively pursues.  Operational risk; This is another kind of risk that faces the bank. This form of risk remains after the systematic and financial risks are determined. The main cause of this risk is breakdowns of banks internal procedures, system and people. It is very clear from the case that Wellfleet bank credit committee was unlimited (Mikes, 2011). The committee had power to approve deals of any size that lay within the banks rigid limits. The case also shows that incase a disagreement over an issue arose between deputy chief risk officer and head of client relationship, automatically the head credit officer took over the decision ultimately. Concentration Risk; from a bank point of view this is a largely spread out of outstanding accounts of a bank to a large number of debtors and to whom the bank has lent money. There are two core businesses that Wellfleet runs, the first one is the corporate banking while the other one is the consumer banking. However, too much concentration is directed to the corporate banking, which has a record of 58% pre- tax profits and has 72% assets holding. The consumer banking accounts for the remaining 42% of pre - tax profits and a total of 28% of all the assets employed. This shows that most of the bank’s assets are concentrated to only one area of the corporate banking. A concentration ratio can be used to calculate this kind of risk. This ration enables one to identify the percentage that the bank holds in terms of outstanding accounts’ The other form of risk is the credit risk; in a bank this kind of risk refers to the loss that is incurred as a result of financial reward that roots from a borrowers failure to pay back a loan or failure to meet a contractual responsibility (Erlenmaier, 2001 p 98). According to the case on Wellfleet bank, the bank management had pointed out both the leveraged and syndicated loans to clients from large corporations. In addition, the leveraged loans were given out to companies that had substantial amounts of debt already. This makes it clear that the leveraged and syndicated loans will result into high risk of default to the bank. There is also a risk of relying more on the credit risk assessment model. Initially this model comprises of the following aspects. EL (in terms of dollars) =Default probability* % of default of given loss*default exposure. The regulatory risk is evident in the case where the bank is formalizing their risk organization strategies in retort to the international regulation rules that is referred to as the Basel II guidelines and accord. Apart from these risks the bank is also prone to mega risk, market risk, business risk, compliance risk among others. The other important issue to note with this bank is that it has compartmentalized greatly on risk. Question 2 According to the case provided on Wellfleet bank, the credit committee group joined hands with other seven risk management committees in handling risks that the bank was going through or was likely to face. It is notable that reputation, business, market, mega, compliance risk among others are all interrelated, but this becomes a challenge to the bank that it has such a big number of committees dealing with the same kind of risks. From a financial point of view these committees increases on the operational cost of the bank (Erlenmaier, 2001 p 102). There is a challenge to ensure that these groups works harmoniously without crises to achieve their set goals. The biggest challenge in this case is that each of these groups will review the risks differently although they are many ,but interrelated. The assumptions or the strategies that each groups adopts might be different or end up not bearing the expected results. The bank also is faced by alpine pass. It is clear that credit proposals in the bank are issued through the credit relations manager. Once this manager and the risk chief offers comes into a disagreement over a certain proposal the proposal is passed directly to the group credit committee. As a result, the credit relations manger waits for longer time because committee with the proposal needs sign offs from both the senior and regional credit managers. In such a case, the bank has an alpine pass which results from the relations culture. The group credit committee and the credit officers depends mostly on the decision of one party, instead they should discuss among themselves in order to come up with a better lasting solution. For example , in the case of GGC proposals and Ashar industry . However, it can be reduced once the relations bankers are granted additional responsibility within the low risk or small credits. From the case given the CEO has not been involved in the system directly. It is important for the CEO Alastair Dawes to be involved in the bank system especially in the case of high profitable credit transactions. The other challenge is on educating sales people, in most cases coming up or increasing the skills and competences of workers is a big challenge to many companies (Mikes, 2011). In the case of Wellfleet, sales people are not selling a specific product otherwise they are aimed at selling the services of the bank to its potential clients .As a result, such knowledge is expensive to offer and increases the operational cost of the bank. Therefore, getting the best team is a big challenge for the bank (Banks, E. 2002 p 45). The other challenge is on coming up with risk models that will enable the bank management and all risk management stakeholders make informed decisions that will enable the bank meet its set objectives effectively. The challenge contained in these models is on the relevant level to set them and the amount of return they get from a certain adopted risk taken. The bank aims at having strong and distended transformational deals especially with the clients, which is a clear challenge. The other thing to note on the risk culture challenge is that it operates as a circle of credit committees , relation mangers , and clients who have a direct contact to each other and a strong understanding of each others with an aim of finding better and profitable solution based in both sides. The challenge here is the banking finding a group that consults each other through understanding in order to come up with profitable measures and approaches for the bank (Mikes, 2011). In the case of approach to risk organization, Wellfleet follows the “ no surprise culture ” strategy to both the banks top management and the board of directors. This is a point where the management and all stakeholders in the bank are able to pay attention to the needs of the client and help them get the kind of services that they want and how they can assist them successfully. As per this issue is concerned the climax part of it is when they adopt operations styles that are able to meet the requirements of the clients effectively or up to their maximum satisfaction. Question 3 Proposal 1: Ashar Industries Item clarification Aim Aims to finance the acquisition of Zellmont Amount proposed $ 850 million Credit potency Chief world steel producer ,A revenue based that is diversified, Integration of raw materials that is high enough, and Excellent financial performance. Credit defy/challenge Debt structure that are complex High political risks in Zellmont Assimilation risk The main aim of this proposal as indicated in the table is Ashar Industries is to help in financing the planned attainment of Zellmont by $850 million. This company credit strength lies under the fact that it is the largest steel maker in the world holding a 6% world steel production. It also has revenue base that is diversified, integration in raw materials that is high, and a standard financial performance. In order to understand on its full functionality it is important to focus on the following areas. Economic profit Economic profit and loss calculation accounts for options not taken. The options not taken in this case refers to the opportunity cost. Total revenue-(Economic revenue-cost- taxes) = economic profit $32.16= (44.6-$0.5-$12) Economic revenue This is the total revenue that Wellfleet expects from the Ashar industries after the stipulated duration of operation. It can be calculated as follows: Economic revenue= RAR- capital charge $44.6 m= ($11.5bn-$3.8m) Expected loss EL( in terms of dollars)=Default probability* % default of given loss*default exposure. (5A=0.22%*$850*52.25)=85000*22*5225) =9,770,750,000 Proposal 2: Gatwick Gold Corporation Item clarification Aim Aims to finance 2.0375 GGC convertible bond Amount proposed $ 1 billion Credit potency Reduced cost producer, Production base that is diversified 3rd world gold producer Credit defy/challenge A total debt of 800% in 2007 to EBITID Protection from debt by EBITID amounted to -3.1 in the year 2007 Aims to refinance a convertible bond worth $ 1 billion in the year 2007 The objective of GGC is to help in the refinance of the convertible bond worth $ 1 billion that is 2.375%. Its the world 3rd gold producer as shown in the table and provides 7% of the the world gold production. Some of its credit strength lies under low cost of production, and a production base that is diversified. In order to understand on its full functionality it is important to focus on the following areas. Economic profit Economic revenue-Cost - taxes = economic profit $32.16= (44.6-$0.5-$12) Economic revenue Economic revenue= total revenue- expected loss/capital charge $44.6 m= ($11.5bn-$3.8m) Expected loss EL( in terms of dollars)=Default probability* % default of given loss*default exposure. (5A=0.22%*$1b*52.25)=100000*22*5225) =11,495,000,000 Decision in respect to the proposals In regard to the two credit proposals, the best choice for Wellfleet bank is the Ashar industries other than GGC. Some of the supporting evidence is that the company has a better reputation in the industry (Ruozi, & Ferrari, 2012.p 23 ). The company contains a 5A credit grade and is able to acquire revenue of 40% on sale from North America , 23% from US, 33% from Europe, and 25% from other parts of the world. Ashar industries financing performance is good and their income stability is also good which is supported by hiked figures in their revenue. The best prove for its revenue is the turnover of $5.4 billion in the year 2001 which increased up to $28.1 billion in the year 2005.This is a clear indication that their profitability value is positive (Ruozi, & Ferrari, 2012.p 63 ). Therefore, Ashar industries should try and get as much fixed cost as possible to be able to grow and increase on their profits, as well as, the responsibility in the approval of the facility. Ashar industries has advantages over GGC because of a number of reasons which includes: In the past three years the company had a record of bad financial performance. For five years consecutively the net margin of GGC and return on equity has be declining steadily. The EBITDA total debt from GGC was 800% in 2007 which was a dramatic increase compared to a debt of 130% and 200% in 2003 and 2006 respectively. The future growth of this business is constrained by the political risk the reason being that 41% of the gold resources comes from this country. This shows that the licenses of the company can be convert in respect to the new regulations in gold production. Therefore, from the above assumptions it is clear that Ashar Industries has a financial position that is strong in terms of their growing rate compared to industry normal and familiarity management. Question 4 The most important thing to note with the risk management process of Wellfleet bank is that it has been established with an aim of assessing the impacts that the discussed risks facing the company has in the overall operation of the bank (Mikes, 2009). Therefore, the role of the risk committee is not only to evaluate the risks, but to determine and ensure that there are adequate control measures put in place to handle the risks found effectively. Wellfleet risk management team comprises of very many committees, however, the kind of risks that they are trying to handle are many ,but interrelated. There is a likelihood of some groups not being familiar with the different elements of risk management process that is effective enough (Mikes, 2009 ). The committee should also be in a position to indentify the risks earlier before they become a threat to the bank. For, example, the strategic plans that the bank is about to adapt is prone to many risks however, there is no financial and management advice that the committee is offering to the CEO in respect to the plan. Therefore, as a recommendation, the bank should try and establish a risk management processes that is best in all areas. The number of risks are too many and yet interrelated, but the groups handling them are too many. The team should also be reduced in order to improve on its operations. The risk management team has several objectives , which is to reduce or eliminate negative risks ,and be able to transfer risks. It is also important for the bank to make sure that they involve CEO Alastair Dawes in the risk management system. The group credit committee Position requires to operate under the group risk committee. Finally, the Group chief credit officer has an obligation of making sure that they have a thorough discussion with the other members in the team in order to come up with a clearly screened decision which will lead into a lasting solution. Reference List Banks, E. 2002. The simple rules of risk revisiting the art of financial risk management. NewYork, J. Wiley. http://search.ebscohost.com/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&AN=82771. Erlenmaier, U. 2001. Risk management in banking credit risk management and bank closure. UK: University Heidelberg fakultat fur Wirtschafts Mikes, A. 2009 . Risk Management at Wellfleet Bank: Deciding about "Megadeals". Harvard Business School Case 109-071,. Mikes, A. 2011. Risk Management at Wellfleet Bank: Deciding about 'Megadeals'Harvard Business School Accounting & Management Unit Case No. 109-071. Available at SSRN: http://ssrn.com/abstract=1992510. policies. S.l, s.n.]. http://archiv.ub.unheidelberg.de/volltextserver/volltexte/2002/1869/pdf/diss.p Mikes A. 2012. Risk Management at Wellfleet Bank: All that Glitters is not Gold. Boston: President and Fellows of Harvard College. Ruozi, R., & Ferrari, P. 2012. Liquidity risk management in banks economic and regulatory issues. Berlin, Springer. http://dx.doi.org/10.1007/978-3-642-29581-2. Read More