Risks Facing the Wellfleet Bank - Assignment Example

Case Study Analysis Name: Course: Tutor: Institution: Date: Question 1: Organisational Risks Default Risks The organizational system in the market is facing a wide range of challenges in the financial market. In this regard, the system, with the advent of the global financial crisis in 2008, the risk system and practices was changing. On one hand, one of the rising risks and challenges was the default risks. Duffie (2011, p.109) stated that a default risk is the probability that an organizational debtor fails to pay up and cover for loans advanced to them. Consequently, in such instances, the lending financial organisations classify such credits as bad debts and write them off their books. Although the financial market is characterized with default instances, risk management systems have enabled such lenders to reduce the challenges. However, the Wellfleet Bank is facing an increasing default risk in the wake of the global financial crisis. In this regard, the global financial system has implicated on a majority of the organisations financial well being. As such, changing costs of production as well as reducing consumers purchasing powers implicated negatively on overall organizational product demands as well as income margins. Therefore, this reduced the organisations overall earnings leading to a declining ability by the ventures to meet their needs as well as cover the overall debt owed to creditors. As such, with increasing implications of the global financial crisis on the organization, the risk of default is increasing rapidly. In this regard, the Wellfleet Bank risk management system is developed and based on an internal credit evaluation system where each of the debtors both retail and corporate are ranked to evaluate their default risks, a virtue adopted to develop the relevant interest rates. An example of default cases in the venture could be cited in the retail section where the value has increased since 2004 from a $ 214 million to $761 million in 2007, illustrating the growing loan default risk for the venture. Political Risks An additional organizational risk that the bank, face is the political risk. In this regard, although the financial market functions independently, it relies on the existing good political will in the respective markets. As such, any changes on the political goodwill front change the overall financial industry operations. In this case, the Wellfleet Bank faces a changing political risk system in the Asian and African markets. In this regard, the regions face rapidly changing political systems with the increasing agitation and strive for increased democratic governments. One of the challenges is political instability that increases the risk of loan repayment failures. In this case, although the respective organisations may be willing to pay up the loans, the cost of production and income levels may make such organisations insolvent (Aksoy and Beghin, 2004, p.151). As such, the bank has to regularly reschedule and adjust such organizational loan repayment systems. Therefore, this leads to the risk of the organization running insolvent itself, thus failing to cover and meet up the operational costs in the short run period. In this case, the political challenges, although indirectly affecting the organisation, pose a major operational efficiency, risk that should be mitigated and overcome proactively. In order to counter this challenge, the venture has established a wide range of risk evaluation committees that report directly to the executive on a quarterly basis. One among s the political risk evaluation committee that develops recommendations and forecasts on specific countries. As such, this ensures that the system has a proper and relevant forecast and insight on any political developments in which the recommended interest rates are evaluated. Financial Risks An additional risk facing the Wellfleet Bank is the risk of financial challenges. In this case, as evidenced in the case study, the industry is facing a changing financial market structure. As such, Cooper (2004, p.93) argued that a major challenge in the market is the constantly changing financial market rates that depict and serve as a tool for interests rate evaluation. In this regard, with the anticipation of this challenge, the organization developed a risk management approach through which it develops a credit evaluation committee for its corporate banking section. In this regard, the committee, comprising the risk management, manager, the deputy and the relationship manager develops a focused approach through which the organization evaluates various financial portfolios to evaluate the financial risks involved. Consequently, the organizational risk committee only recommends and approves corporate credit advances on projects whose financial risk are evaluated and predictable to reduce the financial loss threat to the venture in the future. Therefore, although the financial market presents an increasing threat and risk, the existing risk and credit evaluation system adopted by the venture serves as a critical and efficient management system. Question 2: Expected Additional Future Risks Fluctuating Gold Prices One of the future risks facing the Wellfleet Bank future operations and its likely loan funding for the GGC organisations is the fluctuating market prices. As illustrated in the case study analysis, the venture seeks to offload its current hedge on gold supply that offers the 7% gold market shareholder a low market but stable gold price. In this regard, upon the hedge offloading, the organization will sell its gold supply at the existing market prices. Although the current gold market price is high, the venture falls at the risk of falling gold market prices. In fact, future expectations on an increased financial challenge due to the global financial crisis implications, is likely to reduce gold demand and subsequently the price in the long run period (Oberoi, 2014). As such, in the event that the Gold prices fall below the profitable levels in the market, the venture will lack enough funds to offset its proposed $ 1 billion loan requested. Consequently, this will lead to a bad debt for the Wellfleet Bank bad debts increase in the future. In this case, due to higher loan value the organization faces the eminent failure risk as the value would offset its balance and ability to lend out additional loans to the corporate market. Therefore, prior to advancing the loan to GGC, the organizational risk management committee should evaluate critically the forecasted gold price trends and the likelihood and link between any prices falls with the organizational loan default instances. Production Costs An additional future challenge likely to face the venture is the challenge of increasing production costs. In this regard, there is increasing global market competition from other established stakeholders such as the global bank. In this regard, the challenge will be on the expected reduction in interest rates in the future. For instance, in the case of the proposed GGC organizational loan, the debtor faces the risk of increasing mining costs in the future (Mufson, 2012). As such, the venture will face reduced profit margins and incomes into the future. Consequently, this implies that the organization lacks enough funds to finance and repay back high interest loans charged by the venture due to the risks involved. Therefore, this opens up the bank to two risk sub categories. On one hand, is the risk of default by the venture due to increased costs and declining organizational incomes, rendering the venture insolvent at times. On the other hand, the organizational venture faces the risk of interest rate declines in that other competitors and increasing market costs will force it reduces the loan interest rates as a measure to attract increased borrowers. As such, this is likely to reduce the loan profitability and viability as the expected return on the loan could be below the risk rates, thus making such corporate funding through loans unviable in the long run period. Political Risks A final future risk in the market for the Wellfleet Bank is the political risk in the future. In this regard, the organizational, financial industry, as already discussed, is volatile and highly affected by changing political market conditions. In the case of the proposed GGC company loan, the organization faces the political risk in Asia and South Africa. In this regard, the sub Saharan region, the greatest producer is facing an increased political campaign for the natural resource management and exploitation regulations. Consequently, as Click (2005, p.561) argued, the proposal in the political system is the development of internal local systems through which to manage and reduce such mining activities. Therefore, this is expected to not only increase the mining costs and regulatory requirements in the future, but also reduces the amount of mined products. Therefore, this is likely to reduce the expected organizational productivity and the ability to cover and repay the extended loan as projected by the consumer relationships manger and the credit and risk evaluation committee members. Question 3: Loss, Revenue and Profit Calculations Expected Loss=Probability of default*exposure at default*loss given default 0.22*6000,000*52.25%=$689,700 Total Revenue=Interest Income+Fee Income 6,000,000*52.5%+250=$253.15 million Economic revenue expected= $44.6 million Economic profit= $ 32.16 million The development of the above calculations is based on a wide range of assumptions in the accounting process. On one hand, is the assumption that the current interest rates will remain static. As such, with static interest rates, the venture revenues and costs remain static as forecasted. On the contrary, if the inflation and interest rates were to change in the future, this would alter the actual value of the advanced loan and received payments. In addition, a further adopted assumption in the case study is the analysis of the organizational payments. In this regard, the analysis adopts the assumption that the debtor will advance uniform instalment payments without default and failure as per the credit contract agreed terms. In this regard, the management should rely on the developed recommendations to evaluate and monitor the revenue risks involved in the proposed credit portfolio. As such, this would enable the management to develop a forward rather than a risk management model based decision on credit needs. Question 4: Risk Management Improvement Recommendations Establishing a Credit Cap Although the organizational risk management system has achieved a wide range of success over the years, there is the possibility of future growth and developments in the future. One of the fundamental system characteristics in the system requiring change is the lack of a loan award limit for the group credit committee. In this regard, this evaluation argues that the lack of a ceiling exposes the organization to the risk of over investment in a single project risking its failure in the event that such a portfolio fails to repay the loan. In this regard, this analysis recommends that the system should consider and evaluate the alternative through which the risk management system could be enhanced is the establishment of a syndication platform (Khan, 2008, p.11). As such, a cap on the maximum value of credit the organization can advance alone should be established. Consequently, any credit value exceeding this amount should be placed under the syndication values. As such, the organization should partner with peers in advancing such loan credits to reduce the involved risk amounts. Credit Control Committees Removal The organization developed a committee system through which to establish a platform and system through which credit requests are evaluated by teams rather than by individual persons. In this regard, the orientation targeted at ensuring that there was objectivity in the evaluation process. However, this analysis establishes that as the relationship manager argues, there is increased risk of delay in consumer request, response, a virtue reducing the organizational competitiveness and flexibility in the highly competitive market. Therefore, as argued by Anolli, M. (2013, p.43) based on this analysis, this analysis proposes that the organization should revert to a single manager’s evaluation as a tool to increase responsiveness and flexibility. In this regard, once the risk manager has evaluated the risk nature of any credit request, the executive management should evaluate such a credit approval prior to award, as a proactive measure to ensure approved and awarded credits. Merging Risk Management Committees Currently, the organizational risk management system is based on a variety of risk evaluation committees. As such, the committees headed by different individuals evaluate varying needs such as political risks, financial risks, and default risks among others. However, arguments have been developed that autonomous evaluation and mitigation of these risks is deficient in that they are interactive yet the current system fails to offer that desired interaction. Therefore, this analysis, based on an evaluation study developed by Cameron (2005, p.91)argues that the organization should merge the various committees into an integrated one that covers all the risk challenges. References Aksoy, M. A., & Beghin, J. C., 2004, Global Agricultural Trade and Developing Countries, World Bank Washington Anolli, M., 2013, Retail credit risk management Elektronische Ressource. (Retail credit risk management, Palgrave Macmillan, Basingstoke. Cameron, I. T., 2005, Process systems risk management, Elsevier, San Diego, CA Click, R.W. 2005, "Financial and political risks in US direct foreign investment", Journal of International Business Studies, vol. 36, no. 5, pp. 559-575. Cooper, J., 2004, Global agricultural policy reform and trade: Environmental gains and losses, Edward Elgar, North Hampton, MA Duffie, D., 2011, Measuring corporate default risk, Oxford University Press, Oxford Khan, M. Y., 2008, Financial services, Tata McGraw-Hill, New Delhi Mufson, S, October 25, 2012, Cost of mining coal continues to climb, Washington Post, [Online] Available at < http://www.washingtonpost.com/business/economy/cost-of-mining-coal-continues-to-climb/2012/10/24/d15666ca-1931-11e2-bd10-5ff056538b7c_story.html> [Accessed January 7, 2015]. Oberoi, R., October 26, 2014, Losing its Glitter. Business Today, [Online] Available at < http://businesstoday.intoday.in/story/gold-prices-us-economy-current-account-deficit/1/211037.html> [Accessed January 7, 2015]. Read More