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Financial Markets and Risk - Assignment Example

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Report on Financial and Market Risks in Banking sector and the ways to minimize the systematic risks. Dated 01 June 2011 Understanding capital adequacy and capital liquidity: Financial risks are inevitable while performing banking activities. Hence, liquidity and capital needed to be well maintained by the banks and the other financial institutions…
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Download file to see previous pages It hinders the daily operations and outflows for settlement of balance account. Due to severe cash crunch withdrawals also get affected. Owing to non-liquidity and non-adequacy of reserves the bank turns to be insolvent. They are the measures of financial and market strength of a bank or a financial institution. Capital adequacy is the ratio between the capital and risk weighted assets. So, strength in capital base instills confidence within the depositors. This shows that there is a minimum possibility of insolvency due to systematic risks. It helps to attain stability during economic stress. It also helps to reduce the knock on effect of the stress that comes from the financial environment to the real economy. It helps to measure the financial stability and strength. Bank of International Settlement (BIS) provided a standard for capital adequacy i.e. primary capital base of a bank should be at least 8% of their assets. The regulators generally try to ensure that the banks and the other financial institutions have enough reserve to sustain themselves in an event of crisis. It helps to protect depositors as well as protects the wider economy from collapsing. It has been historically true that failure of big banks affect the wider economy. Financial risk from such economic downturn is termed as systematic risk. (All Banking Solutons, n.d.; Liquidity and capital, n.d.; Michael Hutchison, 1999) Capital liquidity is the cash being maintained by the other financial institutions and the banks and the balances with the central bank. Generally, the banks with large amount of liquid assets are in a lot safer position regarding meeting of any unexpected withdrawals. There are liquidity management measures, which manage liquidity positions that ensure the funding requirements. It also helps in meeting payment obligations under normal or stressful situations. In simpler words, liquidity for bank means the ability of meeting its financial obligations as they arrive in due course of time. They lend financial investments in relatively non-liquid assets. They generally fund loan in short-term liabilities. So, one of the challenge to a bank is to ensure its liquidity in any condition. Different Commercial banks manage their liquidity in different ways. Customer deposits are the main source of fund for small banks. Its assets mostly comprise of loans to the small firms and individuals. Small banks generally have more deposits in respect to borrowers with strong credit position. These excess funds are turned into assets with high liquidity. This type of banking operation is known as asset management banking. In contrast, large banks lack reserves to sponsor their major business. When needed, they borrow funds from the major lenders as short-term liabilities. This type of banking is termed as liability management, which is riskier than asset management banking. In this way the banks maintain the liquidity for daily operations and cash outflows. (All Banking Solutions , n.d.; Liquidity and capital, n.d.) Methods of liquidity management in commercial banks: Liquidity management is a vital process for the financial soundness of a bank or for any other financial organizations. It is one of the demanding elements, not just in terms of managing and optimization of cash reserve in multiple locations and currencies. But it also helps in prediction of the available liquidity accurately and tallying those calculations against ...Download file to see next pagesRead More
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