Risk management

Risk management
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2- Risk Management Post Financial Crisis.

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5. Other Comments.
6. Conclusion
7. Reference
Risk Management Post Financial Crisis: A Period of
Monetary Easing
Introduction to Risk Management Post Financial Crisis: A Period of Monetary Easing
Jonathan A. Batten Niklas F. Wagner
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To cite this document: Jonathan A. Batten Niklas F. Wagner . “Introduction to Risk
Management Post Financial Crisis: A Period of Monetary Easing” In Risk Management
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INTRODUCTION TO RISK
MANAGEMENT POST FINANCIAL
CRISIS: A PERIOD OF MONETARY
EASING
Jonathan A. Batten and Niklas F. Wagner
ABSTRACT
Financial markets have experienced considerable turbulence over the
past two decades. The recent subprime and sovereign debt crises in the
United States and Europe, respectively, have resulted in significant new
regulatory responses. They also prompted the re-evaluation of how best
to manage and measure financial risk. The 20 chapters in this volume
provide a number of different perspectives on financial risk in the postcrisis
period where monetary easing has become a predominant monetary
policy. While asset price volatility has now returned to levels experienced
in the mid-2000s many lessons remain. Among the most important is the
need to accurately measure and manage the complex risks that exist in
financial markets. Our hope is that the chapters presented here provide a
Risk Management Post Financial Crisis: A Period of Monetary Easing
Contemporary Studies in Economic and Financial Analysis, Volume 96, 3
13
Copyright r 2014 by Emerald Group Publishing Limited
All rights of reproduction in any form reserved
ISSN: 1569-3759/doi:10.1108/S1569-375920140000096019
3
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better understanding of how best to do this, while also giving insights for
next suitable steps and further developments.
Keywords: Subprime crisis; global financial crisis; sovereign debt
crisis; monetary easing; risk management; risk measurement
JEL classifications: G01; G1; G2
In recent years the focus of much of the risk management literature has
been on the measurement of financial and related risks, rather than necessarily
the management of the underlying risky positions of financial sector
intermediaries or corporations. This is not surprising given the impetus for
increased regulation of the financial sector arising from revised capital adequacy
guidelines and the events surrounding the 2007
2012 Global
Financial Crisis (GFC). As is well known, these events had an unprecedented
overall impact on the world economy (see, e.g. Stiglitz, 2009, 2010).
As the vast impact of the GFC on the real economy was anticipated,
policy makers worldwide decided to take determined action. The given economic
policy responses included three major fields, namely (i) global bank
and other financial institution rescues, (ii) immense economic stimuli from
fiscal spending packages and finally (iii) monetary policy that provides
ample liquidity and applies non-standard bond buying techniques often
called ‘monetary easing’ or ‘quantitative easing’. Needless to say, these
market interventions caused massive externalities. As many developing
countries are depended on external capital flows and typically cannot
afford large rescue packages, the impact of the GFC on emerging economies
should not be underestimated, which became apparent with capital
flows to emerging economies after the GFC and their recent abrupt reversal
in 2013/2014. Although the European sovereign debt crisis of 2010
2012
has its own roots, it can well be seen as a follow-up crisis to the initial U.S.
subprime crisis as subprime-related bank rescues in Europe led to massive
increases in the amounts of government debt, which in turn, among other
events, triggered several country crises more or less simultaneously.1 These
coherences illustrate that the GFC and its evoked policy actions still
impact, and for quite some time will continue to impact, the state of global
economies and financial markets.
The GFC arose in part due to the complexity of many products traded
by financial market participants, and their lack of ability in managing and
4 JONATHAN A. BATTEN AND NIKLAS F. WAGNER
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measuring risks which subsequently brought attention from regulators.2 It
was in this context and with the U.S. housing market collapse as a trigger,
that many ad-hoc models were put under the regulatory microscope, especially
with respect to the sufficiency of capital that supported underlying
positions. Nonetheless the management of these positions via natural offset,
or through the use of other financial products or derivatives as hedges,
also remains a critical responsibility of both the corporate and financial sector.
Many of these themes are discussed in this volume, where risk management
is investigated very broadly in the post-GFC period. This period may
be described as a period of monetary easing, where asset price volatility has
diminished, financial sector balance sheets have been strengthened, or in
many cases rebuilt, and where attention has shifted to the management of
underlying risks either through the breakdown of these risks into their
underlying components, or through consolidation.3 Consolidation, or risk
aggregation, offers both the benefit of diversification, as well as the possibility
of natural offset. Risk diversification offers particular benefits to credit
risk management, whereas natural offset is clearly evident in the international
positions of banks where offsetting asset-liability positions reduce, or
in some cases, eliminate underlying risks.
This special issue comprising 20 chapters is divided into four parts.
These provide a perspective on global risk management, assess the effects
of integration and risk measurement, the impact of monetary policy and
two parts finally focus on country studies from a monetary policy, intermediaries
and overall markets perspective.
PART I: A PERSPECTIVE ON THE FINANCIAL CRISIS
AND GLOBAL RISK MANAGEMENT
There are two chapters in this part, apart from this introduction. The chapter
by Mertzanis assesses how complexity analysis of financial systems can
be used in measuring and reporting risk despite its lack of a theoretical
foundation. The author considers three dimensions of complexity: financial
instrument complexity, financial process complexity and financial system
complexity. These dimensions of complexity interact with each other in
accordance with prevalent market structures, agent actions and the financial
models used by financial market participants. The chapter argues that
policy makers and practitioners need to take both a micro and macro view
of financial risk, identify proper transparency requirements on complex
Introduction to Risk Management Post Financial Crisis 5
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instruments, develop dynamic models of information generation that best
approximate observed financial outcomes and identify and address the
causes and consequences of systemic risk.
The chapter by Abad and Chulia´ considers the impact of news on financial
asset prices. Their chapter focuses specifically on the impact of macroeconomic
news announcements on bond markets in the Euro area, where
they analyse the impact of changes in the interest rate, unemployment rate,
consumer confidence index and industrial production index on the returns,
volatility and correlations of European government bond markets. Their
results suggest that while bond return volatility is strongly affected by these
news announcements, the response is asymmetric, suggesting a complex
interplay of price impacts from the macroeconomic news releases.
PART II: RISK AND INTEGRATION IN A
POST-CRISIS SETTING
The second part of the present volume contains four chapters that investigate
the role of risk and financial market integration. The chapter by Song
investigates the pro-cyclical impact of Basel III, including the effects on
capital requirements and bank balance sheets. The chapter focuses on the
regulatory capital ratios of six systemically important global U.S. banks
and their development since 2007. The author designs various models to
measure the direct impact of accounting rules on a bank’s regulatory capital
ratios and investigates the impact when the Basel III regulatory capital
definition is applied. The results indicate that Basel III regulatory capital
will indeed enhance the pro-cyclicality of bank capital risk.
The chapter by Righi, Yang and Ceretta investigates an alternative measure
to the widely used Value at Risk (VaR), which is termed Expected
Shortfall (ES) and today is also advocated within the Basel accord. As is
well known, VaR represents the maximum loss given a confidence level
during a pre-specified period, and it does not consider losses above the
quantile of interest. Furthermore, it is not sub-additive, that is despite
diversification, the VaR of a portfolio could be greater than the VaR of
individual assets from the same portfolio. ES is defined as the average loss
given that overcomes the VaR and thereby considers the magnitude of
losses. The authors estimate the ES in conditional autoregressive expectile
models by using a nonparametric multiple expectile regression via gradient
tree boosting. This approach has the advantage of flexibility in data
6 JONATHAN A. BATTEN AND NIKLAS F. WAGNER
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assumptions and avoids the drawbacks and fragilities of a restrictive estimator
such as historical simulation. The authors present various specifications
with the results obtained from simulated and real market data
indicating that this approach provides an important alternative for ESbased
risk management.
The next chapter by Inoguchi examines the price impact of foreign
stock markets on the stock prices of domestic banks in Korea, Malaysia,
Singapore and Thailand during the GFC. The chapter helps to clarify the
debate on whether these banks were immune from events that were occurring
in markets outside East Asia. The author employs a multinomial logit model
to estimate how changes in the U.S. and Japanese stock markets affected the
banking sectors. The results clearly show that foreign stock market indices
exerted a larger impact on the prices of East Asian banking stocks during
the 2000s than during the 1990s. Importantly, the authors conclude that
increased foreign capital flows and foreign assets and liabilities greatly
influenced domestic banking systems in East Asia during the 2000s.
The final chapter in this part by Donadelli investigates the role of financial
market integration in emerging markets. The chapter employs two
newly introduced robust integration measures that rely on principal component
analysis in order to investigate financial integration across 20 emerging
equity markets and the United States. To capture the dynamics of the financial
integration process, both integration measures are computed in four
ad-hoc periods that span the period from January 1994 to July 2007. In
addition, the national market (in each region or country) is divided into
10 different industries. The results show that the level of integration in
the aftermath of the 2008 Lehman Brothers’ collapse was higher than the
level of integration in the aftermath of equity market liberalizations (i.e.
1994
1998). This result holds across industries and suggests that de jure
integration does not necessarily improve de facto integration. In most industries,
financial integration slows between the first and second eras accelerating
as financial markets and trade opens. The author concludes that his
findings give rise to a ‘diversification benefits/insurance benefits trade-off’.
PART III: MONETARY POLICY AND CREDIT IN A
POST-CRISIS SETTING
The third part investigates the impact of monetary policy, liquidity and
completion in the post-crisis environment. The part opens with Suzuki’s
Introduction to Risk Management Post Financial Crisis 7
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investigation of the impact of quantitative easing (QE) on financial markets.
QE refers to changes in the composition and/or size of a central
bank’s balance sheet which are intended to improve market liquidity and/
or credit conditions. The author’s analysis suggests that an appropriate
level of market reference rate would encourage investors to absorb the relatively
wider range of credit risk in the bond market. A higher market rate
would discourage borrowers, while a lower market rate would drain ‘risk’
funds in the bond market. Overall the author argues that there is no clearcut
mechanism based on economic theory for underpinning the commonly
accepted view upon which the concept of QE is based.
The next chapter in this part by Apergis and Ajmi estimates tests the
causality properties between real money demand and a number of determinants,
that is real output, the lending rate and the real exchange rate, across
10 Asian economies through linear and non-linear causality methodologies.
Their results spanning the period 1990
2012 document both bidirectional
and unidirectional causality between monetary aggregates (M1 and M2)
and their determinants for different country groups. These empirical findings
highlight the importance of money demand as a policy tool and offers
useful policy recommendations on the formation of an Asian monetary
union.
This theme is continued with the next chapter by Hosny who investigates
the role of various demand and supply factors in explaining inflation.
Understanding the factors that drive the inflationary process is of critical
importance to central banks given their typical objective of achieving price
stability. The author employs a backward-looking Phillips curve framework
in a dynamic panel framework for 105 countries. Over the years
2008
2011, he investigates the role of product market imperfections in
explaining inflation and inflation persistence, especially among emerging
market economies. The results suggest that product market competition
does not have a significant impact on inflation persistence. On average,
higher competition and efficiency in product markets reduces the inflation
persistence effect especially in the MENA region and countries at lower
stages of development.
The final chapter in this part by Mathur and Marcelin investigates the
association between collateral coverage, country-level governance and various
institutional proxies. The authors note that overcollateralization may
be economically and socially non-optimal since it may thwart efficient
resource allocation. They investigate the role that credit insurance can play
in increasing the level of private credit, investment and growth, where collateral
spread is the main inhibitor of finance. Credit insurance enables a
8 JONATHAN A. BATTEN AND NIKLAS F. WAGNER
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lender to collect the debt on default and liquidate collateral assets at prices
below outstanding loan values, since the lender’s loss is covered through
the insurance.
PART IV: COUNTRY STUDIES ON MONETARY
POLICY, CREDIT AND FINANCIAL INTERMEDIARIES
Next, the volume provides five country studies that explore the relationship
between monetary policy, credit and financial intermediaries. The chapter
by Shi, Sun and Zhang’s is their investigation of recent monetary policy in
China, with specific attention paid to the period around June 2013 when
the Shanghai Interbank Offered Rate peaked at 13.4%. This liquidity
crunch occurred despite the fact that the Chinese central bank (the Peoples
Bank of China (PBoC)) frequently expressed concern to financial intermediaries
about their need to reduce their levels of lending, and despite its
statements that the previous expansionary monetary policy would not continue.
As noted by the authors the PBoC refused to intervene, which was
unexpected by the market, which subsequently had difficulty in adjusting.
The role that monetary policy and credit plays in developing economies
is considered in the chapter by Vo and Nguyen. The authors investigate the
impact of monetary policy on bank risk in Vietnam pre and post the GFC.
They employ a unique and disaggregated bank level data set from 2003 to
2012 and utilise a panel estimation technique. Their results support the
importance of the bank lending channel and show that the transmission
mechanism was affected by characteristics of commercial banks.
The next chapter by Wang and Chang investigates the impact on operating
performance, dividend policy, financial leverage and corporate governance
of excess cash holdings and the use of short-term bank loans by firms
in Taiwan during 2001
2010. One key novelty of the chapter is that the
authors’ survey managers to support their use of variables employed in
their regression analysis. Their findings show that excess cash and shortterm
bank loans in all industries are negatively correlated. When the interest
rate in the money market is low, firms tend to accumulate excess cash.
The survey results highlight the importance of bank relationships in deciding
about the allocation of short-term funds.
The study by Ansari and Goyal examines interest rate pass through for
Indian banks. Their sample period from 1996 to 2012 allows an investigation
of the impact of financial reforms. The authors use a dynamic panel
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data methodology for a sample of 33 banks to estimate the determinants of
commercial banks’ loan pricing decisions. Their results show that commercial
banks consider several factors apart from the policy rate. More competition
reduces policy pass through by decreasing the loan rate as well as
spreads. Financial market reform has had mixed effects, while managerial
inefficiency raises rates and spreads, while product diversification reduced
both.
The last chapter in this part by Misati, Shem and Ngoka-Kisinguh
focuses on the importance of financial market architecture in emerging
markets. With a focus on monetary policy transmission in Kenya, their
study assesses monetary policy transmission channels in an evolving
domestic financial structure during the period of the GFC. Their chapter
employs trend analysis of financial variables to obtain an assessment of the
effects of the financial crisis on financial variables and on monetary policy
transmission. Their results imply that while a central bank can rely on the
interest rate and exchange rate channels in its pursuit of price stability
objective, this does not imply that the retail interest rate rigidities observed
in practice, especially following a monetary policy loosening, have
disappeared.
PART V: COUNTRY STUDIES ON
MARKETS AND RISK
The remaining four chapters in the present volume provide insights into
specific risks and the importance of institutional structure in mitigating
these risks. The first chapter in the part is the analysis of the emerging Dim
Sum or the Renminbi (RMB) bond market in Hong Kong by De and
Mathur. This market enables non-residents of China to invest in yuandenominated
bonds. These securities are typically issued by a select group
of pre-screened entities and financial institutions, outside of China. The
authors discuss the important role that Hong Kong has played in promoting
the Dim Sum bond market, although the recent development of offshore
markets in Taiwan, Singapore and London provide alternatives for
investors. With policy challenges going forward, the development of these
markets is important for the long-term development of the Chinese RMB
as an international currency.
The next chapter by Demir, Mahmud and Solakoglu investigates
another developing market, the stock market in Turkey, the Borsa Istanbul
10 JONATHAN A. BATTEN AND NIKLAS F. WAGNER
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(BIST). The study investigates sentimental herding in the BIST during the
last decade using a state-space model, which employs cross-sectional deviations
of systematic risk (Beta). The authors find evidence of time-varying
herding behaviour that is both statistically significant and persistent over
the period from 2000 to 2011. For example, there was evidence of herding
during the financial crisis in 2000
2001, whereas in more recent times herding
pattern was not so evident due to the difficulty in interpreting internal
and external events.
The real estate market of Brazil is investigated for speculative bubbles in
the chapter by de Oliveira and Almeida. The authors show that the recent
increase in Brazilian housing prices has justifiably fuelled regulatory concerns
that the economy was experiencing a speculative housing bubble. The
authors employ a recently proposed recursive unit root test in order to
identify possible speculative bubbles in the residential real estate market.
The empirical results show evidence for speculative price bubbles both in
Rio de Janeiro and Sao Paulo, the two main Brazilian cities. As the test is
able to identify the presence of asset bubbles at an early stage, it may therefore
provide important insights to market participants in the construction
of early warning systems.
The final chapter of the volume is the study by Uppal and Mudakkar,
which addresses the challenges in applying extreme loss risk estimates in
the context of emerging markets. Their study of the Karachi Stock
Exchange, the main equity market of Pakistan, offers important insights
due to the high country and political risk. Returns in the market have
shown significant periods of high volatility and the impact of extreme
events. Nonetheless Pakistan has a well-established institutional and regulatory
structure. The authors address the important issue of how best to
optimally model the dynamics in such a turbulent environment. Their findings
validate the use of Extreme Value Theory for a small frontier market
like Pakistan and indicate its usefulness for other emerging markets. Risk
management systems based on the Dynamic VaR with tail estimation by
EVT may be more helpful than standard VaR models.
The 20 chapters in this volume provide a number of different perspectives
on financial market and institutional risk in the post-crisis period.
Since the subprime crisis in the United States was surpassed by sovereign
risk events in Europe, the global financial system and worldwide asset markets
appear to have been subject to unprecedented levels of volatility and
risk. Many financial market intermediaries and regulators were caught
off-guard by these events and the turmoil in financial markets, especially
those effects related to liquidity that unfolded. These consequences were
Introduction to Risk Management Post Financial Crisis 11
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exacerbated by the degree of financial market integration and the globalisation
of financial market intermediaries. Thus asset volatility was quickly,
and easily, transmitted to markets worldwide and along with it concerns by
intermediaries over credit quality, liquidity and other forms of financial
risk. While asset price volatility has now returned to levels experienced in
the mid-2000s many lessons remain. Among the most important is the need
to accurately measure and mange financial market risk. We hope that the
chapters presented in this volume facilitate this process and will provide
new perspectives, while also providing insights for next steps and further
developments.
NOTES
1. For the impact of the GFC on emerging economies see for example Stiglitz
(2010) and Batten and Szilagyi (2011). A discussion of the 2010
2012 European
sovereign debt crisis can be found in Lane (2012).
2. See for example Pauget (2009) for a post-crisis outlook on financial regulation
and supervision. For perspectives on the 2007
2009 subprime crisis see for example
Stiglitz (2009) and Breitenfellner and Wagner (2010), for the 2007
2012 GFC see
for example Elliott (2011) and Sikorski (2011).
3. See also the discussion on different approaches to the management of financial
risks by Hull (2007, pp. 1
25).
REFERENCES
Batten, J. A., & Szilagyi, P. G. (2011). The impact of the global financial crisis on
emerging financial markets. In J. A. Batten & P. G. Szilagyi (Eds.), The impact of the
global financial crisis on emerging financial markets, contemporary studies in economic
and financial analysis (Vol. 93, pp. 3
16). Bingley, UK: Emerald Group Publishing
Limited.
Breitenfellner, B., & Wagner, N. (2010). Government intervention in response to the subprime
financial crisis: The good into the pot, the bad into the crop. International Review of
Financial Analysis, 19, 289
297.
Elliott, L. (2011). Global financial crisis: Five key stages 2007
2011. The Guardian, August 7,
2011. Retrieved from http://www.theguardian.com/business/2011/aug/07/global-finan
cial-crisis-key-stages
Hull, J. (2007). Risk management and financial institutions. Princeton, NJ: Pearson
Education.
Lane, P. R. (2012). The European sovereign debt crisis. Journal of Economic Perspectives, 26,
49
67.
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Pauget, G. (2009, September). Regulation-supervision, the post-crisis outlook. Financial
Stability Review No. 13: The Future of Financial Regulation, Banque de France, Paris,
France (pp. 117–122).
Sikorski, D. (2011). The global financial crisis. In J. A. Batten & P. G. Szilagyi (Eds.), The
impact of the global financial crisis on emerging financial markets, contemporary studies
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Stiglitz, J. E. (2009). Freefall, free markets and the sinking of the global economy. London:
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Introduction to Risk Management Post Financial Crisis 13
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