The theory and practice of risk management Dissertation

The theory and practice of risk management - Dissertation Example There has been a major turbulence in the credit market which can be traced to the institutional changes brought about in the housing finance sector, in developed countries. Housing finance markets were deregulated, leading to a heighted competition in the credit lending market, and the integration of housing finance with the capital markets further worsened the crisis (Hoggarth & Pain, 2002). Also, the rapid development of technology brought about significant changes and played a key role in developing and strengthening the money market funds. The wide-scale use of technology further led to a global economic boom and helped in reducing the interest rates to a considerable extent. This increased the profitability of banks to considerable extent. Bank profitability is defined as a result of internal and external determinants (Short, 1979; Bourtke, 1989; Molyneux and Thornton, 1992; Demirguc-Kunt and Huizinga, 2000). Internal determinants include size, capital, credit risk, costs etc. T here is a positive relationship between size and profitability of banks (Akhavein et al, 1997; Smirlock; 1985). ... After the introduction of the Building Societies Act, various building societies were converted into banks, while the rest of the building societies enjoyed unlimited commercial liberty under the Act. Changes such as these, added to the already competitive market. The banking sector was rapidly transforming during this period, following such changes. It was during the period 1991 – 1996 that the mergers and acquisitions increased drastically in the UK. The new entrants in the market comprised of non-financial institutions such as football clubs and insurance companies who were given authority to enter the retail market. Apparently, such drastic changes in the banking and financial services industry, in the U.K., gave rise to critical challenges, as the external environment in which the banks operate became increasingly concentrated. Banking regulation was relatively weaker, thus increasing the vulnerability of the sector, and significantly altering its power to address the ris ks faced by it. The case of Northern Rock: The bank which operated on Northern Rock, is one such glaring example of the vulnerability of the banking sector as well as the credit crunch which ensued such rapid transformations in the U.K. banking sector. This was the oldest running bank in the country, with over 150 years of business, however, its failure posed serious questions and left doubt regarding the effectiveness of the regulatory practices. The inefficacy of the regulatory practices coupled with the vulnerability of the bank, highlighted its inefficiency of responding to the crisis, hence services of the Bank of England were sought as a last resort.