Paper Example on Financial Risk Management

Introduction

The primary objective of banking institutions is to ensure they expand their shareholder's wealth. Nevertheless, as they push for such targets, they leave the organizations susceptible to risks. However, a considerable number of people have not understood the types of risk that will affect the banks. In most cases, people would associate financial risks with the defaults that occur when an individual does not pay back any loans lend among other financial transactions (Wanjohi et al., 2017). In general, it would, therefore, mean changes in financial variables within a company's operational market would bring about various losses. Nevertheless, other types of financial risks affect most financial institutions primarily found in the banking industry such as foreign exchange, liquidity, interest rate, market and credit risk (Wanjohi et al., 2017). In case of any variations in the named type of threats, they might end up affecting the cash flows of these banking institutions which will affect their financial performance in the long-run. The most common kind of risk that affects banking institutions in the Netherlands includes the foreign exchange, interest rate, market, liquidity and credit.

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Therefore, the financial risk management would encompass all the activities undertaken by a bank in ensuring that the volatility of most cash flows becomes reduced through maximizing its performance (Wanjohi et al., 2017). By having an effective and efficient financial risk management framework, it is an indication that the banks will have the ability to reduce any risk exposure giving them a competitive advantage in their operational market. With the current business environment being dynamic, most banks are forced to engage in risk management which is now a key function of its operations. In 2007-2009, the global financial sector underwent massive setbacks which saw the depression in the USA, a global financial foundation for most countries (Thakor, 2015). Through this, there is a need for the banking's sector to rethink some of the various approaches they have previously employed in improving their overall financial success and survival.

Statement of Problem

For the growth of banking institutions to continue, effective financial risk management framework has been a requirement. Additionally, the global financial sector is volatile which makes it a huge challenge for these institutions. The business atmosphere has continued to become more globalized due to increased technological advancement (Yakup and Asli, 2010). Nevertheless, despite allowing organizations are increasing their customer numbers, companies have had to endure volatile and ever-changing interest rates, commodity prices and fluctuations in the foreign currencies. According to Yakup and Asli (2010), this has brought about the need for financial risk management which allows for the firms to remain operational within this tough business environment. Nevertheless, most of the studies on financial risk management since the 1970's have only focused on the risk brought about by foreign currency fluctuations leaving out other forms of risks (Ameer, 2010).

Through employing risk management techniques, it will allow an organization's administration to align all the strategies in a manner that does not expose the business operations to risks (Ameer,2010).In most cases, businesses have employed financial risk management measures in reducing any cash flow disparities when it comes to determining various growth prospects. Irrespective of this, there have been minimal studies that have tried to focus on the affiliation concerning financial performance of banking institutions and financial risk management approaches. Therefore, this study proposal targets to determine the impacts of financial risk management on the banking sector's financial performance in the Netherlands.

Research Question

Does the management of financial related risks have any impacts on the financial performance of banking institutions in the Netherlands?

What is financial risk management?

What are the various financial risks the banking institutions is likely to face?

What are some of the financial risk management models employed by banks?

What is the link involving financial risk management and financial performance?

Can the banking institutions overcome the various financial risks with one model?

What is the role of the stakeholders and management in financial risks management?

Does financial risk management offer a competitive advantage to a banking institution?

The Significance of Research Problem

According to a Financial System Stability Assessment report released by IMF on the Netherlands on March 16, 2017, the nation's financial system is very large making it about eight times the Gross Domestic Product (IMF, 2017). The financial system is comprised mainly of the banking sector which occupies more than half of the entire system. It is an indication that in case of any detrimental impacts on the economy, the nation will suffer as seen in the case of the double-dip recession that hit Netherland some few years back. According to the report, the four main vulnerabilities that affected the financial sector during the recession included interest rate risks, credit risk, borrower defaults and foreign exchange risks (IMF, 2017). It is, therefore, an indication results of this proposed research will assist in formulating risk management policies the banking sector. It will provide the administration and the governing agencies, in this case, the Central Bank in having an insight into the multiple financial risk measures and their effectiveness in boosting financial performance. Additionally, the outcomes will play an essential role in allowing the government to come up with various policies regarding the implementation of financial risks management regulations that must be adhered to by all financial institutions (IMF, 2017). More importantly, the results will allow other academicians in finding relevant awareness data on the influence of financial risks control on the financial health of the banking firms.

The main theoretical contribution of this research is that it will play a crucial role in filling the awareness gap that exists between the affiliation of financial performance and financial risks control in the banking segment. Furthermore, the proposed investigation will add more comprehensive knowledge to parties who would like to know what is happening in the financial industry. Moreover, the study will lay down a foundation for other investigators who would like to further research into the field using other areas of the economy such as the energy, health, mining, and agriculture.

Literature Review

Theoretical Review

Moral Hazard Theory

According to this theory, it states that one individual will take all the risk because other individual elsewhere will endure the risk costs. According to the moral hazard theory, one party will be aware of the risks involved in certain transactions than the party that is paying for the respective operation (Jimenez, Lopez and Saurina, 2013). In the banking sector, this theory can apply whereby it has very little information about its clients who might end up defrauding the financial institutions due to inadequate financial risks management measures.

Enterprise Risk Management Theory

A firm can manage all its risks at once or choose to handle one at a time. Conferring to the enterprise risks management theory, it states that a firm can holistically manage its chances thus solving them all. The ERM allows a firm to come up with strategies that will see it coming up with a consistent and systemic approach towards managing the risks (Eckles et al., 2014). The Enterprise Risk Management theory is valid for it will apply to all the organizational levels allowing them to have a streamlined approach from top to bottom. The administration of an organization and other employees will work together in identifying any possible risks that might affect the firm and come up with practical risk management measures. By employing this theory, a firm will have the ability to ensure that it offers its relevant stakeholder their dues and manage the risk associated with the entire delivery a process. In the long run, it allows the risk manager to have the upper hand in monitoring the risks and change the direction of the company operations to ensure it encounters only acceptable risk levels.

Modern Portfolio Theory

Through this theory, it allows a firm to choose the best strategy that will enable it in maximizing the gains from a specific portfolio while at the same time minimizing the occurrence of the risk. Before the formulation of this theory, most investors would construct their portfolios intuitively with the aim of accessing the risk and rewards from the portfolios. With this theory, it calls on the investors to instead focus on the portfolios overall risk-reward rather than individual portfolio characteristics.

Empirical Literature Review

According to a research piloted by Ahmed, Akhtar, and Usman (2011), on the Islamic banks and how they implement risk management practices, they found out that indeed, there is a definite relationship between various methods and efficient running of the firms. The study was conducted for the period 2006-2009 with exploratory variables used including asset management, capital adequacy, NPLs ratio, leverage and size (Ahmed et al., 2011). The dependent variables used in the research included liquidity risks, operational risks and credit risks. The primary objective of the study was to determine which factors have contributed significantly towards the Islamic banks based in Pakistan to adopt various risk management measures. The research found out that the credit and liquidity financial threats have a positive statistical significance correlation with the bank sizes while operational risks have a negative affiliation. Liquidity and operational risks had a significant positive alliance with asset management while NPLs have a negative association. Nevertheless, the study is different from the research proposal for it based in the Netherlands. However, the research by Ahmed et al. (2011) provides useful knowledge that can help the investigation.

Vucinic (2015) conducted a study to determine the financial stability of three countries, in this case, the Netherlands, Serbia, and Montenegro. According to the study, the global financial crisis has had negative impacts on the economies of various nations bringing about the need for having financial risks management measures. The primary purpose of the research was to define the importance of having these measures to maintaining the financial stability of a country. As seen from the IMF report on the Netherlands, the financial sector in the nation dominates a considerable part of the GDP and led by the banking institutions. According to the three nations, the Central Bank is the primary supervisory and regulatory body governing the financial institutions. Conferring to the study, Montenegro has had a significant setback on its financial health in the recent years. It saw the nation having a decline in its GDP by more than nine percentage points in 2010 (Vucinic, 2015). Additionally; the financial sector lacks liquidity accompanied by massive rate on non-performing loans. Moreover, Netherlands has also suffered the financial instability crisis in the past years with its economy declining by 0.8% and 0.7% in 2013 and 2012 respectively (Vucinic, 2015). The banking sector is an essential part of the economy, and such instabilities could affect its overall health. Additionally, Serbia has also suffered financial difficulties in the last years with high bud...