The Improper Risk Management Caused Financial Crisis Finance Essay


As we known, the planetary fiscal crisis truly started to demo its effects in 2007 and into 2009. Around the universe, stock markets have fallen, big fiscal organisations have collapsed, and authoritiess in even the wealthiest states have had to cover with the jobs of fiscal systems.

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There are many researches for the grounds of crisis, people were told they are about subprime mortgages, hapless accounting criterions, bad fiscal tools made by Wall Street and the investing Bankss, specifically Lehman Brothers ‘ failure and AIG ‘s recognition default barters. Derived functions are the implicit in issues that link all of these points.

High Hazard of Derived functions

Fiscal derived functions have many signifiers, including hereafters, forwards, barters, options, and assorted combinations. Derived functions can cut down concern hazards, trade for net income, pull off capital and support costs, and change the risk-reward profile of a peculiar point or an full balance sheet. ( Risk Management of Financial Derivatives Comptroller ‘s Handbook January 1997 ) .Due to their assorted maps, they have been used widely these old ages and go more and more popular all around the universe, meanwhile, the characters of derived functions make them sensitive to external impacts, such as market monetary value, liquidness, involvement rates, foreign exchange and recognition. The volatility of those alterations can act upon derivative merchandises easy. Unfortunately, these impacts change all the manner, it is hard for people to cover with all the sides when they make investing determinations. We can happen out the chief hazards of derived functions are: monetary value hazard, foreign exchange hazard, liquidness hazard, involvement rate hazard and recognition hazard.

At present, many fiscal organisations put derived functions together to make more sophistic derived functions, the invention is over and improper because they are excessively hard for people to understand, so people may be misled when they make investing determination.

The Improper Risk Management Caused Financial Crisis

Fiscal derived functions were the tools to pull off hazard at first, but when they work without the proper direction system of commanding hazard, it is rather easy to do job, such as crisis. In kernel, what had happened was that Bankss, hedge financess and other fiscal organisations had become over-confident as they all thought they had figured out how to cover with hazard and had ability to gain money expeditiously by these tools. ‘It was a consequence of a system to a great extent grounded in bad theories, bad theories, bad statistics, misinterpretation of chance and, finally, greed ‘ Naseem Taleb said, who one time was a celebrated options bargainer in America.i??Naseem Taleb 2006i?‰

During these 10 old ages, the finance industry flourished as more people began to believe of how to against the downsides when puting in something. For case, one time options could be priced, it became easier to merchandise. Combined with the widely usage of computing machine and Internet, the derived functions market exploded rapidly. As people became successful easy, they used derived functions non to cut down their hazard, but to take on more hazard to gain more money, they were doing more gaming. The crisis came about when the market was bad.

Some establishments are paying for hazard on border so people do non necessitate to pay the full monetary value in progress ; it means that people are able to do large net incomes with small capital. They forget about the chance of losingss, pay no attending on puting bound for hazard. The fiscal organisations ignore to calculator the hazard and do warning for pulling more clients to purchase the derived functions.

Governments play the most of import functions of proctor in fiscal system. They encourage the fiscal establishments to do invention to to a great extent develop finance all the manner. Unfortunately, before the crisis, they focused on benefit instead than the hazard of inordinate invention. The imperfect Torahs give chance to many fiscal companies to gain illegal money. For illustration, the market for recognition default barters was tremendous, transcending the full universe economic end product of $ 50 trillion by summer 2008 ( hypertext transfer protocol: // ) . It was obvious that they were deficiency of commanding. The universe ‘s largest insurance and fiscal services company, AIG entirely had recognition default barters of around $ 400 billion at that clip. Furthermore, many of AIGs recognition default barters were on mortgages, which class went downhill, and so did AIG. Hence, the eventual bailout ( now some $ 150billion ) of AIG by the US authorities to forestall them neglecting. ( hypertext transfer protocol: // )

The Measures to Cover With The Crisis That Caused by Derived functions

The measuring of derivative-related hazards is necessary for proper monitoring and control. All important hazards should be measured and integrated into a bank-wide or corporate-wide hazard direction system. ( Risk Management of Financial Derivatives Comptroller ‘s Handbook January 1997 P10-11 ) Every section must corporate with each other to pull off hazard of derived functions. For illustration, monetary value, liquidness, foreign exchange, market analysis and so on demand to be monitored by different sections in the establishments. Team work can expeditiously roll up utile information and set theoretical accounts for analysing, so the concluding study could be more valuable.

Management should guarantee that the assorted constituents of the establishment ‘s hazard direction procedure are on a regular basis reviewed and evaluated. ( Risk Management guidelines for derived functions July 1994 p8 ) This reappraisal should take into history the alterations in the activities and in the market environment, since the alterations may hold created exposures that we should pay attending on. Any material alterations to

the hazard direction system should besides be reviewed.

A system should put boundaries for hazard and do guarantee the places whether exceed proper degrees.The bound system should be

consistent with the effectivity of the organisation ‘s overall hazard direction procedure and with the adequateness of its capital place. ( Actions Needed to Protect the Financial System Statement of Charles A. Bowsher 1994 P14 ) An appropriate bound system should allow direction to command exposures and proctor risk-taking.


In decision, the over development and inordinate usage of fiscal derived functions is one of the most of import grounds to do this crisis. Some major fiscal establishments such as end-users, common financess, hedge financess, securities houses, and even Bankss have incurred derivatives-related losingss, most of these losingss are due to inadequate risk-management systems and improper control and supervising. To forestall that from go oning, authoritiess and fiscal organisations should concentrate on bettering the hazard commanding system and pay more attendings on construction, rating and hazard bound.


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