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Risk Management Assignment Analyzing Financial Threats Encounter by HSBC

Question

Task: In order to prepare a risk management assignment, select a UK/EU based company from any sector. Evaluate and assess the latest available annual report and accounts for this company in order to address the following points.

Required:
Assess the methods available to the selected company for analyzing its risks.
Critically evaluate the main sources of financial risk for the company that you have chosen.

Answer

Introduction
Risk analysis can be defined as the probability of whether an actual return or an investment will be less than the expected return (Arnold 2019). With the help of sound risk management the bank is able to execute a plan and manage the exposure of the intuition to different risk. The assignment aims to assess and evaluate the basis of financial risk followed by the critical evaluation of the management tools that the bank is facing. To undertake the study, HSBC bank provides banking, as well as financial services. It offers personal and banking services followed by other types of services and serves globally. The report provides a clear reflection that the company's risk management approach is well defined that strives to protect the business, customers, and community at large while ensuring a proper strategy and sustainable growth.

1. Assessment of various risk analysis method of HSBC
Banks need to cope with the error and the event that disrupts the working of the business. This can comprise a failure in terms of compliance with the regulations or losses that are caused by the poor system. Such are operational risk and arise from the insufficient internal processes and system. It has been found that in HSBC, there are many policies that help the firm in measuring, monitoring, and managing its operational risk. Further, planning enables the corporation to identify possible glitches and provide monuments to prevent them. HSBC also needs to be able to respond effectively; this will help them react quickly and fix them if anything goes wrong in the operations.

The primary purpose of the operational risk management framework is to evaluate, control, as well as taming the risk in a cost effective way, selection of the risk level, in progress with the risk measures as recognized by the Group Executive Committee.

Risk analysis method measures already in practice
HSBC’s controls are further enhanced to help ensure that the group knows its customers well by asking the correct queries, monitoring transactions, and raising concerns to distinguish, prevent, and avert financial crime risk (HSBC 2021).HSBC has implemented several initiatives to promote the standards regarding the operation to conduct the business. To detect and manage fraud risks arising that arises from the new technologies and new methods of banking, in need to increase monitoring and enhance detective controls. It is necessary to enhance control and security measures to safeguard clients while using digital channels. HSBC ensured regular enhancement of the risk management of the third party risk that helps to empower constant risk evaluation of the third party service thereby ensuring proper endurance of business. In lieu to this, the company can plan, as well as structure the balance sheet with desired assets and liabilities to enhance the risk and return.

Cybersecurity
The financial services industry is constantly facing numerous cybersecurity threats. Therefore, it is essential to safeguard HSBC and customers by investment into controls to help avert, spot and answer to cybersecurity risks. The exposure to critical assets can breach the network of the network of the organization and thereby lead to potential losses. The control environment of HSBC’s cyber security is aligned to the industry-standard practices cyber security framework and is self-reliantly evaluated on an annual basis. The function of the security operations HSBC provides hands-on 24/7 evaluation, technical analysis backing, and threat retort, which is supervised by a Central Security Operations Centre (SOC). In addition, the firm participates in a number of industry entities and groups to share data about the strategies employed by cybercrime groups and to co-operate in fighting, tracing, and prevention of the cyber-attacks on monetary organizations (HSBC 2021). HSBC operates a consistent internal threat-led testing and assurance operation to incessantly test and detect the cyber control environment in contrast to the potential threats. For instance During the years 2019 and 2020, HSBC completed several cyber-related imitation exercises together with CREST II (1H 2019) through the request of governing bodies.

Data privacy
To maintainthe trust and confidence of customers and employees on the process of how groups collect, use, and share their information. This is needed to enhance systems, processes, and controls for HSBC. Hence, considering the same, HSBC has a prominent policy on the data privacy that has enabled the bank to safeguard the information.

Methods that the bank can use to evaluate the risks
Credit approving authority

The bank should comprises of a well drafted scheme consisting of power delegation. It should bring multi-tier approving system of credit where the approval of loan needs to be approved by the Committee. When the specified limit reaches above a certain limit then the approval needs to be done by the committee consisting of 3 or 4 officers who have no pecuniary interst. This way bank can control the financial risk.Further, the bank should have a strong framework for reporting, as well as evaluating the credit decision undertaken by the functional group. The credit decision should be assesses within a certain time frame say 3-6 months with a well defined loan review method.

Prudential Limits
To tame the financial risk magnitude, the prudential limit should be provided on different credit aspects such as stipulation of the benchmark current or debt equity and other ratios like the profitability and debt service ratio with flexibility concerning the deviations. The conditions to the deviations must be permitted and the authority dealing with it should be mentioned in the loan policy.

Risk Rating
It is essential that the bank should comprise of the comprehensive risk rating mechanism that will serve as a major indicator of different risk factor of the counterparty and for undertaking decision in a regular manner. Hence, for this implementation a higher degree of standardization is needed in ratings across the borrowers. The rating system should be designed as such that will help the bank to highlight the total risk of lending, input for price setting and other loan terms that will help in providing a major information for assessment of the loan portfolio. hence, the risk rating must reflect the credit risk that is underlying.

2. Assessment and discussion of the different categories of Financial Risk
Market risk

Market risk is the risk that appears from the movements in the market factors like foreign exchange rates, credit spreads and interest rates and has a capacity to reduce the income or the value of the portfolio (Elbadry 2018). For HSBC, the exposure to the market is divided into two main portfolios: the trading and the non-trading portfolio (HSBC 2021). In the case of trading risk, the following are the main components that are foreign exchange and commodities, credit spread and interest rate, while the non-trading is the foreign exchange and the credit spread.

The global financial scenario underwent disaster at the onset of Covid-19. Thereby volatility was observed in a market where extreme levels were reached across the asset classes, and the prices of equity fell massively. Further, in the credit markets, the spreads, as well as yields, reached multi-highs (HSBC 2021). The disruption was seen in the region of refining and transportation that impacted the gold futures contracts. This was followed by a drop in oil prices due to rise in the oversupply as demand hit low from the lockdown.

In the scenario, HSBC managed the market risk in a prudent manner. Sensitivity exposures were made under a limit as the business was able to pursue the core market activity in support of the customers. The company undertook hedging activities to safeguard the business from the major deterioration in credit scenario. The market risk was managed through the complementary process of exposure with the limits that include stress and scenario analysis.

Capital and liquidity risk
Liquidity risk

Liquidity risk pertains to the inability of the bank to honor the obligations whether it is real or in the perceived form and endangers the financial position or its existence. Such risks need to be carefully assessed and managed by way of proper management of assets and liability. This risk is defined in the reserve banking mechanism. Hence, under this system only a certain percentage of the deposits are held back in form of reserves and from the rest loans are created as loans. Hence, if all the investors try to withdraw their money at one go then the bank would not have enough money and would be default.

For instance for HSBC the creditor or depositor might demand cash in return for their claim (Hillier et al, 2017). The risk exposure in terms of liquidity is borne by the policyholders when it comes to unit-linked business and the policy holder gets the intimation for insurance non-linked. The management of the capital was underpinned by the framework of capital management and ICAAP

Insurance risk
Insurance risk is that risk which at the time of insurance cost, policies, claims and advantages might exceed the overall amount of premium and receipt of investment income (Welsch 2014). HSBC majorly utilizes the following mechanism to manage, as well as mitigate the insurance risk. It is a formalized product approval process that covers the product design, pricing and the overall composition of the management, for instance, the management of lapses by the introduction of charges of surrender—the introduction of reinsurance, which cedes risk over the maximum threshold (HSBC 2021).

Systemic Risk
Systemic risk happens because the financial system is interlinked and connected. Thereby, the failure of one bank can lead to failure in another. It is owing to the fact that banks are counterparties to one another when it comes to transactions. If one of the banks fails then the same will create a negative impact on another and other bank’s credit risk materializes. Systemic is a grave scenario as was seen in the subprime crisis of 2008.

The analysis shows that the company has stress different concepts that have played a dominating role in ensuring the risks are properly controlled. Stress testing is used by the team in the risk management framework. The management participates in the local and group-wide regulatory tests and internal established tests, including the internal stress test of the group. To mitigate the same, the group has undertaken measures that contain reprising of some products to project the lower interest rates and launch of products that are capital intensive, thereby investing more in assets that are capital efficient. For the proper evaluation of risk, HSBC must ensure that the balance sheet helps in earning a desirable net margin without the exposure of the institution to high volatility and risks.

Conclusion
From the discussion of the risk analysis mechanism to the financial risk faced by the company, it is witnessed that HSBC has tackled the Covid-19 issue prudently which is owing to the strong financial framework followed by the company. The report gives a vivid description of the risk management approach of HSBC and describe regarding the formulated risk and tolerance level of the bank. The company uses derivatives to get protection from adverse market movement so that better cash flow can be attained. Moreover, HSBC has sound management which periodically reviews a product that contains higher risk like those having investment guarantees and other optional features for sound management. New products are constantly added to the portfolio for mitigating the market risk like the change in the investment return. The bank should assess the ability to meet the cash flow and collateral needs without having any negative influence on day to day operations. The company exits the investment portfolio where the risk is not acceptable. Hence, the overall discussion is a clear indication that the bank HSBC has used healthy risk management policy that enabled the company to handle the Covid-19 environment.

References
Arnold, G. (2019). Corporate Financial Management. 6th Ed., Pearson, London. Elbadry, A. (2018). Bank’s financial stability and risk management. Journal of Islamic Accounting and Business Research, 9(2), 119-137. doi:http://dx.doi.org/10.1108/JIABR-03-2016-0038

Hillier, D, Clacher, I, Ross, S, Westerfield, R and Bradford, J, (2017). Fundamentals of Corporate Finance, 3rd Ed., McGraw Hill Education, London HSBC. (2021). Operational risk. Retrieved from: https://www.hsbc.com/who-we-are/esg-and-responsible-business/managing-risk/operational-risk

Welsch, A. (2014). Financial goals disconnected from risk tolerance: Financial goals disconnected from risk tolerance. On Wall Street (Online), Retrieved from https://www.proquest.com/trade-journals/financial-goals-disconnected-risk-tolerance/docview/1912039281/se-2?accountid=30552

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