Risk Management In UK Banking - The Role Of Derivatives Hedging In Particular

Thesis (M.A.) , 2010 , 53 Pages , Grade: 2,0

Economics - Finance

Risk management has been pivotal banking activity, particularly for the last 20 years. Volatile
economic conditions and ever‐growing competitive forces have compressed profit margins and
forced UK banks to look up to sophisticated and more comprehensive methods of identifying optimal
risk‐return positions. Advanced technology and global business focus has presented opportunities to
utilize comprehensive quantitative techniques to contain and manage risk exposure. Technology has
played crucial role in establishing and dispersing electronic trading platforms giving access to equity
and derivatives hence reshaping capital acquisition and risk management frameworks. The topic of
risk management has been even more contextual in times of severe economic/financial crisis.
Analysts have not only been critical of banks’ uncollateralized lending but also of their excessive
trading with derivative instruments. Assuming that no arbitrage opportunities exist, the question
remains as to whether banks attempt to hedge their risk exposure or purely speculate on the
direction of price movements. In this context, central task of this dissertation is to examine the role
derivative instruments play in the UK banking system through aggregately assessing risk position of
largest UK banks relative to aggregate trading volumes. Empirical analysis is conducted utilizing a
two‐stage SUR technique. Results from first stage of empirical analysis confirm that risk premium on
banks’ equity securities is strongly related to market risk premium. More importantly, findings
illustrate that exchange rate exposure of UK banks has more significant impact on stock returns
compared to interest rate risk exposure. Second stage of the analysis fails to provide comprehensive
conclusion due and produces controversial results. Nevertheless, exchange rate derivatives are found
to have impact on exchange rate risk albeit only marginally

Inhaltsverzeichnis (Table of Contents)

• Chapter I: Introduction
• Chapter II: UK Financial system
  • 2.1. UK Financial Services and Banking at a Glance
  • 2.2. Banks
    • 2.2.1. Retail Banks
    • 2.2.2. Wholesale banks
    • 2.2.3. International Banks
  • 2.3. Building Societies
  • 2.4. Other Financial Institutions
    • 2.4.1 Pension funds
    • 2.4.2 Insurance funds
    • 2.4.3. Finance houses
    • 2.4.4. Unit trusts
    • 2.4.5. Investment Funds
  • 2.5. Regulatory Factors
    • 2.5.1. Capital Adequacy Framework
    • 2.5.2. Non-interest Bearing Reserves at Central Bank
• Chapter III: Risk Management in UK Banking
  • 3.1. Overview
  • 3.2. Foreign Exchange and Interest Rate Risk
    • 3.2.1. Foreign Exchange Risk
    • 3.2.2. Interest Rate Risk
    • 3.2.3. Derivative instruments
      • 3.2.3.1. Swaps
      • 3.2.3.2. Options
      • 3.2.3.3. Forwards and Futures
  • 3.3. Credit risk
  • 3.4. Market Risk
• Chapter IV: Literature Review
  • 4.1. Banking Institutions
  • 4.2. Non-banking Institutions
• Chapter V: Empirical Analysis
  • 5.1. Theoretical Model
  • 5.2. Data Characteristics
  • 5.3. Empirical Results
    • 5.3.1. First Stage
    • 5.3.2. Second Stage

Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)

This dissertation aims to analyze the role of derivatives in UK banking by assessing the risk positions of major UK banks in relation to aggregate trading volumes. The primary goal is to determine whether banks utilize derivatives for hedging purposes or primarily for speculation.

• The UK financial system and its key components, including banks, building societies, and other financial institutions.
• Risk management in UK banking, focusing on foreign exchange, interest rate, credit, and market risks.
• The role of derivative instruments, such as swaps, options, forwards, and futures, in managing risk exposure.
• Empirical analysis of the relationship between risk premiums, exchange rate exposure, and derivative usage.
• The impact of derivative instruments on exchange rate risk.

Zusammenfassung der Kapitel (Chapter Summaries)

• Chapter I: Introduction: The chapter introduces the research topic of risk management in UK banking, highlighting the importance of derivatives hedging in navigating volatile economic conditions. The dissertation's objectives and research approach are outlined, emphasizing the empirical analysis using a two-stage SUR technique.
• Chapter II: UK Financial system: This chapter provides a comprehensive overview of the UK financial system, including its key components such as banks, building societies, and other financial institutions. It delves into the different types of banks (retail, wholesale, international), the role of building societies, and various non-banking institutions. The chapter concludes with a discussion of regulatory factors, specifically capital adequacy frameworks and non-interest bearing reserves at the central bank.
• Chapter III: Risk Management in UK Banking: This chapter focuses on risk management practices within UK banking. It discusses the primary types of risks banks face, including foreign exchange risk, interest rate risk, credit risk, and market risk. The chapter also explores the use of derivative instruments, such as swaps, options, forwards, and futures, as tools for managing risk exposure.
• Chapter IV: Literature Review: This chapter reviews relevant literature on risk management in banking institutions and non-banking institutions. It provides a foundation for the dissertation's empirical analysis by examining existing research on derivatives hedging and its impact on bank performance.
• Chapter V: Empirical Analysis: This chapter details the empirical analysis conducted in the dissertation. It outlines the theoretical model used, describes the data characteristics, and presents the results of the two-stage SUR technique. The chapter analyzes the relationship between risk premiums, exchange rate exposure, and derivative usage, and examines the impact of derivative instruments on exchange rate risk.

Schlüsselwörter (Keywords)

The primary focus of this dissertation is risk management in UK banking, with a particular emphasis on the role of derivatives hedging. Key terms include: UK financial system, banking institutions, risk management, foreign exchange risk, interest rate risk, credit risk, market risk, derivative instruments, swaps, options, forwards, futures, empirical analysis, SUR technique, risk premiums, exchange rate exposure.

• College: University of Portsmouth
• Grade: 2,0
• Author: Dimitar Vasilev (Author)
• Publication Year: 2010
• Pages: 53
• Catalog Number: V180772
• ISBN (eBook): 9783656035725
• ISBN (Book): 9783656035572
• Language: English
• Tags: risk, management, banking, role, derivatives, hedging, particular