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
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
Chapter VI: Conclusion
Research Objectives and Themes
The primary objective of this dissertation is to examine the role that derivative instruments play within the UK banking system by assessing the risk positions of the largest UK banks in relation to their aggregate trading volumes, specifically focusing on interest rate and exchange rate risk management.
- Analysis of the UK financial system and its structural components.
- Theoretical exploration of risk types and management tools in UK banking.
- Examination of derivative instruments including swaps, options, and futures.
- Empirical assessment using a two-stage seemingly unrelated regression (SUR) technique.
Excerpt from the Book
3.2.3. Derivative instruments
UK figures epitomize the trend of growing importance of derivative instruments. Nominal derivative trading volumes has drastically increased over the last years. Over the counter derivatives (i.e. interest rate and currency options; interest rate and currency swaps) have recorded 68% turnover increase at the end of 2007 for the period from 2004 reaching $ 1081 bil. in daily transactions. Foreign exchange swaps have been mostly traded recording 110% increase for the three year period from 2004 to roughly $ 900 bil. Frequency of transaction has also gone up by 51%. Most of the real foreign exchange activity is between banks themselves. Foreign exchange trading is a massive global business, with London at its centre. Trading peaks can reach $ 3 trillion a day - number equal to the yearly gross domestic product of the UK - and around a third of all that trading happens in London. Figures underline growing importance of derivative markets for the UK financial sector and support further research on the correlation between risk in UK banking and derivative instruments. Next section gives a quick glance at the characteristics of major derivative instrument types. Description is only brief and focused on the mechanics of these instruments and not on their pricing features in consistence with the research goals.
Summary of Chapters
Chapter I: Introduction: Provides an overview of the UK financial system's structure and the research focus on risk management in banking.
Chapter II: UK Financial system: Details the classification of UK financial institutions, including banks, building societies, and regulatory factors.
Chapter III: Risk Management in UK Banking: Explores theoretical aspects of risks in banking and the specific mechanics of derivative instruments used for hedging.
Chapter IV: Literature Review: Summarizes previous academic studies on risk modeling and the use of derivatives in both banking and non-banking sectors.
Chapter V: Empirical Analysis: Outlines the theoretical model and the two-stage SUR methodology used to test the relationship between derivative positions and risk exposure.
Chapter VI: Conclusion: Summarizes the key empirical findings regarding the impact of exchange rate and interest rate derivatives on bank risk.
Keywords
Risk Management, UK Banking, Derivatives, Hedging, Interest Rate Risk, Exchange Rate Risk, Seemingly Unrelated Regression (SUR), Financial Institutions, Market Risk, Credit Risk, Capital Adequacy, Stock Returns, Equity Beta, Financial Innovation.
Frequently Asked Questions
What is the primary focus of this research?
The research examines how the largest UK banks use derivative instruments to manage their interest rate and exchange rate risk exposure.
What are the central themes discussed in the paper?
Key themes include the structure of the UK financial system, the mechanics of various derivative instruments, regulatory capital frameworks, and empirical risk analysis in banking.
What is the core research question?
The dissertation asks whether UK banks use derivative instruments primarily to hedge their risk exposure or to speculate on price movements.
Which scientific methodology is applied?
The study utilizes a two-stage multivariate cross-equation model employing the Seemingly Unrelated Regression (SUR) technique to analyze the data.
What does the main body cover?
It covers the classification of UK financial institutions, types of banking risks, detailed mechanics of swaps, options, and futures, and an empirical analysis of five major UK banking groups.
What are the key keywords defining this work?
The work is characterized by terms such as Risk Management, UK Banking, Derivatives, Hedging, and SUR methodology.
Why are exchange rate derivatives found to have only a marginal impact?
The second stage of the empirical analysis produced controversial results and suffered from sample size deficiencies, which limited the ability to draw comprehensive conclusions.
How is bank size considered in the analysis?
The research assumes a linear relationship between bank size and derivative exposure, using total assets to scale and assign aggregate derivative positions to individual banks.
- Arbeit zitieren
- Dimitar Vasilev (Autor:in), 2010, Risk Management In UK Banking - The Role Of Derivatives Hedging In Particular, München, GRIN Verlag, https://www.hausarbeiten.de/document/180772
