How to Manage the Risk Essay Example | Topics and Well Written Essays - 1250 words - 2

How to Manage the Risk - Essay Example The major purpose of the bank is to support the favorable economic conditions which will help to stabilize the monetary policy of USA. This factor includes price stabilization, money supply, acquisition of credit and increase in overall growth and employment. As a central bank, it also needs to monitor and supervise the operations of other commercial banks to make sure the safety and security and to protect the interest of the customers. The most important enforcement capability of Federal Reserve is that it controls inflation and generates employment opportunities in the United States. It also helps the US govt. and other financial institutions in the US in their operations. There are mainly three types of tools used by Federal Reserve Bank to implement the monetary policy- Open Market Operations, Discount Rate, Reserve Requirement. Monetary policy is set by basically raising or declining the discount rate that is charged to banks for interbank lending of surplus reserves. This rate is decided by the interbank market but FED also influences that by usage of three tools that are mentioned above. Consequences of Federal Reserve are that Federal funds rate actually affects the long-term interest rates in the economy. Fed is able to keep monetary and financial conditions stable with its monetary policy. Fed can also make policies that will help to add more reserves to the banks which will encourage the lending of low-interest rates thus influencing the growth of money and credit in the economy.... This will leverage the returns. But as the economy goes downwards, assets prices also tend to go downward and it magnifies the loss. Same was happened in the case of Lehman Brothers. They invested in Mortgage backed securities and when the housing price bubble started to default the investments became illiquid. Assume that a well managed retail bank might have a leverage of 12 times which means for every 1 pound it can lend 12 pound. But in the year 2004, Lehman had a leverage of 20 and then it increased to 44 in 2007. But then the assets prices had started to move downside. The situation had become like with 10000 pound someone was buying a property using 440000 pound mortgage and the borrower of the bank became insolvent and thus the bank. Inconsistent management decisions are responsible for it. Management should have thought again before investing in subprime mortgages. Liquidity Businesses mainly fail not because of lack of profits, but it fails because of liquidity crunch. Lehm an Brothers had its assets and liabilities based on a small amount of liquidity. In other words it didn’t have enough ready cash or liquid assets to face the crisis. When market fell, other commercial banks started to protect own selves by using Lehman’s base of credits. It means that Lehman was losing it liquidity t a very fast pace and by seen that other banks refused to trade with the company and market lost its confidence over the investment bank which was the final nail in the coffin of Lehman. The bank became totally insolvent. Overconfidence of the management that it will earn liquidity in proper time was the most vulnerable decision for the bank. Losses After the devastation of twin towers in USA in 2001, interest rates started to crash