Q1: Does financial intermediation require the existence of a bank? Why? Q2: Are banks special? What do you think is special about a bank? “We do not have theories of the steel-producing firm or the...

Question 1:     Does financial intermediation require the existence of a bank? Why?
Solution:    Financial Intermediary means an entity or an institute who works as middleman to ensure execution of a financial transaction between two independent parties.
Since banks also work as financial intermediator because they take money from depositors and give back it as a loan to other borrowers. This is how a bank works as Financial Intermediator.
Yes, financial intermediation requires the existence of a bank because it play a vital role in this field. It is explained as under;
1) Since it is next to impossible to keep large amount of cash with yourself, so we require a responsible entity to take care of on our behalf.
2) Bank give its service in form of many accounts such as saving account, current account etc. according to the need of depositor.
3) It also provides interest in form of return for the amount you have kept with bank, which would have earned nil amount if it would have kept as cash with you.
Question 2: Are banks special? What do you think is special about a bank? “We do not have theories of the steel-producing firm or the automobile firm”-why do you think we need a theory of the banking firm?
Solution: Banks are special because they have system of carrying money with them which eventually help economy to run smoothly. They play a vital role in growth of economy in form of;
1) They finance the emerging start-ups of any country after being evaluating it a growing area.
2) FOREX market also gets effected from interest decided by bank.
3) By fixing interest rate, banks maintain a proper flow of money in market.
4) It provides an easiest way of storing your money.
We need a theory of the banking firm because;
1) It plays an important role in job creation
2) It plays an important role in economic growth
3) It manages financial and economic stability of any country
4) It also affects demand supply curve in the market by fluctuating interest rate.
Question 3. Why banks go for global? Critically discuss the trends in international banking?
Solution: Since being an institution, bank have many employees working for it, many depositors who are expecting good amount of interest and many borrower want to avail loan at a very low rate which can be possible once bank uses its money in other countries market and make more money from the available one. This is the biggest reason why banks go global.
Trends in international banking:
1) Regulation and Global Banking: It is necessary for a regulation to be strengthen. But since many uncertainties are involved with it. Strict regulation also increases cost of compliance for banks.
2) Focus on next generation remote banking solutions- In resultant banks have to constantly assess their remote banking solution
3) Business Intelligence (BI): By the use of BI, banks will be able to serve their customers with many products. But to perform this, banks has to link them with IT partners and also associate them with their banking.
Question 4: What is Market risk in general? Explain the concept and mechanics of the Value-at-Risk (VaR) methodology proposed for the evaluation of market risk-based capital requirements. Comment on the application, effectiveness, and extension of VaR as a risk management tool in banking. Compare the value at risk with expected shortfall and stress testing as a tool of market risk management. Which tool is superior? As a risk manager, which one you prefer in the 21st century?
Solution:
Market Risk is that risk which arises due to some factors which also affect financial market. It is that risk that can’t be mitigated by diversification i.e. by investing in different type of investment products.
Value at risk is a statistic which actually measure and quantifies financial risk available in a particular security or in any portfolio.
In international agreement Basel Accords, capital requirements are specified there. It is controlled by each country’s regulatory authorities. In 1996 an amendment was made to Basel Accord, where capital charges were specified for market risk shown by Value-at-risk. To calculate those capital charges, crude methodology can be used by banks or they can use their own value-at-risk with a 10-day 99% value-at-risk metric. Due to the practical challenges of modelling intra-horizon events, this is calculated as one-day 99%value-at-risk and then scaled by the square root of ten—essentially assuming a static portfolio for ten days and independent daily P&L’s.
We compare the value at risk with expected shortfall; This is known that VaR do not work under market stress. VaR measures excessive price fluctuations. To mitigate this problem, Expected Shortfall comes into picture which considers loss beyond the VaR level. Hence expected shortfall is superior than VaR.
Question:5 Identify the main techniques employed by banks to control for interest rate risk and credit risk. How effective are these risk management techniques and comment on their relation to recent crisis?
Solution:
Technique to control interest rate risk:
· Investment Portfolio: If bank has to provide long term loan then it should consider short term assets in investment portfolio and vice-versa.
· Wholesale funding sources: A wholesale funding is cost effective tool to let grow...