Chapter 1Introduction

Banks and Risk Management

Risk management has gone through a long journey in the history of corporate development. Modigliani and Miller (1958) proposed that in an environment without contracting cost, information asymmetry, and taxes, risk management among other financial policies is irrelevant to firm value creation. Sometimes it even lowers the value of the firm because it is seldom free. In the last decades the topic on the role of risk management in a value creation–oriented corporate world—especially in banks—has driven the evolution of the risk management practice. With the development of the computational technology and the witness of several major financial distresses, a sound infrastructure of the risk management systems becomes not only a regulatory concern but also corporate competitive advantage reality. However, the debate of the value and role of risk management in a financial institution still goes on. Some institutions retain the thought that risk management is just an answer to regulatory compliance or a defense system. The modern financial theory based on the capital asset pricing model and other related models is fundamental to the no-arbitrage principle. That is, excess returns can only be achieved by taking risks. This principle makes it necessary to recognize that risk management is not just a preference but is accompanied by the profit-chasing mandate of corporations.

The discussion on bank-specific risk management topics has to ...

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