Title

Self-reflection report on corporate risk management

and failure of Lehman’s brother bank

Sono Kumar – Gotam Kumar - Hussain Ahmed - kumail Ahmed

(05/05/2024)
TABLE OF CONTENT:
1 introduction 3

1.1 introduction to corporate risk management 4

1.2 failure of Lehman brother and its impact 4

2 list of topics 5

2.1 comprehensive list of topics during course 5

2.2 how topics contribute to learning through semester 6

3 reflection on learning 6

3.1 learning throughout course 7

3.2 considerable Question 7

4 relate learning to case of selected bank 8

4.1 The concepts and ideas covered in the course apply to the failure of Lehman

brother and lessons can be learned from this case 9

4.2 conclusion 10

5. Diagram 11
 1. Introduction: In today’s world where business operations go with the flow, dynamic
market changes, technological disruptions, and geopolitical tensions conspire together
to define modern businesses and the risk connected with them. Risk management
within corporate community plays the leading role in case the changes occur, as it
establishes the procedure for assessing and the reduction of the threat to its business
objectives and goals.

In this current fast-paced business environment in which the extremely volatile and
unstable factors characterize, corporate risk management must be given its due
value. It acts as a guide to help strategic decisions collective the unforeseen problem,
and making the organization strong in the front of trouble. Following this, the core
components of corporate risk management that cannot be ignored are being touched
upon and it is revealed that the role of risk nowadays is irreplaceable in the majority
of business organizations.

1.1 Corporate risk management and its important in today’s business world

Corporate Risk management is an essential part in this contemporary world. It usually involves
the risk’s identification, its assessment and mitigation. And it helps organizations to achieve their
goal of sustainability and long-term growth. In the era of complexity in business activities, it
helps to handle risks like operational, reputational, strategic, etc.
If we talk about today’s business world then organizations are working on a global level, it helps
them to mitigate the risks of regularities as well as economic risks. In the era of rapidly changing
technologies, we find both opportunities and risks together like in data breaches, data disruption,
and cybersecurity risks. Risk mitigation strategies are necessary because global supply chains are
susceptible to disruptions brought on by natural disasters, geopolitical events, or other
unforeseen circumstances. Changes in monetary business sectors, cash trade rates, and ware
costs can affect organizations, requiring proactive gambling on the board. Because of instant
communication and social media, reputational harm can happen quickly. Overseeing gambles
related to public discernment is crucial in the computerized age.

2. Failure of Lehman’s brother:

 Lehman brother filed for bankruptcy on 15 September 2008. Hundreds of employees
dressed in business suits left the office one by one with boxes in their hands. At the time
of collapse Lehman’s was the fourth largest bank in United States with 25000 employees
worldwide. It had and $619 billion in debt.The dramatic fall of Lehman was due in large
part to millions of risky mortgages (subprime mortgages) propping up and unstable
financial system. High Leverage Ratio Lehman’s ratio of debt to equity, was high, which
made it highly leveraged. This strategy enhances the profits during stable periods and
decreases the losses during crises. And Lehman’s assets were illiquid because they were
unable to sell them quickly to raise capital necessary to keep the firm in operation. And it
has poor corporate governance. Lehman Brothers was showing many systemic and
systematic governance failures. The board, regulatory oversight, risk management,
compensation and auditing of the company all did not identify, and fail to address the
risks and conflicts of interest that led to the total failure of the organization.
Impact on other banking industry:
The failure of Lehman Brothers in 2008 was the largest bankruptcy in US history. as Le
hman Brothers reported its first quarterly loss, the stock markets of financial institutions and pri
mary dealers suffered a major fall. Analyzing all this, finally when Lehman Brothers filed for ba
nkruptcy on 15 September 2008, the stock prices for banks and primary dealers declined by −2.9
0% and −6.00% respectively and the stocks were the worst affected publicly traded stocks that da
y.
2.1 comprehensive list of topics during the course of corporate risk management:
 Definition of risk and risk management
 Historical context and evolution of risk management
 Role of risk management in organizational success
 Features of a risk management framework
 Risk governance, Risk tolerance, Risk appetite, Risk budgeting
 Methods for measuring and modifying risk exposures and factors to consider in
choosing among the method
 Financial and non-financial sources of risk and how they may interact
 Decision-making under uncertainty
 Risk Attitudes (Risk averse, Risk Neutral, Risk lovers)
 Measuring and analyzing the different attitudes.
 Bank and its classification
 Commercial Banking – Functions, Role in Economy and Limitations
  Commercial Banking from a Risk Perspective – Bank’s Balance Sheet – Bank’s Business
Model • Profitability and risks – Performance evaluation – Regulatory requirements –
Principles of bank management – Risk management.
 What are Bank Regulations, why it is need to be implemented, type- micro-prudential
regulation, macro prudential, consumer protection; banking authorities- international [e.g.
BCBS] and domestic[ SBP]; Recent Developments- BASEL 1, BASEL 2 And BASEL 3.

2.2 How these topics have contributed to my learning experience throughout the semester.

In a corporate risk management course, learning about risk and how to manage it has been
similar to laying a solid foundation. Understanding the history of risk management enables us t
o better comprehend why current practices are the ones that they are. We now have a whole di
fferent perspective on risk management's function after realizing how crucial it is to a business's
success. To improve abilities in managing erratic situations, the distinction between financial an
d non-financial sources of risk was emphasized, and decision-making under uncertainty was dis
cussed. To facilitate group decision-making, the psychological components of risk attitudes wer
e examined, along with techniques for assessing and evaluating various attitudes. Examining a b
ank's balance sheet, business model, profitability, and performance evaluation were among the
subjects covered from a risk standpoint. The regulatory environment was examined, including c
onsumer protection, macroprudential, and micro-prudential laws, as well as foreign agencies (li
ke BCBS) and national organizations (like SBP).

3. Reflection of Learning

3.1 Learning experience throughout the course.

Throughout the Corporate Risk Management course, we delved into risk management from vari
ous perspectives, focusing on individuals, corporations, and financial institutions. We explored t
he key pillars of the financial system, including households, firms, and financial institutions, all
with the common objective of wealth maximization.
Starting with the measurement of wealth for firms through share prices and understanding the
market and intrinsic values, we expanded our view to individual wealth, considering accumulate
d assets like real estate over a lifetime.

We then distinguished financial institutions into banking and non-banking sectors. Within the n
on-banking sector, we covered topics such as risk and uncertainty, different methods to quantif
y risks like Coefficient of Variation and Sharpe Ratio, and identified various risks like credit, infla
tion, interest rate, and operational risks.

3.2 considerable questions:

Most important concepts or ideas learned: I found out about identifying risks that may affect a
company, predicting the chances of such risk materializing, and determining the level of impact
it may cause. We also studied various different kind of risk management, such as to survive
them, to transfer them, or to decrease their outcome. Learning the relationship between
different processes was the important part.

Changes in understanding of corporate risk management: In the beginning I had a very limited
concept of risk management and it was about the elimination of bad outcomes. However, as
time went on, I learned how much more it is than only that. It is safeguarding your company
goals and reputation which are important aspects of risk management. This can be done by
being proactive and planning well. Besides, I found out that it's not as much as a single person's
responsibility – we all in a company have a say.

Most challenging aspects of the course and how you overcame them: Well, some of the areas
were really tough especially the financial and legal side. However, my challenge was that I did
not understand everything in class. Therefore, I tried to ask lots of questions and get extra help
from the professor during his/her office hours. I discovered that talking through topics with my
classmates not only helped me fully grasp the matter, but also that by breaking the material
into smaller, more manageable pieces I found understanding the subjects much easier.

4. relate learning of specific selected bank:

Risk and uncertainty:

Risk is an uncertainty and consist of two types (Quantifiable and Unpredictable). How you quan
tify the risk that is quantified by standard deviation also discussed the drawbacks of Standard d
eviation i.e. it measures both upside and downside and if you are able to quantify that how muc
h impact it will have that is the risk.

In discussing risk management, we emphasized the importance of understanding risk capacity, r

isk appetite, and risk tolerance

Other Methods to Quantify Risk

 Coefficient of Variation: Risk/Return

 Sharpe Ratio: Return/Risk

 Value at risk ( focus only on the downside)

Identification of Risk:

1- Credit Risk (Borrower's inability to repay a loan or other debt obligation)

2- Inflation Risk (Potential loss of purchasing power due to general increase in prices)
3- Interest Rate Risk (Financial loss from changes in interest rate)
4- Operational Risk (Supply chain disruptions)

 Risk Capacity: The risk that you can afford to take

 Risk Appetite: The risk that you need to take
 Risk Tolerance: The risk that you prefer to take

Risk Management Process:

The risk management process involves balancing risk exposure and risk tolerance to achieve the
ultimate objective: wealth maximization, expressed through Economic Value Added (EVA).

EVA= (ROIC-WACC) X IC.

Different Approaches to manage and modify risk:

Risk Prevention and Avoidance: Avoiding risk seems like the safest option it means sacrificing p
otential gains or opportunities.
Risk Acceptance: When actual Risk exceeds the acceptable level, these approaches are used to
manage risk:

 Self-Insurance: ( setting aside capital to cover losses)

 Diversification: (spreading investments across a variety of assets or securities.
 Risk Transfer: (Transfer Responsibility like Insurance Company)
 Risk Shifting: (Transfer Burden to third Party like Derivatives)
Furthermore, we discussed the Risk Attitude:

Risk Aversion: They always prefer lower-risk options even if the expected return is lower

Risk Lover: They always prefer higher risk options even if the expected return is lower

Risk Neutral: (The risk is irrelevant for them, they focus on expected return)

Decision Making: Investors, by and large, tend to be risk-averse, shaping their decisions based o
n the concept of Risk-Adjusted Return. This involves utilizing metrics such as the Coefficient of V
ariation and Sharpe Ratio to assess the relationship between risk and the potential return on in
vestment.

Utility Function: It is a measure that describes the preferences of an individual in terms of risk a
nd uncertainty. It can be expressed in a graphical Form by Indifference Curve.

The second part of financial Institutions is Banking.

In this segment, we explored the realm of banks and their primary objective, which is to steer cl
ear of bankruptcy. This unfortunate scenario occurs when a bank's liabilities surpass its assets, u
nderscoring the crucial importance of maintaining a healthy balance between the two.

Further, we discussed Commercial Banks and their basic functions (to accept deposits and to m
ake loans)

Balance Sheet Of a Commercial Bank:

On the Balance Sheet:

Assets

 Trading Book( Held for sale like hedging)

 Banking Book (Held till maturity for the sake of return)

Liabilities: Deposits, Borrowings

Equity: Types of equity holders (common and preferred) and (Tier 1 and Tier 2)
Tier 1 is the capital that is the banks core capital that is available to absorb losses and Tier 2 is t
he Capital that is the bank’s supplementary capital.

OFF the Balance Sheet:

These items are not recorded on the bank balance sheet but they have an impact on the bank's
financial position.

 Loan Commitments
 Loan sold
 Derivative contracts and more.

Business Model of Commercial Banks

The primary source of revenue for commercial banks is the interest earned on loans and other
interest-bearing assets. The interest charged on loans is higher than the interest paid on
deposits which contributes to the bank's profitability.

Factors to evaluate the performance of commercial Banks

CAMELS is the analysis of six indicators that reflect the financial health of commercial banks.
when evaluating a bank, it's crucial to look at five key aspects. First is Capital Adequacy, which
checks if the bank has enough financial cushion to handle unexpected losses. Asset Quality
assesses the health of the bank's loans and investments cushion, making sure they're not too
risky. Management Soundness evaluates how well the bank is run, ensuring responsible
decision-making. Earnings and Profitability look at the bank's ability to make money while
Liquidity checks if it has enough cash to meet its daily needs. Finally, Sensitivity to Market Risk
examines how well the bank can handle changes in interest rates and market conditions. These
factors together give a comprehensive picture of a bank's overall health and stability.

Bank Regulations: Bank regulations are laws, and regulations that govern the activities of banks
and other financial institutions. These are also called Bank Prudentials.
Further, we discussed the two authorities
 at the international level that is (Basel Committee on Banking Supervision)
 at domestic i.e. Central Bank.

These regulations consist of two levels:

Micro Prudential ( All the rules and regulations which are there to safeguard the individual
bank)
Macroprudential (For overall economy)
The above-mentioned were the important concepts that we learned during this course on
corporate risk management.
4.1 The concepts and ideas covered in the course apply to the failure of Lehman brother and
lessons can be learned from this case:
Risk Management: Lehman Brothers' downfall gave a clear indication that appropriate risk management
policies are a vital element of financial institutions' functioning. Lehmans relied on its heavy exposure to
subprime mortgage-backed securities without adequate risk mitigation processes, when the housing
bubble burst, it had to face large losses.

Lesson: Financial institutions have to implement comprehensive risk management systems to assess and
reduce risk among various opportunities.

Liquidity Management: One of the main reasons that acquire Lehman a liquidity crisis was its reliance
on short-term funding to finance its long-term investments. When creditors of Lehman lost confidence
in its capability to repay the debts and faced a serious liquidity shortage, it eventually led to the
bankruptcy of the company.

Lesson: Financial institutions should maintain funds of adequate sizes and diversify sources of funds to
allow them to survive the stresses of markets.

Corporate Governance: The governance structure and cultural direction of Lehman have also been
identified as the cause of their business collapse. There existed the problems of inadequate monitoring
by the board of directors, the use of reckless strategies by employees, and non-transparency in finance
reporting.

Lesson: A robust corporate governance framework, which entails independent board oversight, rigorous
risk management oversight, and ethical leadership, constitutes the backbone of any sound financial
institution.

Systemic Risk: Besides Lehman's collapse having certain ramifications, it induced a panic on stock
market and eventually turned to be the first stage of the great recession. The interdependence of
financial institutions and markets had Lehman crash impacts intensify rather than diffuse in global
economy.

Lesson: To stem systemic problems financial institutions and the government need to be attentive about
the spreading of economic difficulties and every effort to this effect must be made.
 4.2 Conclusion:
In other words, corporate risk management is very essential. It is all about companies being smart
and careful in handling possible issues that could arise. When businesses are skillful at handling
risks, they are able to detect problems before they become large problems and find ways to solve
them. This enables them to safeguard their cash, image, and long term survival. It's like having a
cushion to save you if something bad happens. Furthermore, transparency in risk management
enables companies to establish trust with those who matter to them the most, such as investors and
customers. In our super dynamic world where a lot can go wrong in a short period of time, knowing
how to cope with risks is like a ninja weapon. Hence for the organizations to prosper and keep
growing, the risk management becomes the highest priority for them.

Potential consequences of Lehman’s failure:

Loss of confidence: The size and the "network" that Lehman Brothers had, made itself to be felt on
a global level. Doubtlessness of the investors in finance system led to deterioration of financial
status where banks were no longer able to give and take loans.

Credit Freeze: The lending institutions resorted into mistrusting each other stability, therefore a
credit crisis came about. The inability to spread the risk of default resulted in less lending as a whole,
hitting businesses and individual borrowers hard.

Regulatory Changes: The crisis marked a turning point in the introduction of tighter aid regulations
in order to avoid this reoccurrence. These necessarily intensified the regulation of banks and
increased capital as well as other prudential regulations.

Global Financial Crisis: The fallouts of such low credit scores and shattered financial continents of
the universe were, thus, the 2008 financial crisis. Stock markets dived and businesses collapsed; the
employment market has grown to be unbearably deplorable.

The collapse of Lehman Brothers wasn't only an institution after all it was a huge turning point that
underlined the complex nature of the financial system and showed the consequences of cases of
risky behavior.
5. Diagram: