Question

Do you believe financial innovation can lead to greater risks in financial stability?

Discuss the three types of restructuring strategies and provide real-word examples of instances when each has been used.

Answer 1

The idea behind innovation in financial product is to serve the customer in more better way and provide them the options to choose among many. Innovation does not necessarily lead to Increase in risk in the financial stability but most of the time it benefits the companies and customer both. What happens sometimes is some financial models and product are so complex that the a simple customer might not understand the risk and reward related to that product but when companies are selling that product to customer, they focus more on selling rather explaining the risk associated with that product. For example Derivatives are one very efficient way to trasfer some proportion of risk to other but most people in the market do not use it for risk transfer but for speculative purposes. The innovation in any field is very Important and it brings more transparancy, reduces operation cost, increases efficiency, and serves the customer in more productive way not necessary a issue for stability of the system.

The three types of restructuring strategies are:

• Downsizing: Downszing is basically reducing the number of employees on the payroll of the company. It reduces the number of manpower to reduce the cost of salary to improve the overall performance. Downsizing reduces the number of operating units but does not necessarily change the companies portfolio. In recent year, especially after 2008 economic crisis, a number of companies has significantly reduced their manpower. HSBC, a global banking giant has gone for downsizng to improve the performance. The same with General Motors has reduced manpower to improve the overall operation.
• Downscoping: Downscoping is basically segregating businesses that are not related to the core operation of the business. It can be in the form of divestiture, spin-off or selling it to others. This is mainly done by conglomorates when they have diversifies themselves and it becomes difficult to manage. Like in the recent years Tata group which is a large diversified conglomerate has been trying to refocus on their core businees like IT and looking for partners to spin-off the Jaguar and Land rover business. Downscoping is not necessarily a negative thing. It can enhance the core performance of the business
• Leverage buyout (LBO): In leverage buyout, a private equity may buy all the assets of the firm by either full cash or part cash and part debt. LBO is executed by firms mainly when they believe that a particular firm is temporarily facing cash crunch and it'sperformance can be turned around. one of the example of Levarage buyout would be the purchase of Hilton hotels by blackstone group in 2007, financed partly through cash and debt.