Question

Please construct an essay that explains five of the following ideas or terms and the challenges that they continue to present: Shadow banking system Enterprise risk management Change in mortgage markets Gap management Asymmetric information Macro-prudent supervision

Answer 1

The shadow banking system is made up of financial entities which have the same functions as traditional banks but which are subject to little, if any, regulation.

Like traditional banks, shadow banks provide credit and liquidity but, unlike their traditional counterparts, they do not have access to central bank funding or safety nets like deposit insurance.

Shadow banking includes money market funds, private equity funds, hedge funds, securitisation, securities lenders, and structured investment vehicles. Broad definitions also include investment banks and mortgage brokers.

Ironically, it was tighter regulations on traditional banks that drove capital into the shadows. This demonstrates that even the best-intended policies can have unforeseen secondary consequences that end up causing more problems. Regardless, these shadow banks were also heavily levered and are now being forced to de-lever, which is adding to the confusion in markets.

Enterprise risk management (ERM) is a plan-based business strategy that aims to identify, assess, and prepare for any dangers, hazards, and other potentials for disaster—both physical and figurative—that may interfere with an organization's operations and objectives.

The discipline not only calls for corporations to identify all the risks they face and to decide which risks to manage actively, but it also involves making that plan of action available to all stakeholders, shareholders and potential investors, as part of their annual reports. Industries as varied as aviation, construction, public health, international development, energy, finance, and insurance all utilize ERM.

Companies have been managing risk for years. Historically, they've done this by buying insurance: property insurance for literal, detrimental losses due to fires, thefts, and natural disasters; and liability insurance and malpractice insurance to deal with lawsuits and claims of damage, loss, or injury. But another key element in ERM is a business risk—that is, obstacles associated with technology (particularly technological failures), company supply chains, and expansion—and the costs and financing of the same.

More recently, companies have managed such risks through the capital markets with derivative instruments that help them manage the ups and downs of moment-to-moment movements in currencies, interest rates, commodity prices, and equities. From a mathematical point of view, all of these risks or "exposures" have been reasonably easy to measure, with resulting profits and losses going straight to the bottom line.

Akerlof first argued about information asymmetry in a 1970 paper entitled "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism." In this paper, Akerlof asserted that car buyers possess different information than car sellers, giving the sellers an incentive to sell goods of poor quality without lowering the price to compensate for the inferiority.

• Asymmetric information theory suggests that sellers may possess more information than buyers, skewing the price of goods sold.
• The theory argues that low-quality and high-quality products can command the same price, given a lack of information on the buyer's side.
• Others argue that ignorance of the facts is not a given, as wary buyers have access to information on demand.

A gap analysis, which is also referred to as a needs analysis, is important for any type of organizational performance. It allows companies to determine where they are today and where they want to be in the future. Companies can reexamine their goals through a gap analysis to figure out whether they are on the right track to accomplishing them.

• A gap analysis is how an organization examines its current performance with its target performance.
• A gap analysis can be useful when companies aren't using their resources, capital, or technology to their full potential.
• By defining the gap, a firm's management team can create a plan of action to move the organization forward and fill in the performance gaps.
• There are four steps to a gap analysis, which are defining organizational goals, benchmarking the current state, analyzing the gap data, and compiling a gap report.
• Gap analysis can also be used to assess the difference between rate-sensitive assets and liabilities.

Macroprudential analysis is a method of economic analysis that evaluates the health, soundness and vulnerabilities of a financial system. Macroprudential analysis looks at the health of the underlying financial institutions in the system and performs stress tests and scenario analysis to help determine the system's sensitivity to economic shocks.

• Macroprudential analysis is the study of the health, soundness, and vulnerabilities of a financial system to identify risks to it.
• It uses macroeconomic data including gross domestic product (GDP), growth rates, inflation, interest rates etc., and involves cooperation between multiple financial institutions.