Investment Risk Management

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Investment Risk Management

Causes of Lehman Brothers Bankruptcy

Undoubtedly, creative accounting was one of the biggest reasons of their financial failure. Cosmetic accounting was performed to portray a less shaky picture at each quarter end. Securities were temporarily removed from the company's balance sheet as a part of a repurchase agreement and were named as an outright sale that created a financial condition that was materially misleading. Management failed to manage this risk as they did not deploy strong internal controls. In future, firms should establish a system of strong internal controls which can prevent staff collusion and building up of strong relationship between firms and their auditors. External auditors of Lehman brothers should have not expressed a positive audit opinion when financial picture of the company was this shaky (Zingales. 2008).

The bank had violated the basic banking principle of borrowing on short term and lending on longer term. Even the remuneration process was left unchecked by the shareholders. While the company was failing in health top executives awarded themselves stupendously. Significant investment in Subprime mortgage-backed securities was another reason of the demise. Management failed to manage risk by not addressing operational risk factors. In future firms should appoint more non executive directors who will act as a coolant for shareholders' eyes (Zingales, 2008).

Sufficiency of risk management techniques

Financial institutions are prone to risks be it interest rate risk, liquidity risk or operational risk. Mortgage backed securities are indeed very risky and can have devastating effects on the valuation of investments. Financial institutions can bring into use many risk management techniques. Banks and other financial institutions can eliminate risk but at times riskier ones provide the greatest returns. Eliminating them would add to the opportunity cost. At times all risks cannot be avoided which means they need to be actively managed. Barclays a leading financial institution manages risk by identifying all possible risk faced by the group. It then establishes the risk appetite of the group and ensures that the operations of the bank are consistent with it. Risk/return decision are optimized. Management of risk profile is considered essential which takes into account adverse and favorable market conditions. Risk management techniques at Barclays assist its executives to enhance the control and coordination of risk taking. In my opinion, risk management techniques are sufficiently managed keeping in mind the demise of Lehman as a bitter example. Financial institutions are continuously identifying risks, developing risk appetite and risk management framework and then monitoring and measuring risks on regular intervals to ensure another bankruptcy and a subsequent financial crisis is avoided (Saunders et al, 2006).

Management's role for risk management

Implementing a sound system of internal controls is the responsibility of the board. A sound system of internal controls will help in preventing, detecting and correcting deficiencies in risk management. It is management's role to setup and furnish the corporate culture that places risk management at the heart of its activities. For high risk investments proper risk management procedures needs to be in ...