Introduction
Financial management strategy refers to the process of identifying all possible strategies that can assist in maximizing a business net worth by allocating the available scarce resources in the best way possible among various competitive environment and how to implement, monitor and develop the said strategy to achieve the intended objectives. Strategic financial management takes into account the identification and comprehension of the changing environmental factors and hence planning accordingly. Strategic management initiative is very vital for firms that operate internationally. This calls for special types of structures to be enhanced in the business organization to facilitate its financial management strategy. Strategic financial management helps the business organization to be able to compete well in a competitive market environment hence able to stay afloat (Cary, “et al”, 1998).
Objectives of the financial management strategy
The basic objective of the financial institutions strategy is to maximize its profits while minimizing the risks associated with it. However, other objectives have to be achieved in a bid to supplement the original objective. These objectives are;
- To identify the existing or probable risks associated with retail lending that could negatively affect the financial base of the firm.
- To evaluate the overall integrity and effectiveness of the mortgage lending system’s risk management and controls while trying determine compliance with all applicable legislations and regulations that would negatively affect the service delivery by the financial institution.
- To provide findings and recommendations for any corrective action within the recommended time frame to the management board and the board of directors regarding possible risks associated with such leading.
- To obtain assurances for correcting significant inadequacies and to verify the effectiveness of the remedy action taken.
- To monitor any significant changes in the retail and mortgage lending rates in the market and our risk management practices that would negatively affect our lending system or affect our customers’ financial institutions.
Confidentiality of information and data from competitors is very essential so that the firm can be able to compete effectively in the market. The Integrity of data, its accuracy and reliability of data and information from which decisions are made needs to be of the highest quality to give way to sound decision making. The technology used in the planning and overseeing of financial resources should facilitate the achievement of the organization’s goals and objectives. The firm’s financial stability largely depends on the maintenance of capital necessary to support the ongoing operations and its ability to generate enough profit to maintain its capital base and sufficiency of liquidity due to potential overvalued financial assets or cash shortages during this time of recession. Financial difficulties can adversely affect the lending and mortgage sector due to deteriorating economic stability and quality of service (Duffie and Singleton, 2003).
Primary risks associated with financial management
For any firm to maximize its profits, it must take into consideration all the possible risks associated with its operations. It must have a conscious plan of its financial risk management. Financial risk management is the practice whereby the firm creates economic value in a firm by using financial instruments to manage the risks especially the credit risks and market risks. Financial institutions also encounter other types of risks such as foreign exchange, liquidity risks, inflation risks, volatility and shape associated risks. Financial risk management should be considered in qualitative and quantitative aspects. This entails identification of its sources, measuring it and devising means and ways of addressing them. Financial risk management deals with, how and when to evade these problems, using financial tools to manage and prevent the costly experiences of risks (Servigny, Arnaud and Renault, 2004).
The firm should have good risk assessment criteria. It should consider the operational or the transactional risk as the main risk linked with financial lending. This risk may arise from fraud, error, or the incapability to deliver goods or services, maintain a competitive lead and to manage information. These risks exist in each process level involved in the delivery of financial products and services. Operational risks includes transactional risks, transaction processing and other crucial areas such as customer service, system development and support, internal control processes and capacity building. Operational risks may affect other areas of risks such as credit, interest rate, compliance liquidity, price and strategic planning. Other risks associated with financial institutions include the reputation risk, strategic risks and compliance risks. Reputation risks encompass risks such as errors, delays or omissions in service provision. For a firm dealing with provision of financial services such as Nassau Finance Corporation these risks have direct impact on the strategic planning at a time like this when the economy is in recession. A poor lending strategy will automatically weaken its ability to provide efficient services at a time of stiff competition and hence potential customers will end up in other firms offering the same services. Similarly, strategic risks are caused by inaccurate information which makes the management of financial lending institutions make poor decisions. Consequently, provision of inaccurate data relating to consumer compliance revelation or unauthorized revelation of confidential customer information can expose financial institutions to civil punishment and legal action. Interest rate, liquidity, and market risks include those errors related to investment income or repayment assumptions that increase interest rate risks of serviced lending institutions (Brigo and Masetti, 2006).
The board of directors should look at the extent of risks and the quality of risk management they apply so that they can be able to serve their clients well while keeping the probability of occurrence of risks low. The board of directors should consider some factors while evaluating the quantity of operational risks. These factors should include the financial status of the firm, the amount of clients and institutions served, the quantity of transactions processed for financial lending institutions, the total size of all regulated financial institutions serviced, the type of product lines provided and the technology used in serving the clients and the continuity of the business. The effectiveness of operational risk management asses how well risks are identified, measured, controlled, and monitored. The directors should consider some factors in evaluating the quality of operational risks. These are the quality of the lending policies, the effectiveness of the lending system control and operational processes, the extent of the lending policies technical and managerial expertise, directorate oversight and the timeliness and completeness of management information systems used in measuring performance, formulating decisions about risks and assessing the effectiveness of processes (Bluhm, “et al”, 2002).
Financial leading companies also face the challenge of credit risk management. Credit risk is the risk associated with loss due to a debtor’s failure to pay of a loan, whether the principle, interest or both. The directors should employ certain models so as to be able to identify potential and existing customers according to their ability to repay loans advanced to them, and employ appropriate strategies. In case of Nassau Financial Corporation, they issue unsecured personal loans and mortgages, they should charge higher interest rate for higher risk customers or those clients whose creditworthy is in question. They should also control risks through setting of credit limits and also request for securities in form of real assets before a client qualifies for a loan of a certain amount. Consequently a biding loan agreement should be written to allow the lender some controls. These agreements should; limit the client’s ability to borrow more money than his or her paying capabilities, provide for checking of the debts requiring audits and term reports, allowing the lending organization power to decide when to recall a loan based on certain circumstances or when financial ratios or interest rates get worse. The board should also consider the use of credit derivatives. These are contracts that allow financial lending firms to obtain protection against defaulters from firms that sell protection especially the insurers. The insurers receive some regular fees periodically as compensation fees for covering the risks. Should a borrower defaults to pay, they buy the debt. This in turn reduces the risks associated with retail lending and mortgage lending. The corporation should develop a credit scoring model as a part of its framework while giving credits to its customers. These models should have both qualitative and quantitative aspects spelling out various aspects of risks such as operating experience, management expertise, asset quality, and leverage and liquidity ratios. After thorough review by the concerned credit officials or committees, they should give the loans in accordance to the terms and conditions as stipulated in the agreement (Brigo, Damiano and Andrea, 2007).
The board has to manage its financial and mortgage financing to avoid financial turmoil. They have to find ways to maintain financial stability of their corporation, the management and regulations of financial institutions and protection of their clients in financial transactions. The board should develop the originate-to-distribute approach model in their leading approach. This approach spreads risks while reducing financing costs. It also offers greater access to capital to fairly large amount of borrowers and still allows investors a higher degree of flexibility to select and organize their credit borrowing. However despite the advantages provided by this model, problems always appear at the end of each step of the credit extension chain. In the process of initiation, guaranteeing standards has become increasing compromising. Studies have shown that the worst cases occur in cases of sub prime mortgages. In sub prime mortgages, the incentive given by the originators to the financial leading firms are the source of break down of the countersign. The originators income of sub prime mortgages is usually tied to the quantity of the loan instead of the value of the original credit being passed to other creditors. This problem was however hidden by the continued rise in home values. Due to continued rise in the prices of houses, the home equity of the borrowers continued to increase and hence they were able to re invest into maintainable mortgages. The board should weigh the advantages and the disadvantage of originate-to-distribute model before engaging it in their mortgage lending considering that the economy of the Bahamas country is in the decline. The firm should take sufficient care while evaluating the risks associated with credit borrowing to avoid bad debts at a time the major economies are in recession. Nassau Finance Corporation (NFC) should however employ the services of financial regulators to oversee, regulate and strengthen their risk management practices and review of their lending policies coupled with proper guidance and up-to-date supervisory practices in identifying areas in which enhancement needs to be done (Cornett, “et al, 2006).
The Nassau Finance Board in its bid to stay afloat and to compete favorably in the market it can employ the following risk management practices. These are; risk identification and measurements, valuation practices, liquidity risk management and senior management oversight. In risk identification and management practices, the risks have to be identified first and their extent measured to be able to fully manage them. The management must consider the relationship between the credit risk and the market risk to have a better understanding of the potential risks and hence decide the best way to invest that is those clients whose records guarantee them credit facilities and those who don’t, and the way they can affect their credit system. The management should take a wide perspective on risks and with sufficient approval of the need to take a wide range of measures both qualitative and quantitative. They should employ sophisticated models such as value-at-risk models to assist in good risk management. They should place more emphasis on justification, independent review and other quantitative techniques for control models. They should also employ the techniques of stress test to supplement models and other better placed techniques for risk management. They provide valuable outlook on risks that are not taken into consideration by statistical model. Such risks include those linked to tremendous price movements. At a time like this with economic recession the management should sit back and think of those scenarios that may seemingly seem to be unlikely to happen but can pose a great danger to the firm if they happen. The stress tests should be relevant to the activities carried out by the firm, change in cost of borrowing and the associated risks and therefore should be of concern in decision making (Frenkel, Karmann and Scholtens, 2004).
The management should come up with its own way of valuating its financial instruments. Valuation practices are critical to any business organization. In a recession period, the market is always very shallow. They should develop their own know-how in conducting their own independent valuations instead of relying on employing third party to do valuation for them. This in turn would help the management constantly evaluate its lending system and act accordingly. Those firms that do not have adequate capacity to carry out constant independent valuations are not in a better position to asses their lending capability. The management must understand realize their liquidity needs at a time like this and prepare themselves for more erosion of the market liquidity and the associated risks.They should develop a strong risk controls mechanisms that will encompass information from all of its business activities with primary lending and mortgage lending taking the lead. The management should also take into consideration the use of senior management oversight of the whole cooperation. This is a basic requirement of a good risk management practices. The senior managers including the directors themselves should play an active role in risk management. They should participate in formulating the firm’s overall risk preferences and putting into effect ways of motivating the employees to work towards achieving the preference. They should also strive to have the necessary information so as to put in place the suitable policies and information systems as well as effective ways of identifying and measuring those risks. The senior managers should ensure that critical information is transmitted both horizontally and vertically. The management should ensure that all those concerned in financial lending and mortgage lending share all the information important to risk positions and business strategies in order to minimize probability of risks and also maximize the profits. The senior managers should work towards having strong and independent risk policies which supports clear and well composed thinking of the whole firm’s risk profile. The managers should assist the risk managers unearth hidden risks and to establish cases where excessive lending should result to too much risks (Duncan H. Meldrum, 1999).
Conclusion
In summary for times like this when most economies are on their knees, there is need for effective and efficient risk management controls to maintain a strong financial business organization. The managers and the supervisors must work hard to improve the risk management practices of their companies especially when the economy is declining. The Nassau Financial Corporation should remain vigilant in light of the competitive and shrinking market conditions. The management should take into consideration proper and effective risk identification and measurement need to develop objective valuation methods, the necessity of organizing liquidity disruptions and the need to have close monitoring by senior managers. Improvement in the institutions risk management will provide the corporation with a sound financial that will make it resistant to such financial shocks. Taking these factors into consideration, the management of Nassau Financial Corporation should be able to overcome the difficulties associated with risks that pose a threat to its survival (Brigo, Damiano and Andrea 2007).
Work cited
- Bluhm, “et al” An Introduction to Credit Risk Modeling. Chapman & Hall/CRC 2002.
- Brigo, Damiano and Andrea Counterparty Risk under Correlation between Default and Interest Rates. 2007.
- Brigo and Masetti Counterparty Credit Risk Modeling: Risk Management, Pricing and Regulation. Risk Books 2006.
- Cary, “et al” The Concise Blackwell Encyclopedia of Management. 1998.
- Cornett, “et al” Financial Institutions Management: A Risk Management Approach, 5th Edition. McGraw Hill 2006.
- Duffie and Singleton Credit Risk: Pricing, Measurement, and Management. Princeton University Press 2003
- Duncan H. Meldrum Country Risk and Foreign Direct Investment. (1999)
- Frenkel, Karmann and Scholtens Sovereign Risk and Financial Crises. Springer 2004.
- Servigny, Arnaud and Renault The Standard & Poor’s Guide to Measuring and Managing Credit Risk. McGraw-Hill 2004