The influence of credit risk in financial institutions Research Proposal

The influence of credit risk in financial institutions - Research Proposal Example Financial institutions primarily play a role of assisting the flow of funds from various ‘individual surplus units’ to ‘deficit units’. Financial institutions comprise of commercial banks, finance companies, savings institutions, credit unions, money market funds, mutual funds, pension funds and insurance companies (Madura, 2008). Adequate management of the credit risk in the financial institutions is a critical aspect for the growth and survival of the institutions. If a financial institution fails to control risks like that of credit risk then it can lead to insolvency (Wenner & Et. Al., 2007). The recent financial crisis had a major impact on the worldwide financial system. Managing risk and capital requirements in the various financial institutions have turned out to be an utmost necessity. Financial institutions generally have a quite complex structure related to liability. Credit risk of a financial institution is considered as a function of market val uations of the institution’s asset portfolio and its leverage (Chen & Et. Al., 2009). Thereby, the study aims to critically discuss the influence that the credit risk generally has on financial institutions. Aim of the Study & Specification of Objectives The aim of the study is to recognise the significant and influential capabilities of credit risk in financial institutions. The relevance of the study can be judged from the fact that in terms of financial risks that a financial institution face, the credit risk or default risk is considered to be one of the most significant and critical risk factors that every financial institution endeavours to mitigate to protect the financial institution and its consumers from insolvency. Objective of the study is to analyse and identify influence of different credit risks on financial institutions such as default risk; credit spread risk, sovereign risk, downgrade risk and counterparty risk. Therefore, a few questions that can be conside red are: What is the credit risk? What is the influence of credit risks on financial institutions such as commercial banks, insurance companies, savings institutions and others? What are the ways by which credit risks are being mitigated by financial institutions? In order to find answers to these questions scholarly articles, books, journals and others will be observed and used to identify the relevant aspects related to the study. Literature Review According to Investopedia (2011), credit risk can be identified as a risk if an individual or a company will be incapable to pay the principal or contractual interest on its debt obligations. This type of risk is mainly concerned with the investors who generally hold bonds within their portfolio. Government bonds, primarily issued by the federal government, are considered to have the slightest amount of default risks as well as lowest amount of returns. Corporate bonds have a tendency to have the highest level of default risks but it al so provides higher level of interest rates. Bonds that hold higher chances of being default are measured to be junk bonds, whereas, bonds that have lower chance of default are generally