managing financial institutions has never been an easy task but in recent years it h 638334
Managing financial institutions has never been an easy task, but in recent years it has become even more difficult because of greater uncertainty in the economic environment. Interest rates have become much more volatile, resulting in substantial fluctuations in profits and in the value of assets and liabilities held by financial institutions. Furthermore, as we have seen in Chapter 5, defaults on loans and other debt instruments have also climbed dramatically, leading to large losses at financial institutions. In light of these developments, it is not surprising that financial institution managers have become more concerned about managing the risk their institutions face as a result of greater interest rate fluctuations and defaults by borrowers. In this chapter we examine how managers of financial institutions cope with credit risk, the risk arising because borrowers may default on their obligations, and with interest rate risk, the risk arising from fluctuations in interest rates. We will look at the tools these managers use to measure risk and the strategies they employ to reduce it.