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Investing in the underserved urban markets is an innovative practice in which institutional investors can enjoy competitive financial returns on their investment while stimulating economic growth in urban communities. Over the last three decades, targeted investment has undergone a paradigm shift from the traditional subsidy-driven model to the market-driven model. In the capital-driven model, institutional investors perceive investing in the underserved urban areas as an overlooked economic opportunity. Public sector pension funds look for ways to maximize their overall investment returns while managing risk. In doing so, they seek alternative investment strategies and increasingly allocate a portion of their portfolio to illiquid, riskier investments in pursuit of higher returns. Key to such sound investments is recognizing and mitigating the financial and political risks to which pension funds, particularly defined benefit pension funds are prone. This chapter deconstructs how pension funds use urban investments to meet their long-term liabilities while also managing risk. It argues that pension funds can use urban investments together with risk management tools to achieve their portfolio diversification requirements, through evidence drawn from over 100 individual interviews with pension fund trustees and officers, investment vehicles, and other stakeholders in examining the targeted investing strategies of the large California, New York, and Massachusetts' public sector pension funds.

This chapter presents a summary of the main themes of the preceding chapters. It presents the following principles to guide in the design of the new international financial architecture: (i) full cognizance of the social costs of the externality of systemic risk is needed, particularly its macroeconomic impact; (ii) homogeneity of market behavior is a threat to liquidity, particularly at time of high volatility, when convention has broken down; (iii) steps need to be taken to reinforce the stabilizing power of convention; (iv) international policy formation and implementation should be international in scope because financial markets are today international; and (v) international decision making and standard setting should be effective in devising principles of efficient regulation, accountable in terms of transparency and clear lines of decision-making authority.

The deadweight costs of financial distress limit many firms' incentive to include a lot of (tax-advantaged) debt in their capital structures. It is therefore puzzling that firms do not make advance arrangements to recapitalize themselves if large losses occur. Financial distress may be particularly important for large banking firms, which national supervisors are reluctant to let fail. The supervisors' inclination to support large financial firms when they become troubled mitigates the ex ante incentives of market investors to discipline these firms. This chapter proposes a new financial instrument that forestalls financial distress without distorting bank shareholders' risk-taking incentives. Reverse convertible debentures (RCD) would automatically convert to common equity if a bank's market capital ratio falls below some stated value. RCD provide a transparent mechanism for unlevering a firm if the need arises. Unlike conventional convertible bonds, RCD convert at the stock's current market price, which forces shareholders to bear the full cost of their risk-taking decisions. Surprisingly, RCD investors are exposed to very limited credit risk under plausible conditions.

This introductory chapter begins with a discussion of financial crises around the world. It then considers the microeconomic and macroeconomic components of financial crises, and the impact of regulation, risk, and liquidity on financial markets. An overview of the succeeding chapters is presented.

This chapter explores financial asset allocation strategies when human wealth, the expected present discounted value of future labour earnings, is not tradable. Investors should adjust explicit asset holdings to compensate for their implicit holding of human capital and reach the desired allocation of total wealth. Riskless labour income makes human capital equivalent to an implicit holding of safe assets, thereby creating a strong tilt in the financial portfolio towards risky financial assets. Idiosyncratic labour income risk, uncorrelated with financial asset returns, can reduce this tilt but not reverse it; positive correlation between labour income and financial asset returns can reverse the tilt, increasing the demand for safe financial assets. The ability to adjust labour supply makes investors more tolerant of financial risk, because they can respond to poor investment results by increasing work effort, while subsistence needs to act like negative labour income and reduce tolerance for financial risk.

This chapter analyzes why a business or a project fails to meet its debt-service commitments. It is devoted to a full-scale credit risk analysis of a lending decision and pricing of a particular risk category of a borrower, using real-life examples. The approach is kept simple and practical, so that the system proposed can be easily implemented by lending organisations.

This chapter examines the extent to which the women's wealth gap is exacerbated or mitigated by the ways that men and women save and invest their money. When it comes to saving and investing, women and men do have different portfolios. Women are less likely to own assets that are considered more financially risky but that also have the highest average rates of return over time: stocks, investment real estate, and business assets. Women are often caught in a financial Catch-22: their lower disposable incomes put them at a disadvantage for building savings, and their lack of a financial safety net means that their smaller nest eggs are subject to depletion in crisis situations. Because of these two factors, they cannot afford the risk and the long time horizon necessary to secure higher rates of return on investments.

Chapter 7 reports two aspects of research on contracting in the NHS. The first investigates how the policies to use contractual mechanisms including financial risk allocation work in practice. Most of the contractual relationships between NHS owned acute providers and commissioners were characterised by the use of general annual financial settlements outside the terms of the contract. This behaviour appeared to be increasing over time. The second study comprises a review of the evidence concerning new forms of contract being introduced into the NHS: alliance and outcome based contracts. These are aimed at facilitating the integration of services and improving quality of care. Evidence from other sectors indicates that new models of contracting may result in cost savings including a reduction in capital costs, the development of innovations and benefits in relation to time. But there are high transaction costs in relation to the process of contract negotiation and specification. The evidence base regarding improvements in the quality of services is not convincing. These models carry a number of potential governance issues in relation to their implementation in the NHS, and are at risk of failing to satisfy public sector governance objectives including accountability, integrity and transparency.

This chapter argues that, in passing the Sarbanes–Oxley Act, Congress was concerned principally with the process by which disclosures are prepared and the information within them is gathered and verified. Thus, much of the Act was concerned with accounting and auditing. While the benefits of these rules are hard to identify, their costs are easy to identify and have proven to be quite high. It is not clear that the game is worth the candle, especially when one considers the possibility that boards may have become so preoccupied with these issues that they failed to devote adequate time to managing the sort of financial risks that came to a head in the crisis of 2007–2008.

Given the firm's objective with respect to shareholders and other stakeholders, it is naturally desirable that a risk management strategy is consistent with the objective. A firm's objective has several dimensions. It can be defined in terms of a target variable such as profit, economic value, shareholders' wealth, or book value. In addition, the time horizon must be made explicit. Risk attitude with respect to the target variable is a third dimension. Determination of a risk management strategy requires also that management takes a position with respect to financial market efficiency, the existence of risk premiums, purchasing power parity, and costs of adjusting operations. These costs determine the role of financial risk management relative to the adjustment of operations and pricing. Flexibility of operations is a real option. Four types of strategies for financial risk management are discussed in this chapter based on the management's risk attitude and perception of profit opportunities in financial markets; laissez-faire (do nothing), aggressive, minimize variance, and selective hedging. These strategies can be chosen for any target variable and time horizon. Choosing a strategy is, to a large extent, an information problem. Information requirements for selective hedging, in particular, can become so overwhelming that the range of feasible strategies does not encompass it. In this situation management is faced with the need to determine what risk management objectives can be achieved with the available information.

In this chapter, I argue that financial risk poses unique challenges that justify a differential application of corporate law oversight standards. The steps in my argument are as follows. First, I show how modern firms with significant exposure to financial risk are different in fundamental ways that matter crucially to the application of oversight standards. Second, I argue that, notwithstanding these differences, the major Delaware oversight cases were correctly decided, though the result might have been the opposite if complaints had been framed differently, with relevant and important facts. Third, I argue that the federal case involving the JPMorgan “London Whale” episode was wrongly decided. I am not arguing for any change in the oversight standards themselves. Instead, my argument is that Delaware law already provides ample support and justification for holding directors to a higher standard with respect to the oversight of financial risk. The complexities of financial risk pose unique challenges that the Delaware courts should take into account when assessing director oversight failures. Such an approach would not subject directors to unwarranted exposure for oversight failures, or have negative implications for business, and it would not change Delaware’s approach to cases that do not involve financial risk.

This book advances the understanding, measurement, and management of financial institution risk. It addresses the determinants and measurement of risks at the level of individual institutions, as well as the determinants of systemic risk in a world where individual financial institutions measure and manage risk using approaches developed over the last twenty years. It also describes how interconnected the changes in progress are, and advocates the importance of continuing efforts to understand them. Risk management maximizes the wealth of its shareholders. Model risk denotes the risk institutions face because of model errors. Financial institutions find it difficult to aggregate firmwide risks. Risk management should help firms take risks that make money for them and avoid those that do not. Finally, an overview of the chapters included in this book is provided.

This chapter presents a modeling framework that forecasts both indicators of systemic real risk and systemic financial risk, as well as stress tests of these indicators as impulse responses to structurally identifiable shocks. The framework is implemented using a set of quarterly time series of financial and real activity for the G-7 economies for the 1980Q1 to 2009Q3 period. Two main results are obtained. First, there is evidence of out-of-sample forecasting power of the model for tail risk realizations of real activity for several countries, which suggests the usefulness of the model as a risk monitoring tool. Second, in all countries, aggregate demand shocks are the main drivers of the real cycle, while bank credit demand shocks are the main drivers of the bank lending cycle—a result consistent with the hypothesis that shocks to the real economy are the main drivers of both real and financial risks. A commentary is also included at the end of the chapter.

This chapter first takes into account the history of financial crises in America, citing financial crises as a regular and often debilitating feature of American life. The lack of a crisis for about 50 years, here, is attributed to the federal government’s active role in managing financial risk. This is a role which began to blossom in 1933 with the passage of the Glass-Steagall Act, which introduced federal deposit insurance, expanded federal supervision of banks, and separated commercial banking from investment banking. Critics of the Glass-Steagall Act, however, cited problems that could have arisen, such as the undermining of the nation’s financial system, or the encouragement of excessive risk taking or “moral hazard.” In the end, private financial institutions and markets cannot always be relied upon to manage risk effectively on their own. As a result, the best way to address the issue is through the identification and systematic regulation of significant financial institutions on an ongoing basis.

This chapter looks at controlling risk, operational risk management, and executive protection. Directors and officers have a duty to participate in risk management. Internal protocols and procedures are a subset of operational risk management. When there is a breakdown in internal controls, directors and officers will be held accountable for operational failures contributing to trading losses. The chapter discusses the duty to manage risk, risk management for financial and non-financial institutions, quantifying financial risk, portfolio dynamics, directors' and officers' understanding of financial instruments, risk policy, reporting lines and audit techniques, information flow, ethical concerns, responsibility for risk management, business judgment rule, education at financial institutions, and disclosure under the Sarbanes-Oxley Act.

This chapter focuses on the European Investment Bank and the Juncker Plan in terms of its impact on industrial policy and state-market relations. Showing the growth of both the EIB and the EIF over the past two decades, the chapter highlights the increasing importance of engaging private investors in their financial operations. By proposing an analytical distinction between “economic” and “financial” risk, it argues that operating on risk-sharing arrangements has led the EIB—and the Juncker Plan—to effectively accumulate the latter at the expense of the former, which has resulted not only in a trade-off between actual policy steer as envisaged by the Commission and increased leverage as a developmental strategy, but also in political tensions within the field of development banking.

This chapter discusses the issue of risk management in Relentless Monetization (RM), the fact that philanthropists cannot know for sure the impact of their interventions. The following broad points are considered: funders, to best fulfill their missions, need to take account of the risks that their decisions impose on the intended beneficiaries—an obligation known as the “good steward” responsibility; when addressing issues of risk, funders might well resort to simple rules of thumb; for large grants that impose sizeable risks for the funder's intended beneficiaries, RM sets out a more elaborate conceptual framework; the notion of “real options valuation,” a fundamental feature of the literature on managing financial risk, can be usefully applied to philanthropic decisions; the notion of game changers—investments that substantially alter the economic landscape of which they are a part—can be usefully applied to philanthropic decisions.