Report On

Departmental
ental Operations of Orion Group, Moral Hazard & Excessive Risk taking

By
Fariha Hussain
ID: 17264103

An Internship Report Submitted to the BRAC Business School in partial fulfillment of

the requirements for the degree of MBA

BRAC Business School,

BRAC University
November, 2021

© [2021]. Brac University

All rights reserved.
Declaration

It is hereby declared that

1. The internship report submitted is my/our own original work while completing degree at

Brac University.

2. The report does not contain material previously published or written by a third party,

except where this is appropriately cited through full and accurate referencing.

3. The report does not contain material which has been accepted, or submitted, for any other

degree or diploma at a university or other institution.

4. I/We have acknowledged all main sources of help.

Student’s Full Name & Signature:

___________________________________________
FarihaHussain
17264103

Supervisor’s Full Name & Signature:

___________________________________________
Riyashad Ahmed
Assistant Professor, Brac Business School
Brac University

2
Letter of Transmittal

Riyashad Ahmed
Assistant Professor,

Brac Business School

Brac University
66 Mohakhali, Dhaka-1212

Subject: Departmental Operations of Orion Group/ Moral Hazard & Excessive Risk Taking

Dear Sir,

It is indeed a great pleasure to be able to hand over the internship report prepared as a part of
the requirement for my Bachelors program under BRAC Business School of BRAC
University. I have worked with utmost sincerity and successfully completed my internship
report.

Working with Orion was a great learning experience for me as it teaches the differences
between practical and theoretical work. I hope you will find the report to be objective and
reliable. I have to make this report as comprehensive as possible, which is why there may be
some discrepancies due to various restrictions. For this reason, I beg your kind consideration
in this regard.

I would like to take this opportunity to thank you for all the support and guidelines that you
have provided, which I hope to continue getting in the future.

Sincerely yours,
_______________________
Fariha Hussain
17264103
Brac Business School
Brac University
Date: November, 2021

3
Acknowledgement

I convey my sincere gratitude to my academic Supervisor Mr. Riyashad Ahmed from BRAC

Business School. Without his kind direction and proper guidance, this study would have been

impossible for me. In every phase of the project, his supervision and guidance shaped this

report to be completed.

I would like to take this opportunity to thank my supervisor at Orion Group and my co

workers for assisting me with any information needed regarding the report.

4
Table of Contents

Declaration

Letter of transmittal

Acknowledgement

Chapter 1: Overview of Internship

1.1 1.1 Student Information: Name, ID, Program and Major/Specialization

1.2 Internship Information:

1.2.1 Period, Company Name, Department/Division, Address

1.2.2 Internship Company Supervisor’s Information

1.2.3 Job Scope

1.3 Internship Outcomes:

1.3.1 Student’s contribution to the company

1.3.2 Benefits to the student

1.3.3 Problems/Difficulties

1.3.4 Recommendations

Chapter 2: Organization Part: Overview, Operations and a Strategic Audit

2.1 Introduction

2.2 Overview of the Company

2.3 Management Practices

2.4 Marketing Practices

2.5 Financial Performance & Accounting Practices

2.6 Operations Management and Information System Practices

2.7 Industry and Competitive Analysis

5
 2.8 Summary and Conclusions

2.9 Recommendations

Chapter 3: Project Part: Title of the Project

3.1 Introduction

3.2 Methodology

3.3 Findings and Analysis

3.4 Summary and Conclusions

3.5 Recommendations

6
Overview Of Internship

Name: Fariha Hussain

ID: 17264103

Program: MBA, Major in Finance

Period: 2017-2020

Company Name: Orion Group

Department/Division: Corporate Affairs

Address: 153-154 Tejgaon I/A, Dhaka

Supervisor's Name: Ferdous Jaman

Position: Company Secretary

Job Description

● Preparation of Annual Report of the listed concerns of Orion Group.

● Corresponding to emails of the Company Secretary on a daily basis.

● Checking and finalization of daily class wise and shift flyover report with

analysis for top management on a daily basis..

● Preparing any official report assigned by the Supervisor.

● Corporate Affairs related activities like checking and finalizing meeting

minutes, write up, briefing and other assigned activities.

7
My Contribution to the Company

My supervisor is Company Secretary therefore I need to correspond to many emails coming

from abroad, communicate with foreign banks and also need to work on the Annual Report of

the company. My communication skill is better in English as my background is english

medium and that really helped to draft an email, write a report and make write ups for Annual

Report. As my competency level lies in English, I can help my boss in preparing official

documents in English and also maintain a network with the international stakeholders. My

bachelors in Economics has also made me capable of making official reports consisting of

economic data relevant to the business of the company.

Benefits to the student

It has been over 3 years I have been working as an Executive in the Department of Corporate

Affairs in Orion Group and in these three years I gained the experience of working in a large

corporate culture. The job has benefited me in developing my communication and

interpersonal skills, working with people from various fields and dealing with them. It has

also taught me to be punctual about any given assignment and how to be an effective team

player. As I have been working for quite a long time, it has helped me to be more

independent financially and socially. This 3-year job experience will make my resume

stronger for seeking a better job in other local giants/multinational companies in future.

8
Recommendations

Orion group is a well recognized conglomerate of Bangladesh providing lucrative

opportunities of working in various fields and gaining experience. As I am working in the

Corporate Affairs department, my scope in the field of finance is very limited as my subject

for my major is Finance. The Corporate Affairs department is confined within the tasks of

working personally with the higher management of Orion, preparing Annual Report of the

listed concerns and organizing meetings. It limits the scope of gaining practical skills in a

diversified field which can enhance the skill level and also help to gain practical knowledge.

The management must consider this issue and work on how to bring transformation by

introducing more highly skilled tasks and diverse the scope of learning in the Corporate

Affairs department as it will play a crucial role in the employee's future career development

in terms of his/her working experience by focusing on diversification as well as

specialization.

9
Objective

The objective is to analyse Orion Pharma Ltd, a renowned pharmaceutical company in

Bangladesh and concern of Orion Group, its different business segments to gain concise

knowledge about its entire corporate management system, operational and financial activities.

The report has emphasized on the company's corporate governance policies, board of

directors, management policies, financial operations, its competitive and industrial policies

and how advanced the company is in terms of technologies. Company's strength and

weakness has also been identified by SWOT analysis and the market forces which are

responsible for driving the business.

Limitations & Significance

Due to Covid-19 pandemic, it was difficult to conduct primary research on the company as

employers/employees were all working from home to maintain social distance. No survey

was possible to run or take interviews from individual employees. All the information is

collected from secondary sources provided that sources are all reliable and contain all valid

information. The significance of the report is, it gives a comprehensive idea about the

company's structure, its management system and policies.

10
Methodology

With a view to completing the report the information has been collected from the secondary

source only. The report covers the organisational structures, its financial operations, corporate

governance system, its industrial and competitive analysis and its IT system. All this

information is collected from the recent Annual Reports, company's website and company's

various business reports. The information is known to be precise and updated according to

the current state of the company's position.

Overview of the Company

ORION GROUP is a leading and continuously thriving corporation and a legendary brand

name in the business arena of Bangladesh and beyond. Orion has a long history of

determination, commitment towards excellence, integrity, and a firm promise to deliver value

to its consumers and clients since early ‘80s.Orion Group is endowed with a highly

diversified portfolio of Pharma & Healthcare, Power Generation & Energy, Shipping,

Infrastructure Development, Real Estate & Construction, Cosmetics & Toiletries, High-tech

Agro Products, Consumer Products, Food & Restaurant Chain, Textiles & Garments, Home

Appliance sectors and so on. Orion in recent times has exclusively focused in Power

Generation & Energy, Consumer Products and Infrastructure sectors

Orion Pharma Limited (OPL) was formed as a pharmaceutical manufacturing company in

1965. With the mission to serve the ailing humanity around the globe, Orion Pharma started

its operation nearly five(5) decades ago, and after a great run of success the company today

has proliferated out into one of the leading pharmaceutical companies in Bangladesh. The

company has its name listed with Dhaka Stock Exchange (DSE) and Chittagong Stock

Exchange (CSE) from the year 2013. OPL also owns 21.76% shares of another concern of

11
Orion Group named Orion Infusion Limited (OIL) which is known for producing Large

Volume Parenteral (LVP) & other life saving injectable products. OIL is also listed in DSE

from the year 1994 and in CSE from the year 1996. With the number of pharmaceutical

giants increasing spontaneously in our country, competition within the industry is fierce. OPL

believes in exceeding boundaries to deliver life changing results. OPL is a healthcare

company dedicated to the improvement of human health by producing world class general

medicines of supreme quality and distributing them globally. The company always believes

in 'Quality never ends' and refuses to settle for anything until it exceeds the existing standard.

The company comprises the production of capsules, tablets, syrup,suspension, injection, dry

powder for syrup / suspension under different classifications like anticancer, cardiovascular,

antibiotics, anti-diabetics, anxiolytics and others. With growing markets and an increasing

reach, this pharmaceutical powerhouse is operating with one hundred & twenty (120) brands

and two hundred & thirty one (231) presentations with the anticipation of rapid growth and

innovation in the years to come by staying compliant with the ISO-9001:2015 guidelines and

Good Manufacturing Practices (GMP).The new pharmaceutical manufacturing plant of Orion

Pharma Limited named as Pharma Park is located in Siddhirganj, Narayanganj, by the bank

of river Shitalakshya. The plant is well designed and well equipped with all latest facilities

and state-of-the-art technologies and contains facilities with the imported equipment like

ETP, Air Compressor, Chiller, WTP, dust collector and many more with the aim to expand

and upgrade the current quality & quantity production.

Management

At Orion Pharma Limited, the Board of Directors is independent of management and has no

association that can interfere with their judgment or scope of work. The Nomination and

12
Remuneration Committee (NRC) has been assigned to assist the Board to review the

independence of the Directors as well as the sub-committee members. Both the Independent

Directors have submitted a signed and dated declaration to demonstrate their independence to

the Board of Directors. The Board of OPL determines and declares at the end of the year that

all of its members along with those of its sub-committees are independent.

Orion Pharma Limited has a flexible corporate culture which is always open to improvement.

We are a team-oriented company and give plenty of room to our employees for opportunities

to learn and fast-track their career. Our human resources practices are one of the best in the

country and we are committed to establishing equal employee opportunity for our valued

employees. Our philosophy is to make the appropriate compensation and benefits to the

service employees provide the company. Integrity is one of our core values and we believe in

being transparent and fair in all our dealings by providing the best quality to the customers

along with fulfilling our responsibility towards the society.

Senior management team

In last financial year’s annual report, we reported that we had a management team which was

established by making the heads of different departments as its members with the headship of

the Chief Executive Officer. During the year under review, there is a modification in the

composition of our management team. Mr Md. Ibrahim Khalil, Head of Internal Audit and

Compliance; Mr. Md. Zakir Hossain, AVP – Production and Mr. Md. Faisal R Ferdous, VP –

HR have been included in the team. The other members of the team are Mr. Salman Obaidul

Karim, Chief Executive Officer; Mr. Samaresh Banik, Chief Financial Officer; Mr. Md. Arif

Hossain, SVP –Marketing Operations & Commercial. The senior management team of the

company is involved in full control of the company’s affairs and is also accountable to the

Board. It builds the confidence of the Board by ensuring that all the activities carried out by

13
them are consistent with high ethical confidence of the Board by ensuring that all the

activities carried out by them are consistent with high ethical standards. The Board of

Directors of Orion Pharma Limited has always prioritized the assurance of protection of the

interest of stakeholders by means of maintaining integrity of financial reporting, effectiveness

of risk management and internal control systems and related corporate governance and

compliance matters. The responsibility of ensuring these important matters is exclusively

delegated to the Audit Committee (AC),a sub-committee of the Board, appointed by and

responsible to the Board of Directors of OPL. At Orion Pharma Limited, the Board of

Directors through its Nomination and Remuneration Committee is responsible for overseeing

the succession planning. The management team is particularly assigned to assist the Board

and the committee with senior leadership succession planning when necessary. The company

always plans ahead the succession keeping factors such as skills and knowledge, diversity,

professional background, expertise etc. into consideration.

Marketing Management

Customers and consumers are the key stakeholders of OPL. Their satisfaction is the

foundation for our business growth and expansion. Serving them with the right products at

the right time is always our prime concern. The company gives high importance to seek their

opinion or complaints about our products and to gauge how the company is perceived by our

customers and consumers. In line with this, product complaint forms are available and also

customer satisfaction surveys and market surveys are carried out and the findings are

considered to improve business, products and/or overall customer experience.

Orion Pharma Limited is dedicated to its valued customers with products of excellent quality,

through continuous improvement in process & technology, sourcing of best quality raw

14
materials, complying with the guidelines of Good Manufacturing Practices (GMP) and the

requirements of ISO 9001:2015.

Financial Performance & Accounting Practices

Financial capital represents the fund used to facilitate the process of building and

strengthening the foundation for our ability to develop and create value for our providers of

funds. The main sources of this capital are equity, debt, earned surplus etc. which are raised

through the financing, operating and investing activities. After deduction of the dividend for

shareholders, the surplus earnings generated from business activities ultimately make our

financial capital base stronger and this is the main source of internal fund raising. We are

operating in a capital-intensive pharmaceutical industry and are now in the business

15
expansion stage for which OPL tends to retain more of its earnings to reinvest rather than

paying them out to shareholders. Other than internal fund raising options i.e. retained

earnings, we also focus on availing long as well as short term loan facilities from different

banks as we are expanding our business operation by increasing our product lines. Financing

via Export Credit Agency (ECA) is currently one of our key external funding options. We

plan the effective utilization of our financial capital and try to maintain optimum capital

structure. We analyze various factors for the selection of fund providers particularly for

loans, including project financing and working capital loan. Major issues considered includes

However, the company are constantly focusing on our actions to sustain growth, develop

operations and ensure the highest return for the shareholders and strengthen the financial

position. Funds generated are being used for the maintenance of regular business operation,

repayment of loan along with interest expenses, investing activities and dividend payment.

Information System

To illustrate progress towards achieving the performance goals of the company our

Information Technology (IT) continues to and innovative ways to move forward with more

advanced technologies. Our IT department is introducing new applications or updating the

existing one to simplify the day to day official tasks and strengthening the technological base

of Orion Pharma Limited. Desktop and Server Virtualization, Mobile Technology,

renegotiating maintenance contracts, that provides security and reliability needed and looking

into software applications that will create employee efficiencies. Many of our software were

purchased from vendors; again many of OPL’s software were developed by OPL’s highly

skilled internal software developers. The IT department is in charge of the following. There

are some useful online applications which have been created by Orion Pharma’s IT

department to make all kinds of operations and tasks fast and accessible.

16
Orion Online Solution

Orion Online Solution is the application where different departments can access it and make

utilization of it for various purposes. Orion Portal is a widely used mobile app by the

employees because they can get information about their attendance, appraisals, monthly pay

slip etc from anywhere they want to. Recently, Orion Pharma introduced few online

applications which have eased the field force’s regular job tasks. OPL also takes online

exams for recruitment and promotion purposes using the software known as Orion Online

Exam. Some of the applications Orion Online Solution includes e-bill process, MIS system,

e-attendance & leave system, vehicle system, fund requisition etc.

Industry & Competitive Analysis

Orion Pharma Limited has made an effort to portray all its activities, carried out in its regular

business to create value for its potential stakeholders, by a value chain model. In order to do

this, OPL has adopted Porter’s Value Chain Analysis to examine all of its activities, the way

in which value chain activities are performed, to see how they are connected and how these

activities are affecting costs and profits. This analysis helps OPL to understand the sources of

value for our company and for society.

17
Support Activities

Firm Infrastructure

• The design of the building and factory is good and reflects modern concept

• Prevalence of good governance

• Practice of strong code of business conduct

• Structured departments and hierarchical system

• Improved communication between different departments through the intranet

• Better accounting and financial management practices PPORT ACTIVITIES

Human Resource Management

• Strong HR team to recruit, train and motivate employees

• Excellent corporate culture for teamwork and leadership development

• Competitive remuneration package and compensation benefits

• Ensuring employees’ health and safety issues

• Offering safe and healthy working environment

• Non existence of gender discrimination

Technology Development

• IT department with required expertise and experience who supports both IT

infrastructure and software

• Automated Central Distribution Centre, distribution channels and depots

• Real time access to sales records from all depots

18
• Strong IT department is continuously developing many customized software

• Efficient R&D departments continuously engaged with developing new products or

upgrading existing one

Procurement

• Direct contact with suppliers

• Good cross border relationship

• IT based procurement planning and inventory management system

• Practice of strong code of business conduct

• Structured departments

Primary Activities

Inbound Logistics

• Good relationship with suppliers

• Sourcing supplies of high quality materials

• Efficient storage facilities- easy storage and retrieval

• Inventories are dealt with swiftness and efficiency

• Hired and owned vehicle fleet

• Supply schedules are matched with production

Operations

• Automated manufacturing processes

• Comply with compliance in every aspect and step of the production.

• Quality control and inspection

19
• Order fulfillment on time

• Real time inventory and sales tracking system

Outbound Logistics

• On time delivery through 58 customized vehicles

• Inventory management

• Efficient dispatch and delivery system

• Emergency resupply

• Emergency shipment

• 31 Regional Sales Offices and 19 depots all over the country

• 1 Central Distribution Cell

Sales & Marketing

• Efficient sales force of 1,106 number of employees

• Regular training of the sales team through sales training department

• Customer management

• Entering new and emerging markets

• Sales analysis

• Market research

• Branding and promotion of products

Service

• Product complain form

• Customer survey and seeking feedback

20
• Structured approach to understand the requirements of individual customers

• Fast response to customer requirement

• Expired product management

SWOT Analysis

This SWOT (strengths, weaknesses, opportunities and threats) analysis is a process where the

management team identifies the internal and external factors that will affect OPL’s

performance. The company’s strengths and weaknesses are the internal factors whereas

opportunities and threats deal with factors external to the company. This helps the overall

corporate planning process in which financial and operational goals are set for the upcoming

year and strategies are created to accomplish these goals.

Strength

• OPL has overseas marketing network in eleven (11) countries, products of OPL have

already been registered in

other five (5) countries and in the process of registering products in more than ten (10)

countries;

• Strong corporate and company brand image;

• Strong, transparent and professional management;

• Strong demand for our cardiovascular drugs;

• World leading generics are available in our product line;

• The biggest Pharma Park in the country with huge production capacity including capacity of

hi-tech products;

21
• Strong and country wide distribution network ensures supply of products up to retail level;

• High quality products with extensive product lines;

• Active participation in CSR activities;

• Front runner of some generics for the 1st time launched in Bangladesh; and

• Existence of competitive advantages

Weakness

• Emerging new international markets;

• High annual growth rate of pharmaceutical industry in Bangladesh with lot of potentials;

• Increasing demand for quality healthcare products due to the increase in consciousness

among people;

• Grant for the least developed countries, including Bangladesh, an exemption from

obligations to implement patents

and data protection for pharmaceutical products until 2033 as per trade related intellectual

property rights (TRIPS); and

• Chronic diseases continue to be the major factors for mortality worldwide, with developing

nations suffering from

high levels of public health problems related to chronic diseases.

Opportunities

• Lack of presence in international market particularly in Europe and in USA;

• Sub standard position in few areas of HR indicators;

• Lack of branded product recognition in local market;

• Low investment in R&D; and

• Lagging behind in grabbing the opportunities to introduce new potential therapeutic

products.

22
Threats

• Increase in competition both in local and overseas pharmaceutical market day by day;

• Change in rules and regulations from Bangladesh Food & Drugs Authority can make

products out of the market;

• Exposed to foreign currency fluctuations in case of importing raw materials and exporting

products;

• Interest rate fluctuations can have an adverse effect on the business sustainability; and

• Political instability and turbulence and disruption by the law enforcement agencies may

disrupt supply chain,production and hamper cost competitiveness.

Analysis of Five Forces

Industry analysis is a vital part of the decision making process in business. In this case

Michael Porter’s model is a widely used tool for industry analysis. This model identifies five

core competitive forces and by gaining knowledge about these forces and how they impact on

the business, decision makers can make better decisions and plan better. From that point of

view an analysis of the pharmaceutical industry of Bangladesh in terms of the five forces is

given here:

Threats of entry posed by new

or potential competitors: (Low)

• Economies of scale achieved by the established businesses;

• Huge capital intensive business;

23
• Access to the distribution channel is difficult;

• Government rules and regulations, particularly regulatory permission from the drug

authority; and

• Customers’ brand loyalty

Degree of rivalry among

existing companies: (High)

• High rivalry exists among the companies in the industry as same medicines under different

brand names are available;

• Industry is benefited from the strong demand of the consumers; and

• In the long run companies require low fixed cost and high working capital

Bargaining power of buyers: (Low)

• Price sensitivity is low as government strictly maintains the retail price of lifesaving

medicines, so consumers have

little room for switching;

• Companies influence medical practitioners, wholesale and retail shops for prescribing their

products;

• If any drug is prescribed by medical practitioners or physicians, the end user prefers to buy

that without thinking

about any alternative; and

• As medicine is related to health issue which is one of the basic needs, it is very important

for people and their

bargaining power is low.

24
Threat of substitute products: (Medium)

• There exists threat from generic drugs, because generic drug companies do not expend

in research and development

of new drugs. So they can sell their medicines at cheaper rates. So threat exists in generic

competition; and

• On the other hand if any drug is prescribed by medical practitioners then end user must

have to buy that without any

choice left. Even though end customers can switch to other brands due to the

unavailability of suggested brands.

Summary & Conclusion

Orion Pharma is one of the very old pharmaceutical companies running in Bangladesh. Its

production is on a massive scale, producing many varieties of medicines. To support its

mass production and keep up with the revenues and gross profit every year, OPL has

invested wisely on capital required, employing people with immense potential for its

efficient management. The company is also ahead in terms of technologies and its

infrastructural setup. Considering its financial positions in the last 5 years, the company

has fluctuating figures of its revenues, gross profit and after tax profit which means the

consistency is lacking. It has its highest profitable values in the year 2016 and lowest in

the year 2018. Various economic factors and competition in the market have affected the

company's business and its profit resulting in weak performance in recent years. To

conclude, as the number of pharmaceutical companies are growing the competition is

25
getting more challenging as there are new innovations and products emerging in the

market and OPL being one of the very first pharmaceutical companies , is pretty much

lagging behind in competition which is also the reason for its deterioration in profit.

Recommendation

Orion Pharma Ltd is a distinguished company in Bangladesh which played a crucial role

in the pharmaceutical industry for the past few decades. But its declined value in profit in

recent years has made its financial position quite weak. The main reason is its poor

marketing strategies. OPL's poor marketing structure has led to lower sales for which

reason its profit margin stays low and also declined significantly in the past few years.

According to the shareholders, the management must emphasize on its marketing policies

and should come up with more innovative and modern ideas to be able to compete with

the emerging pharmaceutical companies. As OPL has its own subsidiaries to support its

financial operations, the company must look forward to investing more in its marketing

segments to promote its supreme quality products which are being exported every year

and are equally good as any other products produced by its competitors. The company

must come out of its primitive selling strategies and be more flexible in adopting the

modern marketing policies to survive in the competition which will eventually boost up

its sales and revenues hence, increasing the profit margin.

26
Background
When money is given to someone, it must be ensured that it will be returned with interest.

However, this is less likely if the money is misused or lost through excessive risk-taking.

Moral hazard is the risk that the receiver of funds will not use the money as was intended or

they may take unnecessary risks or not be vigilant in reducing risk. The primary reason why

people give their money to financial intermediaries instead of lending or investing the money

directly is because of the risk that is present from the information asymmetry between the

provider of funds and the receiver of those funds. A seller knows more about the sale item

than the buyer. Likewise, a borrower knows more about his financial condition and his future

prospects than the lender. The 2 types of risks that are present when there is information

asymmetry:

1. Adverse selection, which is a risk exposure that exists before the money is lent or

invested and

2. Moral hazard, which is a risk after the financial transaction.

Selecting whom to give more of your money is a very important part of controlling risk. In

fact, without precise and detailed information about those seeking funds, theory goes that one

would have to charge an average price for the money or sale item. But an average price

would cause those who are better risks or have better products to shun the offer, while those

with higher risks will seek the offer, resulting in adverse selection.

The moral hazard problem of the Asian financial crisis and others could be a lesson to all the

emerging nations including Bangladesh. Moral hazard can bring an outsized shock to the

financial system of a country specifically to the banking sector. A design of optimal contact

27
among four parties including issuers, credit rating agencies, investors and regulators can help

in reducing the negative impact of moral hazard problem.

Objective

In this paper, the performance of the financial institutions are discussed as well as its

excessive risk taking and how moral hazard can be a barrier for the institutions when

providing loans to a newer organization and making risky investments. The key objectives

are to discuss the factors influencing the financial institutions' to take excessive risks and

analyze the association between moral hazard and investments on risky assets during the

financial crisis along with the role of government in restoring the stability in the financial

system.

Significance

The significance of the study on excessive risk taking by the financial institutions will

provide a precise idea on how the financial crisis and moral hazard turn the loan giving

business more challenging. Undertaking excessive risk can lead to poorer performance and

failure of the financial system. Financial institutions lose their confidence level of performing

alone and always seek government support which can make the government spend more on

giving backups to those institutions instead of spending money for development of the

country and its nation. The following analysis and findings will also give a distinct idea of the

impact of moral hazard and how the financial institutions are adopting and formulating new

strategies to overcome the tendency of excessive risk taking.

Methodology

Based on the entire paper the information illustrated and discussed are mainly collected

through secondary sources like published journals, newspaper articles like that. The data and

analysis are done through qualitative research method describing the financial projects and

28
risk associated in making huge investments on risky assets to get higher return by the various

banks worldwide and how undertaking excessive risky projects leading them to increasing

moral hazard problems followed by the government coming forward to protect them so as to

protect the sovereignty of a country as well as protecting the banks from getting collapsed.

The data and analysis part consists of a chart and graph to highlight the reformation of the

banking system from taking excessive risk and moral hazard with the support of government

measures.

Data & Analysis

Based on the journal of Financial Regulation, bursting of the housing bubble triggered the

financial crisis in August 2007 in the USA which also caused decline in credit quality of the

subprimBe mortgage but rise in delinquency rate. Such convulsions in the subprime

mortgage market lead to the disruption in the rest of the mortgage and structured finance

products. As a result, there was a skepticism working within the financial market and the

financial stakeholders were bound to lend each other. The interest rate spread grew in the

asset backed commercial paper and in LIBOR as a result of running out of liquidity. There

was a drastic drop in the asset values and mortgage backed securities which lead to write offs

of the balance sheet of the financial institutions followed by pressure on cost and instruments

and fall in the equity values. Government and central banks had to adopt immediate remedial

measures to bring back the solvency in the financial market. The actions they took consisted

of recapitalization, loans, implicit and explicit guarantees by government and central banks

and the bigger companies got merged. After the Lehman Brothers tragic incident there were

safety net arrangements by the government to provide infinite coverage on retail deposits and

the countries which received the coverage are illustrated in the chart below.

29
Fig: 1 Deposit insurance coverage limits.

The role of government guarantees in restoring the financial positions of the banks and other

institutions has significantly improved the overall conditions as financial damage caused by

the crisis. The tendency of banks taking excessive risk considering the government as backup

is not any ideal strategy to increase profit as the government has to put taxpayers' money into

saving the banks from getting indebted. This is why excessive risk taking and moral hazard

problems are largely discouraged where the government has to come forward to rectify the

financial situation thus preventing the country going into deficit.

30
According to IBSU scientific journal 2009, where the significance of deposit insurance is

discussed and how it can be a vital part in stabilizing the banking system. Findings from the

empirical data indicate that the large banks and banks with usually lower charter value and

capital are most likely the high risk takers but the regulators are aware of this phenomenon

because failure of any large banks can lead to economic disruptions. Risk and charter values

are inversely proportional to each other. Charter value is defined as the economic growth of

the future opportunities. Banks usually are less willing to adopt risky strategies when charter

value is higher comparatively. If a bank fails it becomes difficult to sell the charter. When the

creditor has larger funding than the stockholders the incentives to take risk increases which

induces the stockholders to confiscate wealth from the creditors. Once the bank undergoes the

reformation process the relation between risk and charter value goes weak as the government

provides them with higher deposit insurance backup and in case the banks attempt to

undertake risk the cost is higher insurance premium. Thus, the empirical evidence from the

hypothesis elucidates the relation between risk, moral hazard and the charter values, asset

values, equities which actually remain strong prior to the government interventions but to

regain the stability of the financial institutions the regulators keep continuous connection with

them in order to trace any anomalies in the financial system. Government backed deposit

insurance has brought stability in the system, although it is contradictory to many researchers

that this measure of government doesn’t fully guarantee the long term stability. There might

be other external factors as well behind the bank collapses. But deposit insurance might help

to build confidence among the public so that they continue to put in more funds with higher

security than before. Designing the insurance schemes more wisely can also prevent bank

collapse, otherwise poorly designed schemes can also be a factor behind long term

instability. Long term stability can be ensured only by redesigning the schemes so to avoid

the moral hazard associated with deposit insurance minimizes the probability of any
31
instability in the long run. Also, increased regulations and monitoring can keep the financial

system in control. Back in 1920s when Great Depression took place many banks collapsed

until the deposit insurance emerged in 1933 as the saviour to the failed banking system,

regaining a strong financial stability by 1941and in the next 40 years the bank collapse

dropped dramatically resulting an average of seven bank failures per year since 1979.

Figure 2: Insured Bank Failures

Summary & Conclusion

To sum up the discussions and assumptions elicited from the scenarios illustrated in the data

& analysis are that banks taking excessive risk to maximize profit can lead to severe

instability and disasters that can be a threat to the future economic growth and financial

market. Moral hazards and risk taking is a common tendency of the banks which can be well-

regulated by the government and also encouraging the banks to apply for deposit insurances.

Banks going for deposit insurances are insured from any financial crisis or recessions. These

32
can prevent banks losing their reputation and incur huge losses and depositors losing faith in

them. Moral hazard can result in even worse consequences if not kept in control. Banks tend

to take risks when they are insured and also when they have the government at their back. In

this case banks should be able to calculate the amount of risk they are capable of tolerating

without harming their reputation, business and of course stakeholders' interests. In the above

mentioned analysis it is illustrated how banks undertaking deposit and getting full coverage

against retail deposits and government measures have kept the banks under control from

excessive risks and reduced the number of bank failures.

Recommendation
Government interventions and bank guarantees play the role in favor of banks taking

excessive risks. During the period of financial crisis when the assets value dropped drastically

the government took measures like this but it's depicted that government measures can allow

the institutions taking more risks by investing in riskier assets. Thus, it is suggested that

becoming more strict and rigid as a government can make the banks take less risk and make

sensible investments on the assets that contain less risk in order to divert the banks away from

taking excessive risk followed by moral hazard. Insurance firms must design the insurance

contract in a way which is beneficial to the banks keeping them away from moral hazards.

Also bigger banks should split up to smaller ones in order to keep away from major failures.

33
REFERENCES

Journal of Financial Regulation, Volume 1, Issue 1, March 2015

Anginer,D., A. Demirguc- Kunt, M.Zhu. 2012. How does deposit insurance Affect bank risk?

World Bank Policy Research Working Paper No. 6289

Sophio. K. The Problem of Moral Hazard and Effects of Deposit Insurance Project. IBSU

Scientific Journal 2009, 2(3), 89-114