In setting strategies for risk/return for a financial institution, what would be the likely respective opinions of different stakeholders (stockholders, uninsured debt-holders, regulators, managers, and insured depositors) for taking on more or less risk? Explain why some stakeholders prefer more risk than others.

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The Answer is Stockholders with limited liability with a maximum loss their investment may prefer greater risk-taking with in effect a put option where future returns on a small investment are unlimited, but the investment loss is limited to the amount a shareholder invests. Uninsured debt-holders, in contrast, would prefer that managers take less risk to ensure that they will be paid back. Similarly, regulators would prefer that managers take less risk to protect the financial system from financial institution failures, and to ensure against losses for deposit insurance funds. Managers may or may not prefer more or less risk taking depending on bonuses, salary incentives, and the culture of the organization, desiring to protect their own human capital, in terms of their jobs. During the Subprime Loan Crisis, with bonus and fee incentives to make a large volume of loans versus the quality of loans, lenders were encouraged to engage in greater risk taking. Depositors would prefer lower risk taking to protect the bank against failure, but have less incentive to monitor the bank than other debt holders for insured deposits.

In Setting Strategies for Risk/return for a Financial Institution, What