Investment firms, lending institutions, and corporations are called to adjust to an always changing financial environment, and in simple terms to evolve and bulletproof their practices. With the financial crisis that shocked the stability of the global economy taking place the previous years, and the with the serious bankruptcy events occurring at that time, the need for better risk management assessment tools and risk management techniques increased. Indeed there was action taken towards that direction and also by the help of a new regulatory framework that emphasizes on considering the stability of the whole financial system rather than taking isolated measures, we have seen some progress in the recent years.

By making a reference on the significance of the Analysis and Research as a function, is by no means, to undermine the importance of the technics used for the managing of risk, despite the fact that the mechanistic application of certain risk mitigation techniques and models proved superficial and dangerous through the years. The reason that we should strongly rely on in the Analysis and Research function is primarily because it is the first protection mechanism against the excessive risk often taken by investors and financial institutions. A well-established Analysis and Research function inside a financial firm is at the very core of a prudent investment decision-making process. In other words, it is this function that assesses the fundamental financial stability of a target entity. If this department inside an organization follows all the necessary procedures and scientific technics to properly evaluate and analyze the investment or lending opportunity under consideration, it will also support the risk management units of the organization.

In general, financial risks can be separated into market risk, credit risk, liquidity risk, operational risk, legal and regulatory risk, human factor risk, model risk. Here we will see the components that constitute market risk and credit risk and have a basic understanding on why analysis and research plays a crucial role.

Market risk is the risk that changes in financial market prices and rates will decrease the value of the investor’s or lender’s positions. Market risk could be further decomposed, into equity market risk, interest rate risk, foreign exchange risk and commodity risk. As it is clearly understood, a thorough macroeconomic analysis on a fundamental basis should be employed in order for the decision makers and risk managers to have the most accurate input for their models. Even though the analysis and research cannot always predict the future movements of rates and asset prices, it provides the essential insight for proper instrument selection when it comes to hedging an exposure.

Credit risk is the risk that a change in the credit quality of a counterparty, will affect the value of a lender’s position. Default by means of a counterparty being indisposed or unable to satisfy its contractual obligations. Investors or lenders are also exposed to the risk that the counterparty might be downgraded by a rating agency. The traditional credit evaluation process is a rigorously analytical process of balance sheets and income statements and is accompanied by an extensive due diligence process. Although credit scoring methodologies are heavily applied in the assessment of credit risk of prospective borrowers, these methodologies rely on the use of operational research, statistical and data mining models and are usually being provided by external vendors. The Credit evaluation process encompasses the analysis of business risks, financial risks, capital structure analysis and adequate sources of repayment for the sufficient protection of the creditors. From monitoring the behavior of the borrower, gathering the relevant financial documentation and guarantees, examining the collaterals’ quality, assessing the financial health of the potential obligor’s industry of operation and defining the limit of the level of credit extension for a borrower, we conclude that the weight of reducing the credit risk exposure of a lending entity is mainly directed to the analysis, research and due diligence functions.

Despite the trend of relaxing the lending standards due to the increase of risk transferring techniques, the credit quality of companies is deeply related to the overall financial, economic, political and business environment, the industry-specific characteristics and of course the financial health of the company. The analysis and research function should always be at the core of every investment or credit decision-making process. An artificial and illusionary economy, after all, may be good for some entities in the short-term but definitely is not linked with a sustainable economic growth.