The paper talks about the following points:
- Explain the key business and financing strategies undertaken by banks over the past 20 years.
- Discuss how regulatory authority reactions to the recent financial crisis may affect the business and financing strategies of banks in the future.
A) Explain the key business and financing strategies undertaken by banks over the past 20 years.
Whenever there is a strategy to be implemented, it is always accompanied by an objective. This statement would apply to any business entity regardless of the different industries that they compete in. Each one of them is bound to decide on a particular approach.
As in any firm, capital in banking is comprised of equity and debt. Equity pertains to common stocks such as deposits made by clients (Fraser et, al. 2001). A range of choices can be considered by the bank to organize its business and financing units. One would be, product organization wherein all units with the same tasks and responsibilities are grouped together to form a division. Another choice , geographical organization, involves putting together all units with the same geography. Rewards are given according to the ‘profit performance’ of a unit. Incentives are also tailored to the unit’s location. A third choice, multi-dimensional organization, is a combination of the two, where divisions share the authority of evaluating performance and deciding on rewards to specific division manager. This strategy was adopted by Citibank. They customized their products according to geographical locations (developing and developed countries) of their branches in order to dominate the industry. Although in the mid 1990’s, Citibank’s strategy changed to a more customer and employee based approach by offering exchange and cash management services and offering bonuses solely on performance for the top management (Baron & Besanko, 2001). The stakeholder focus strategy was proven effective for competitive edge.
As cited in the Citibank example, various countries, both developed and developing ones would have differences on adopting strategies as they have to answer to their own regulatory authorities also, each country operates in a different economic environment. Each section briefly explains the fundamental strategies taken and its effect on the industry both domestically and internationally.
Developed Countries:
London became a new breeding ground for international banks wanting to establish their name in the UK. A huge percentage of US banks adopted this strategy to avoid regulatory restrictions back home. This was proven to be a good move for them as they held more than 60% of loans from UK companies by the end of 1990’s.
The penetration in the industry has led to increased competition, especially between the major banks in the UK (Lloyds, NatWest and Barclays) during the period. (Rogers, 1999). This type of entry pushes some regulatory entities to restrict bank charters. Although this is the case, some banks still favour this situation by being predator to bank entrants. They use fierce competition to overpower their smaller competitor (Guttentag, 1967). Different approaches were implemented to get ahead; major phases can be explained as follows:
Phase one: ‘ Big is Beautiful’
British banks pursued such tactics through M&A’s and international diversification. Barclays, with its CEO at the time, Sir John Quinton had the slogan ‘number one in ‘91’ pertaining to mindless selling of lower priced stocks in hopes of increasing market share. The plan failed
when the bank suffered major losses, as someone quoted ‘in the loo by ‘92’. This growth scheme had damaging effects on UK banks. Apart from a handful of CEOs being sacked, some stable banks were dragged down because of poor decision making regarding the acquisition of already ailing banks.
Phase two: Focus on shareholder’s value
Lloyds, with its new management outlook took the initiative of downsizing when they realized that the main focus should be on quality not quantity. Innovation was the key during this phase, where various methods of delivering services were introduced such as phone and PC banking. Change in the top management was also made as candidates for CEOs were gradually filled with younger generations of ‘non -banking’ fields such as IT. It was an attempt to bring in fresh and innovative ideas for competitive edge.
Phase three: ‘Virtual Bank’
Finally the objective of providing wholesale customers with a range of services was undertaken through ‘externalizing’ bank services thereby preventing conflicts within the management about losing its control (Rogers, 1999). Financial innovation brought about various services that a bank can offer. For example, they can now securitize loans and sell them to insurance companies as the latter is less heavily regulated and is willing to take lower returns. Banking supervision and regulation (Anon, 2009).
During recession, various approaches are considered, one of which is the concept of dividing banks into parts. The concept was first introduced in 1988 and was practiced in early 90’s when Scandinavia and America started extracting bad assets from the banking system so that the healthier part could live on to resume lending. During the same time in Sweden and Finland major banks were nationalized where they set up a ‘bad bank’ to liquidate some assets. Using this tactic, an illusion was created for investors that the bank can still resurface after selling off its damaging part, whereby encouraging new capital to be pumped in the sector. Investors would then be convinced that they are not taking on great risk after the ordeal. Economic focus: The spectre of nationalisation (Anon., 2009). Restructuring, comes next after selling off ‘bad’ parts, one of which is known as portfolio consolidating strategy, wherein the value of assets are reallocated due to the changes in the bank’s size. Such strategy is taken to return to the original state of the banking environment where proper estimation of cost and revenue is required (Alessandrini et,al. 2008).
Developing Countries:
These countries in general are becoming more aggressive with accumulating risk, bearing loans and the balance of payments for the banking sector. For instance the Indian government’s main goal was to promote competition thereby imposing on financial stability of the banking sector. They focused on deregulation to induce cost minimization to maintain market shares and profitability. The industry accumulated value- adding strategies to take advantage of financial reforms (Casu, 2010). The aggressiveness of banks is shown when they try to expand their portfolio by accumulating more risk. By doing this, they require more credit which will boost their leverage thereby increasing the use of external funding towards asset purchases (Alves et, al. N.d). Some incentives were also given to managers to improve efficient decision making especially when banks take on more risk. Bankers would be more careful on how to invest their money and less likely to hold dangerous investment in hopes of getting a hefty pay check. Three Trillion dollars later (Anon., 2009).
Countries in Latin America offered a haven for banks in search of expanding internationally. Some of which penetrated the market either by subsidiaries or foreign branch. They are more likely to have a branch when there is a higher tax but lower regulatory supervision. The reason for this is that they most likely would want to establish a new bank within the region and would find it much easier when the host country is not heavily regulated. Also, it will be convenient to transfer profits across borders when operating under a branch sector. Subsidiaries are established when the main goal is to provide broader range of services (Cerutti et,al. 2007).
During the last two decades, various approaches were implemented to consider the economic climate (recession or boom) that banks are operating in. In general, there is a broad range of strategies that banks can learn to adopt, be it a mixture of debt and equity capital or just a simple restructuring in the system. Different economic environments operating in developed and developing countries require customized methodology that should be taken into consideration before taking a step. It all comes down to the main goal that the entity seeks to establish.
B) Discuss how regulatory authority reactions to the recent financial crisis may affect the business and financing strategies of banks in the future.
A crisis is defined as a shock that the economic system has failed to absorb. Two elements that comprise the phenomena are its magnitude and the margin of safety that the industry exercises. Both developed and developing countries were affected during the financial crisis on 2008. Although the latter have been sheltered during the first phase of the dilemma, it is no longer the case as of now. Fingers are pointed to responsible authorities as to how such phenomena happened when every measure is taken care of. Global financial crisis and implications for developing countries (Anon., 2008).
Regulations ensure the safety of banking industry. Various authorities see to it that guidelines are followed thoroughly hence, they are more concerned with the risk sustained by the whole system. Such authorities exist to monitor the amount of risk undertaken by a financial institution as it is widely known that taking on additional risk maximizes survival (Bessis, 1998). It is there to prevent the crisis. Given the current circumstances, the system failed to do so. Now, the main objective would be to build an even better policy requirement to avoid future disasters. Banking supervision and regulation (Anon, 2009). One such requirement would be the capital employed which must be on a certain level to avoid bank crises fuelled by excessive risk taking (Resti & Sironi, 2007). During the recent crisis, such phenomenon was observed through resuscitations of defaulting banks that are just ‘too big to fail’.
Various financial institutions reacted to the crisis. ING, a Dutch financial company, decided to sell off its American operations. It has also decided to split its banking and insurance business. Rock Carving (Anon., 2009). This is because the government wanted to ‘scale back’ banks that received state aid. Northern Rock, who also received a hefty bail out, was urged to split into ‘good’ and ‘bad’ banks. Downsizing (Anon., 2009). It is only reasonable to assume that any bank that was rescued would face an added pressure either from the commission or its own government. Aside from the risk of being nationalized, a comeback from the slump is nearly out of reach, as observed with ING and Northern Rock (Smith, 2009). On the other hand, Austria’s plan to divide its major banks was supported by some. The government extended the deadline until the end of 2010 for financial institutions to appeal for support. This approach would be proven unpractical in the long run as banks would be totally dependent on regulatory authorities to bail them out each time their capital dries up. Another effect would be the reckless risk taking that goes with complete confidence in bail-outs (Bryant, 2009). Such actions were taken by the FSA to announce a reform of banks that are known to be ‘too big’ to fail. It is quite common that regulators do tend to be more lenient on major banks because of the ‘too big to fail’ attitude. Because of this and the recent phenomena, authorities are determined to downsize major European banking that received compensations. Officials may have caused accidental damage to cross-border banking by forcing them to shrink but it would prove to be a good long-term investment Slimming cures (Anon. 2009). As Hoenig(2009) puts it, the so called ‘big’ banks should be permitted to fail to have less damage on the financial sector. He continued that the whole turmoil would be avoided if action was taken beforehand. For example, the failure of the financial model adopted by Northern Rock or AIG’s risk choices. This should be an expensive lesson that has a major toll on everyone. On this basis, we can conclude that tougher regulations can be expected by the banks post-crisis and this would directly affect the kind of strategy that they would want to undertake.
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- Sarah Bassam Awad (Autor:in), 2010, Banking and Financial Analysis, München, GRIN Verlag, https://www.grin.com/document/212013
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