Merits and Disadvantages of Banking Consolidation - Essay Example

Merits and Disadvantages of Banking Consolidation Banking consolidation is the merging up of banks or buying out of small banks by bigger banks in an effort to create larger entities. Strategically, the banking industry, through consolidating, responds to the forces of competition in the industry contributed by increased levels of deregulation, globalization and financial innovation. With the dynamism in the current business environment such as increased costs of doing business and competition, business organizations and financial institutions seek for ways of reducing costs and increasing their productivity levels. Through consolidating by mergers and acquisitions, banks hope to curb these challenges. Although a preferred means of solving the inherent challenges in the current banking industry, the reality is that it has its own disadvantages, as discussed in this essay. According to economists, there are a number of benefits of banks consolidation. One of these advantages is increased efficiency in the banking sector. Consolidation eliminates geographical restrictions in the banking industry, exposing it to high levels of competition, driving out all inefficient banks from the industry. This is not the only way of ensuring efficiency in the banking sector; moving to larger banking organizations too increases their levels of efficiency due to economies of scale and scope of work. Since consolidation increased the diversification of the loan portfolios by banks, thus lowering the probability of a future banking crisis. Mergers and acquisitions in the banking industry are economical, providing banks with an opportunity to minimize their expenditures. In the event of a merger, there is closure of overlapping branches, laying off any unnecessary staff, and sale of unwanted capital goods, thus minimizing some of the operational expenditures while at the same time creating some of income for the bank. Merging also increases sales volumes of banks’ products, especially when done from a central branch. One of the major advantages of consolidation in the banking sector is market diversification, creating new geographical markets. With these new markets is an increase in business revenues. Bank mergers additionally create stronger market power, changing the pricing offered by the banks. Although argued as a means of beating the inherent operation problems in the industry, consolidation faces a myriad of drawbacks. Critics of this form of banking fear on the elimination of the smaller banks from the banking industry due to acquisitions. Not only do the investors lose in such instances; small businesses too lose their source of funding. Large business organizations seek funding from large banks while small businesses seek for funding from the small banks. If large banks acquire the small banks in an effort to minimize competition, small businesses lose their source of funding. If this trend persists, the banking industry risks suffering from domination by a few banks. This makes the banking industry less competitive, reducing the quality of services provided to the customers. Some of the economists however argue that this does not have any significant effects on the industry, since there is freedom of entry into the market, and thus balances the equation of competition. Differences in the working cultures of the merging banks could lead to failure of these mergers. In their initial stages of merge, different businesses suffer from increased operational costs, for instance resultant from communication differences. Although experts argue on the efficiency of creating bank mergers, the reality is that when a merger takes place, managers face more vast and complicated organizations, exceeding their usual capacity. They may lack the essential expertise required in the field, reducing such bank’s efficiency. Some of the experts argue that the creation of stronger markets provides the banks with an opportunity to exploit their customers. Strong markets mean that there are reduced levels of competition, giving dominant banks an opportunity to overcharge their customers. Consolidation of banks is a noble idea, as discussed in this essay. However, it has created an opportunity for some of the banks to exploit their customers, while in other instances it reduces the level of efficiency of these mergers, especially with managing expensive businesses. The advantages of consolidation however outweigh the drawbacks, favoring the idea among the banks. Backed by these advantages, the banking industry has sought to improve its operations and profitability through mergers and acquisitions. Advantages and Drawbacks of an “Independent Central Bank” For The Banking Industry Central banks in the current banking industry hold more responsibilities, especially in regulating the commercial banks. This increased mandate has sparked numerous debates on the need let the central banks operate independently. Such independence means a decreased intervention of the government in the activities of the central bank. Proponents of this argument hold that an independent central bank can deliverer its services better and in a more transparent manner. This is because the government drops its role of an actor, and assumes the role of an oversight authority. Further, they agree that the independence of the central bank translates into tighter regulations of the banking industry, protecting the consumers more. Opponents on the other hand cite a myriad of disadvantages, among them being discrimination in the regulation, exploitation, among others. This essay looks at the advantages and drawbacks of an “independent central bank” for the banking industry. Monetary policy is one of the ways the government ensured control of the economy. At will, and for a number of reasons, the central bank would opt to influence the economic level, giving priority to lowering inflation, higher growth, targeting exchange rates and establishing a balance of payments. Allowing the independence, the central bank would improve the monetary policies made by the government. In some cases, the government makes poor monetary policies, due to short-term political considerations. Before an election, the government faces the temptations of lowering the interest rates in order to increase the money supply in the economy. Subsequently, this increases the rate of economic growth, reducing unemployment rates in the country, and winning support that is more political for the party. Negatively, the expansionary monetary policy may cause inflation in the country, while in other cases it may lead to an economic boom. Thus, allowing the central bank to operate independently reduces the influence of the government on the monetary policy. Since people have more trust in the central bank, the central bank helps in reducing inflationary expectations, thus making it possible to keep the rate of inflation low. There have been arguments on the instability of the banking system in case the central bank was to become independent. Maintenance of the exchange rate policy is one of the elements likely to face negativity was the central bank to become independent. as its one of the most significant roles, exchange rate policy determines the rate at which other banks should exchange domestic currency with foreign currency. The government needs to watch over this activity of the central bank, to avoid influence of the exchange rate by unscrupulous individuals in the central bank. The independence of the central bank is no guarantee against any form of monetary policy mistakes. On the contrary, it could lead to even more problems than the solutions it offers. In principle, there is a higher likelihood of an independent central bank causing inflation than one under government’s control. For instance, elected officers of the central bank could succumb to arguments that there is no harm in inflationary conditions. Additionally, an independent central bank could get its policies wrong. At times, the officials and policy drafters could excessively focus on inflation, thus blinded by the effects of monetary policy on the real GDP and employment. This could lead to a recession, and incase there is one, it could potentially deepen it or make it last longer. The question of whether to allow the central bank operate independently requires a scrutiny. There are cited advantages and disadvantages of allowing central banks operate independently. Proponents of this argument point out to the advantages presented by the independence of the central bank. On the other hand, the opponents believe that setting the central bank free would undermine its operations, to the extent of operating as an income generating entity. However, setting them free is not a bad idea at all. The ability to manage the cited drawbacks facing the independence of the central bank would not only convince the opponents on the viability of the idea, but also ensuring the success of the idea in case of its implementation. Read More