Comparing and evaluating the financial performance of US commercial banks during the recession - Essay Example

Research Proposal Comparing and evaluating the financial performance of US commercial banks during the recession (Words 3255) Summary The continuous increase of risk in all business activities is a common phenomenon in the modern market. The recent recession has proved that all firms can be affected by the strong financial turbulences – even those organizations that are traditionally considered as being the fundamental supporters of economies worldwide – referring to the banks and the financial institutions that operate in the financial services industry. The examination of the effects of the current financial crisis on the financial performance of US commercial banks led to the conclusion that these organizations failed to take the necessary measures in order to protect effectively their assets/ capital – a fact that led, in many cases, to the collapse of these firms – especially when the support of the state was not available. Problem Statement The financial crisis that began in 2007 has been strongly related with the banking sector; in USA, the effects of recession on the performance of commercial banks were extensive. In fact, the financial results of US commercial banks show a correlation between the financial crisis and the financial performance of these organizations; this correlation is made clearer by analyzing the financial results of these firms for the period in interest. Aims and Objectives As already noted, current study focuses on the comparison and evaluation of financial performance of US commercial banks during the recession. Primarily, the financial performance of US commercial banks – during a specific period of time – needs to be carefully examined and evaluated – using appropriate methods of financial analysis as explained analytically in the sections that follow. At the next level, answer will be given to the following questions: a) which are the main effects of recession on the US business activities, b) are the effects of the crisis on the banking crisis more severe than on the other industrial sectors – reference is made to the firms operating in US, c) which were the effects of the crisis on the commercial banks across US, d) were banks in US ready to face the crisis – which were the measures taken in advance – if any, e) which has been the role of US authorities/ government in the limitation of the effects of the crisis on US banks, f) was the support provided to US banks after the appearance of the crisis adequate – in terms of their losses/ damages and g) which are the prospects for the recovery of US banks – either in the short or the long term. Rationale/ Justification of the study The recent financial crisis began in 2008 – although signs of the crisis could be identified in 2007; since then, the crisis has being expanded in all countries worldwide causing severe losses to businesses of all industrial sectors (see Graph 1, Appendix). In its primary form, the crisis was related with the banking sector in US; in fact, the subprime products that were promoted by the US banks were proved to be more risky than initially estimated; as a result, US banks were highly exposed to the recession. Many banks in US collapsed – as a consequence of the crisis; however, there were also those banks that managed to limit the losses and protect effectively their equity/ capital. This study will help to understand the effects of recession on the financial performance of US commercial banks using the figures included in these organizations’ financial statements. In other words, it will be an evidence – based study not just a critical analysis of the behavior of these firms since the beginning of the crisis. On the other hand, the level of resistance of US banks – as identified through this study – would be valuable in order to estimate the expected development of the US banking industry both in the short and the long term – the prospects for the development of US firms that operate in other industrial sectors could be also estimated using similar criteria. Finally the study would be use in order to identify the framework of successful strategic decisions – referring to the banking industry – a fact that could further lead to the increase of this sector’s credibility. Literature Review The review of the literature referring to the effects of recent recession on the performance of banks shows that not all aspects of these effects have been explored; more specifically, despite the fact that the financial crisis has been related to the practices of US banks the studies examining the relationship between these banks and the recession are limited; furthermore, a gap has been identified in the literature in regard to this study’s subject – effects of recession on the financial performance of US commercial banks; the development of this study aims to reveal the main aspects of the above relationship and highlight any potential issues – referring to the specific subject – that need further examination. The development of financial crisis in US can be characterized as rather an unexpected outcome; of course, signs existed that the financial market in US would be threatened in case that the rate of payment of mortgage-backed loans to the US banks would not be improved – however, it could not be expected that a series of the country’s bank would collapse and that others would face severe losses with no prospects for quick recovery; in this context, it can be stated that the current financial crisis has been one of the worst for the US market (Tarullo, 2008, 78). The appearance and the development of the crisis worldwide has been extensively examined in the literature; a series of studies have been developed aiming to show the relationship between the recession and the banks; however, the reference to the relationship between the recession and the US banks – especially in regard to these firms’ performance – is limited – as proved through the literature presented below. A. Recession and banks Recession can have severe effects on banks; in case that a bank do not manage to face the financial crisis and collapse then it is expected that ‘its assets are liquidated and its depositors are compensated by the DIF’ (Rochet, 2008, 113). Usually, during a recession the banks tend to use specific practices – those that have been already tested and proved effective to help the firm exit the crisis. This issue is highlighted in the study of Baumol et al. (2008) who noted that ‘during a recession profit-oriented banks would be prone to reduce the money supply by increasing their excess reserves and declining to lend to less creditworthy applicants’ (Baumol et al., 2008, 259). The effects of recession on banks have been examined by Santos (2009); the above researcher notes that ‘during recessions investors demand higher risk premiums’ (Santos, 2009, 107); another finding has been the fact that ‘in recessions investors are relatively more demanding on riskier banks than on safer ones’ (Santos, 2009, 107). It should be noted that the effects of recession on a bank are differentiated in accordance with the sensitivity level of the bank’s regulatory capital; if the latter has a quite high sensitivity level then it is expected that ‘the capital requirements’ (Murphy, 2008, 275) for the particular bank will be increased. Moreover, it has been proved that banks that are based on similar capital regulatory models ‘have an incentive to act the same way, potentially intensifying asset price bubbles and market crashes’ (Murphy, 2008, 275). On the other hand, Santos (2009)noted that ‘the information which can be extracted from the credit spreads on bank bonds varies across banks for reasons unrelated to their risk’ (Santos, 2009, 107) At this point it should be made clear that recession can have different effect on each particular banking activity; in this context, as for the bank’s rediscount rate this is expected to be reduced during recession – in order for the bank to be able ‘to increase money supply’ (Chosh et al., 2008, 514); furthermore, during recession reserve rations are expected to be decreased as the extension of the easy credit is then a bank’s priority (Chosh et al., 2008, 514); finally, the open market operations of banks are likely to be differentiated during the recession; in this context, recession is related with the buying of securities in order for the bank ‘to give more in the hands of people for consumption’ (Chosh et al., 2008, 514) – despite ‘the common complaint that large banks they are not much interested in small customers’ (Herendeen, 2008, 248). A well-known practice of banks for protecting their investors during the crisis is to securitize. This practice has been proved particularly successful; in fact, in a relevant research made by Uzun et al. (2007) it has been revealed that ‘bank size is a significant determinant of whether a bank securitizes’ (Uzun et al., 2007, 11); the above finding can lead to the assumption that banks that are well established in the market can offer to their investors and their customers increased security of their funds – compared to the smaller banks. The above findings could also lead to the assumption that the development of recession could lead banks of all sizes to reconsider their decisions in regard to the securitization. B. Recession and US commercial banks US commercial banks have been strongly affected by the recent crisis; the fact that the number of US banks that have collapsed after the crisis has being continuously increased – since the first appearance of the crisis – proves that the measures taken by the US legislators towards the protection of banks depositors and investors across the country have been insufficient (Jain, 2009, 98); another assumption would be that the pressure on the US financial market reached such levels that was quite difficult for US banks to survive (U.S. News, 2008). Furthermore, the above practice is in opposition with the suggestions of Fed (US) regarding the handling of financial crises. More specifically, in the study of Nugle (2009) it is noted that ‘when the country is in the recession, the Fed wants to encourage borrowing from any source; cutting interest rates on loans is one way to entice individuals, businesses and even other banks to obtain credit and increase their ability to spend or invest’ (Nugle, 2009, 63). In other words, releasing money in the market is one of the most effective ways to face a financial crisis – of course the reserves of the banks need to be kept at the level required by the law ensuring the ability of the banks to respond to their financial needs; when banks are asked to proceed to the specific initiative they would make the claim that their finances could be set under pressure. Under these conditions, the denial of US banks to support the market against the recession can be considered as the main reasons for the failure of banks to face the crisis. The responsibility of the banks’ managers for the development of the crisis has also to be highlighted. In fact, the expansion of recent crisis proved – among other facts – that managers in US banks failed to take effective strategic decisions – referring to the distribution of the banks’ funds among various financial products and the promotion of innovation in the various activities of their organizations (Foo, 2008, 292). This issue is also highlighted in the study of Holland (2010) where emphasis is given on the responsibility of governments and regulators for the survival of banks during periods of recession. There is also the view that the recession can be regarded as the expected outcome of the failure of banks to follow the rules that regulate the specific activity and their failure to understand the trends of the market (De Soto, 2008, 149); in accordance with this view, the non-application of the rules that govern the banking industry and the lack of effective strategic decisions – referring to the decisions that are based on specific market needs – can be regarded as potential causes of recession. However, additional facts seem to have led to current recession. More specifically, in the study of LaBonte et al. (2009) it is noted that ‘among the most important errors were the Fed’s failure to counteract the contraction in the money supply’ (LaBonte et al., 2009, 10). In other words, the failures in the management of US banks were not exclusively responsible for the development of recession across the specific country; the local authorities were also proved unprepared to design and promote a scheme that could effectively control the crisis in the US financial market. In the literature, the examination of the relationship between the recession and US banks has been rather indirect highlighting specific issues, as for instance: a) the effects of recession on housing activities across US (Von Arnim, 2009, Ghent et al., 2010), b) the effects of credit shocks on the development of the financial crisis (Gilchrist et al., 2009), c) the availability of adjustments for the recovery of US banks (Krainer, 2009) and d) the prospects of US banks to exit the crisis (Aliaga – Diaz et al., 2010, Azis, 2010). The effects of the recession on the financial performance of US commercial banks have not been explored and evaluated – at least as revealed through the existing literature; the specific problem could be resolved through the literature and the research developed in the context of the proposed study. Research Methods Current study will be based on two different research methods; the qualitative and the quantitative methods of research will be combined in order to explore the study’s subject. A. Literature Review The qualitative research will be developed through the review of studies that have been published on the issue under discussion or on issues that are relevant with this study’s subject; at the next level – in the context of the quantitative research - a series of statistical data published by governmental and non-governmental organizations – especially in regard to the study’s issues – are going to be critically reviewed and analyzed aiming to identify the various aspects of the issue under examination. The literature review developed for this study will be based on the following principles: a) studies published in academic databases will be preferred – non-academic studies will be limited– for instance, article in recent press and b) recent studies will be preferred aiming to reflect the conditions of US bank industry after the appearance of recent recession. b. Empirical Research b1. Description of research methods The empirical research is based on the examination of the financial data of US banks – the relevant figures are available of databases like Bankscope and Thomson. The data of US banks retrieved through the above databases will be processed using appropriate econometric techniques. In this way, the performance of US banks through the years will be identified and evaluated – using at this point the literature published on the issue under discussion. In order to identify the differences in the performance of US banks under the influence of the financial crisis it is necessary to use the relevant financial data before and after the crisis; in this context, the financial data of US banks for the years 2006 onwards, i.e. for a period of about 5 years, will be identified – as explained above – and critically examined in order to find out whether the effects of the recession on the performance of US banks have been major; also, the duration of these effects will be identified and evaluated. It should be noted that a total of 125 US banks will be examined – as of their financial performance for the years 2006 onwards; in this way, it is expected that the credibility of the research will be high. b2. Analysis of data As noted above, the financial data of US banks for the period 2006 onwards will be processed and analyzed using appropriate econometric techniques; the use of relevant software will be necessary in order to categorize and compare these figures; tables and graphs will be also produced in order to highlight the findings of the empirical research. b3. Justification of research methods The use of econometrics for the identification and the evaluation of financial performance of US banks under the influence of the recession has been considered as necessary; as noted above, the financial data of 125 US banks will be examined and compared in order to identify the effects of recession on these institutions’ financial performance; the process of data of such volume would not be possible without using appropriate econometric techniques; otherwise, there would be the risk to come to false assumptions as of the study’s issues. Ethical Considerations One of the study’s most important characteristics is its alignment with the ethics that govern the academic research. Towards this direction, the material used in the development of the study has been appropriately referenced. On the other hand, the studies involved in the literature review have been critically evaluated making sure that only academic pieces of work will be used for the development of this study; on the other hand, where data are not available on a particular organization – referring to the firms involved in the quantitative research – this fact is clearly explained; the gap resulted is appropriately filled using the views of the literature – where possible. Finally, the timescale/ plan of the study – as described below – will be strictly followed; expansion of the time required for the completion of one of its phases would be permitted only under emergent circumstances or if crucial data or information cannot be retrieved. Timescale/ Plan A specific plan has been designed in order for the development of the study to be clearly explained. The phases of the study (see also the Gantt Chart in the Appendix section) could be described as follows: 1. The review of existing literature should be completed before any other task; in this way all views and other material available will be identified and categorized – the needs of the study in terms of the empirical research will be identified – having in mind that the design of the questionnaire needs to follow and its content has to be carefully chosen. The literature review is expected to take 10 days – including the writing of the part of the project, i.e. the literature review chapter of the dissertation. 2. At the next level, the data related with the financial performance of the US banks involved in this study need to be gathered; the financial statements of these organizations will be carefully examined and the information required for the evaluation of their performance will be appropriately categorized. Furthermore, research will be made on relevant databases in order to identify necessary financial data – where the figures required are not available in the firms’ financial statements. This task is expected to take 15 days. 3. Next, the writing of the study’s introductory section needs to be completed – the literature review will be ready at this point. This part of the dissertation will be completed in 2 days. 4. About 3 days will be further required for writing the study’s conclusion and recommendations section and for checking the overall study – as of potential mistakes or points that need to be further highlighted and analyzed. Resources/ Cost The plan of the study has been designed in such a way that its cost is kept at low levels; There will be no need for fees for accessing academic databases – the databases available through the University will be used instead. Also, books, journals and periodicals – used in the literature review part of the project – will be retrieved from the University’s library. An amount of 150£ will be required for photocopies, printing and preparing the dissertation for submission. The specific amount, of 150£, is the expected total cost of the dissertation – following the plan of the study presented above. References A. Books Baumol, W., Blinder, W., 2008. Macroeconomics: Principles and Policy. Cengage Learning, 2008 De Soto, H., 2008. The theory of dynamic efficiency. Taylor & Francis, 2008 Ghosh, P., Choudhury, P., 2008. Managerial economics. Tata McGraw-Hill Herendeen, J., 2008. Issues in Economics: An Introduction. University Press of America LaBonte, M., Purcell, P., 2009. Recession, Depression, Insolvency, Bankruptcy, and Federal Bailouts. The Capitol Net Inc Murphy, D., 2008. Understanding Risk: The Theory and Practice of Financial Risk Management. CRC Press Nagle, J., 2009. How a Recession Works. The Rosen Publishing Group Rochet, J., 2008., Why are there so many banking crises?: the politics and policy of bank regulation. Princeton University Press Tarullo, D., 2008. Banking on Basel: the future of international financial regulation. Peterson Institute B. Journals Aliaga-Diaz, R., Olivero, M., 2010. Is there a financial accelerator in US banking?: Evidence from the cyclicality of banks price–cost margins. Economics Letters, Volume 108, Issue 2, pp. 167-171 Azis, I., 2010. Predicting a recovery date from the economic crisis of 2008. Socio-Economic Planning Sciences, Volume 44, Issue 3, pp. 122-129 Foo, C., 2008, Conceptual lessons on financial strategy following the US sub-prime crisis. The Journal of Risk Finance, Vol. 9, No 3, pp. 292-302 Ghent, A., Owyang, M., 2010. Is housing the business cycle? Evidence from US cities. Journal of Urban Economics, Volume 67, Issue 3, pp. 336-351 Gilchrist, S., Yankov, V. 2009. Credit market shocks and economic fluctuations: Evidence from corporate bond and stock markets. Journal of Monetary Economics, Volume 56, Issue 4, pp. 471-493 Holland, J., 2010. Banks, Knowledge and Crisis - a case of knowledge and learning failure. Journal of Financial Regulation and Compliance, Vol. 18, Issue 2 Jain, A., 2009. Regulation and subprime turmoil. Critical perspectives on international business, Vol. 5, Issue 1/ 2, pp. 98-106 Krainer, R., 2009. Portfolio and financing adjustments for U.S. banks: Some empirical evidence. Journal of Financial Stability, Volume 5, Issue 1, pp. 1-24 Santos, J., 2009. Do markets “discipline” all banks equally? Journal of Financial Economic Policy, Vol. 1, Issue 1, pp. 107-123 Uzun, H., Webb, E., 2007. Securitization and risk: empirical evidence on US banks. The Journal of Risk Finance. Volume 8, Issue 1, pp. 11-23 Von Arnim, R., 2009. Recession and rebalancing: How the housing and credit crises will impact US real activity. Journal of Policy Modeling, Volume 31, Issue 3, pp. 309-324 C. Online sources Econbrowser, August 3, 2009, Comparing the Current Recession and the "1980-82 Recession", [internet], available at http://www.econbrowser.com/archives/2009/08/comparing_the_c.html U.S. News, January 15, 2008, Recession Watch: 5 Reasons Banks Face More Trouble, [internet], available at http://www.usnews.com/money/business-economy/articles/2008/01/15/recession-watch-5-reasons-banks-face-more-trouble.html Bibliography Chuang, I., Chiu, Y., Wang, E., 2008. The performance of Asian airlines in the recent financial turmoil based on VaR and modified Sharpe ratio. Journal of Air Transport Management, Volume 14, Issue 5, pp. 257-262 Jermias, J., 2008. The relative influence of competitive intensity and business strategy on the relationship between financial leverage and performance. The British Accounting Review, Volume 40, Issue 1, pp. 71-86 Kao, C., Liu, S., 2004. Predicting bank performance with financial forecasts: A case of Taiwan commercial banks. Journal of Banking & Finance, Volume 28, Issue 10, pp. 2353-2368 Lin, S., Penn, J., Gong, S., Chang, C., 2005. Risk-based capital adequacy in assessing on insolvency-risk and financial performances in Taiwans banking industry. Research in International Business and Finance, Volume 19, Issue 1, pp. 111-153 Niemann, M., Schmidt, J. 2008. Improving performance of corporate rating prediction models by reducing financial ratio heterogeneity. Journal of Banking & Finance, Volume 32, Issue 3, pp. 434-446 Reynolds, S., Ratanakomut, S., Gander, J., 2000. Bank financial structure in pre-crisis East and Southeast Asia. Journal of Asian Economics, Volume 11, Issue 3, pp. 319-331 Appendix I. Graph 1 – Current recession compared to the 1980-1982 recession (source: Econbrowser) II. Gantt Chart – Phases of the study Days/ Tasks Literature Review Identification/ process of financial data/ development of graphs Writing of Introduction Conclusion/ Recommendations/ Overview of the Study Read More