Financial Institutions Strategic Management The USA Banking Industry - Case Study Example

 Financial Institutions Strategic Management – The USA Banking Industry Table of contents 1. Introduction 3 2. USA banking industry – overview 3 3. USA banking industry – dimensions of performance 5 3.1 Profitability 5 3.2 Efficiency 6 3.3 Pricing 7 4. Key environmental factors currently driving bank strategy within the USA banking industry - future impact of these factors on bank performance 8 5. Conclusion 10 Works Cited 11 Appendix 13 1. Introduction The standardization of organizational performance is one of the major challenges for firms operating in various sectors. The 21st century, as also the 20th, has been characterized by the high involvement of financial institutions in each country’s economic growth. In USA also a similar trend has been developed. In the above country, the severe failures in managing risks related to banking activities led to the recession of 2008, which still negatively influences markets worldwide. The performance and the challenges of the USA banking industry are analyzed in this paper. Reference is made to the factors that have most affected the above industry’s performance but also to the factors that would continue to influence the particular industry in the future. The research developed in regard to the specific subject has led to the assumption that the USA banking industry has been highly supported, as of its establishment and further growth, by politicians and analysts; however, the relevant plans have often failed to meet the criteria set by their initiators. The need for radical changes on the sector’s strategic choices is clear; certain trends, as for example, the need for hiring stars for improving organizational performance, have been eliminated. In any case, problems related to the specific organizational sector, should be resolved by continuously updating the strategies of the industry’s firms, as appropriate, so that their goals are continuously aligned with the market rules and ethics. 2. USA banking industry – overview The development of banking industry in USA has been gradual. In fact, in USA banks have always been a key factor for economic growth (Coulbeck 1984). The establishment of the USA banking industry has been related to the Glass-Steagall Act of 1933, which has emphasized on the categorization of the sectors of ‘the financial services industry, as following: commercial banking, investment banking and insurance’ (Koch and Scott 2009, p.2). Other legislative texts that followed, especially ‘the Bank Holding Company Act of 1956’ (Koch and Scott 2009, p.2), set the rules on which the activities of banks across USA should be based. The literature indicates that the establishment of bank branches across the country has been related to certain geographic criteria. In the study of Coulbeck (1984), emphasis is given on the following fact: in USA, banking activities have been always quite developed; in 1940 the banks operating across USA were estimated to 5,144 while in 1980 the above number has been decreased to 4,425 (Coulbeck 1984, p.165). The above figures should not lead to the assumption that banking-related activities in USA have been reduced the last 50 years; on the contrary, the operations of the industry’s firms have been significantly increased, as revealed in the following fact: in 1940 the branches of banks operating across USA were just 1,542 while in 1980 about 19,738 branches of banks were active in different areas internationally (Coulbeck 1984, p.165). Moreover, DeYoung, Klier and McMiln (2004) note that the extensive consolidations in the banking sector of USA, has allowed large banks ‘to move their headquarters from small cities to large cities’ (DeYoung, Klier and McMiln, 2004, p.29), a fact that has increased the efficiency of these banks in terms of profits. In other words, the expansion in banking activities in USA for the last decades has been based on continuous mergers and acquisitions, a fact that has highly harmed the country’s social and judicial frameworks. The above figures also reveal the following fact: the history of the US banking industry is highly related to mergers and acquisitions, which have led to the transformation of the particular market, as analyzed above, and have set the industry’s competition in risk (Mowery 1999). 3. USA banking industry – dimensions of performance 3.1 Profitability The profitability of the USA banking industry has been negatively affected by the mortgage crisis of 2008 (Doyle 2009). However, in order for the industry’s performance to be standardized, it would be necessary for ‘heavy regulation to be avoided’ (Doyle 2009), since, in this way, banks and other financial institutions would be discouraged from offering financial products ‘of low –rates’ (Doyle 2009) to the public. In a report of the Federal Reserve Bank of New York in 2007, i.e. almost before the appearance of the mortgage crisis, it is noted that the profitability of the banking sector in USA could be highly enhanced by the expansion of retail banking, which is initiated mostly by large banks (Federal Reserve Bank of New York 2007). In the future, the prospects of US banks to improve their performance seem to be limited. In fact, according to a report of S&P published in December of 2011, the key trend in regard to the performance of US banks in 2012 seems to be ‘the slow economic growth’ (S&P 2011). Moreover, the above organization considers that ‘2012 will be a challenging year for US banks mostly due to the reduction of debt by corporations and households and the low interest rates’ (S&P 2011). On the other hand, the effectiveness of the rules regulating the particular sector is characterized as satisfactory (S&P 2011); still, the costs for complying with these rules are high. An important characteristic of the US banking industry seems to be its ability to keep its position standardized, despite the global economic crises. This fact is revealed in Figure 1 (Appendix) where the failures of US banks during a period of 60 years, i.e. from 1944 to 2004 are presented. It is clear that the sector’s performance, as related to its profitability, cannot be easily affected by global market’s turbulences. The continuous increase of profitability of US banks is made clear in Figure 2 (Appendix). 3.2 Efficiency The efficiency of banks within a particular market is depended on a series of factors; usually the legal framework regulating the activities of these organizations is used as the basis for deciding the level of their efficiency (Vasudevan 2003). On the other hand, Van Hoose (2010) notes that in highly developed economies the efficiency of banks tends to be higher, compared to economies of developing countries. According to Kann (2004) the efficiency of a country’s banking sector can be measured by using certain ratios, which can indicate the potential of the sector for growth, either in the short or the long term. An example is the ‘cost to income ratio’ (Kann 2004, p.54). As for the effects of consolidation on banking industry, these seem to be limited. Indeed, as noted in the study of Amihud and Miller (1998) the increase of consolidation between large banks does not affect ‘the efficiency of the banking industry’ (Amihud and Miller 1998, p.113). It is explained that these organizations are already well positioned in the USA market and their consolidation cannot particularly the market’s performance, in terms of profits (Amihud and Miller 1998). However, it can highly affect the market’s structure, an issue which is, however, relevant only to competition and not to the sector’s profitability (Amihud and Miller 1998). From a different point of view, Berger et al. (1993) claim that the efficiency of the banking industry could be characterized as ‘X-efficiency’ (Berger et al. 1993, in Mowery 1999, p.162), a framework describing the ability of managers in the banking sector ‘to align technology and other resources in order to achieve a high performance’ (Berger et al. 1993, in Mowery 1999, p.162). 3.3 Pricing Banks in USA are not fully depended on the public sector; they are also partially independent from the rules of the private sector (Polski 2003, p.94). More specifically, banks in USA need to promote the interests of their shareholders but only under the terms that the USA laws regulating the banking industry are not violated (Polski 2003, p.94). This means that banks in USA are related both to the private and the public sector. In this context, for keeping their competitiveness, these banks need to ensure that they align their operations with the market’s ethics and rules and that they keep their prices low, in order to be able to compete their rivals (Polski 2003). On the other hand, Fitch (2010) note that the ability of USA banks to keep their prices low is rather limited mostly because of the following facts: a) USA banking industry is highly fragmented, meaning that there are several banks offering products of similar quality/ performance (Fitch 2010), b) at the same time, the specific sector is characterized by extensive consolidations; certain large banks have acquired the key share of the market reducing the chances of the other sector’s firms to standardize their performance (Fitch 2010). In fact, it has been proved that ‘in 2006 the 74% of the sector’s assets are hold by large banks’ (Fitch 2010, p.11). Under these terms, it is quite difficult for small banks to secure their position by keeping their prices low. 4. Key environmental factors currently driving bank strategy within the USA banking industry - future impact of these factors on bank performance Currently, the strategies of banks in USA are aligned with specific market trends: the increase involvement of technology in banking activities, the change in ‘population demographics’ (Polski 2003, p. 104) and the ‘alteration of economic activities’ (Polski 2003, p.104). More specifically, in US economic needs of population have been changed since a limitation of the ‘baby-boom phase’ (Polski 2003, p.104) has appeared. The ageing of the population has resulted to the increased need for certain banking products, as for example, for pension plans. At the same time, the limitation of young population and the deterioration of the job marketplace has led the decrease of customers’ demands for certain products, such as loans for studies (Polski 2003, p.104). Another important trend of the US banking industry in the beginning of the 21st century has been the limitation of the house borrowing, a fact that is closely related to the recession of 2008 (Thakor and Boot 2008). On the other hand, consolidations in the US banking industry have been significantly increased during the last decade (Thakor and Boot 2008). Consolidations, through mergers and acquisitions, have been considered as an effective means for helping banks in USA to secure their market position. In practice, it has been proved that consolidations can significantly harm a specific industry by leading to ‘the concentration of power to certain firms’ (Thakor and Boot 2008). In this way, competition is reduced, and the chances for the development of strong monopolies are increased (Thakor and Boot 2008). The above trends in the USA banking industry highly affect the strategies of the industry’s firms leading to the need for the introduction of new financial products and the alteration of terms on which funds from the US banks will be borrowed to individuals and organizations. The particular trends will be further developed in the future. According to a report published in Harvard Business Review (2011), the 20th century has been characterized by an important trend in the financial services sector: financial institutions, including banks, tried to hire stock analysts who have been popular in the market (Harvard Business Review 2011). It was expected that these stars would help these organizations to achieve a significant growth, an expectation that often was not realized (Harvard Business Review). An example of the above practice is revealed through the case of Prudential Securities; the particular organization aimed to achieve a rapid growth; in this context, in 1987 the firm hired 42 experts, ’30 senior investment bankers and 12 star analysts’ (Harvard Business Review 2011, p.187); it was believed that this strategy would highly increased the firm’s profitability. The above project was soon led to a failure; in 1988, i.e. just one year after,’ 25% of these analysts were fired’ (Harvard Business Review 2011, p.187). At the same time, the firm stopped hiring personnel for a while aiming to cover the losses caused by the above initiative. A similar problem appeared in ‘Barclays de Zoete Wedd , the Barclay’s investment banking arm’ (Harvard Business Review 2011, p.187); the head of the above firm’ hired in 1990 about 40 star analysts’ (Harvard Business Review 2011, p.187), aiming to enhance organizational growth. However, the above target was not achieved; in just one year most of these analysts were fired after failing to respond to the needs of the organization for rapid growth (Harvard Business Review 2011). Unlike the other trends of the USA banking industry, as analyzed above, which are likely to influence the sector in the future, the particular trend, i.e. the hiring of stars for supporting organizational growth, is not expected to continue influencing the strategies of banks in USA. 5. Conclusion The presentation and analysis of the key elements of the USA banking industry has led to the following assumption: the particular industry is quite dynamic, being continuously transformed in order to meet the customer demands and the market trends. On the other hand, certain of the industry’s strategies for increasing its competitiveness, as for example the hiring of stars for managing key sectors of the industry’s firms, have been proved quite ineffective. Still, the ability of the industry to face the challenges of the market cannot be doubted According to the figures and the graphs included in the study, the rate of growth of the industry’s firms can be characterized as quite satisfactory, even after the 2008 recession. In the long term, the ability of the USA banking industry to stabilize its performance and achieve a further growth will be related to its potentials to focus on appropriate strategies and to establish measures for limiting losses in cases of failures in regard to strategic choices. The key challenge of the industry seems to be not so much the standardization of its performance in the global market but rather the protection of its integration and coherency that is highly threatened by extensive mergers and acquisitions. Works Cited Amihud, Yakov, and Geoffrey, Miller. Bank Mergers & Acquisitions. New York: Springer, 1998. Coulbeck, Neil. The Multinational Banking Industry. London: Routledge, 1984. DeYoung, Robert. “Safety, Soundness, and the Evolution of the U.S. Banking Industry.” Economic Review. Federal Reserve Bank of Atlanta 2007: 41-66 DeYoung, Robert, Klier, Thomas, and Daniel, McMillen. “The Changing Geography of the U.S. Banking Industry.” The Industrial Geographer 2.1(2004): 29-48. Doyle, Larry. “Outlook For The US Banking Industry.” 20 Nov. 2009. Daily Markets. 18 April 2012 < http://www.dailymarkets.com/economy/2009/11/20/2010-outlook-for-the-us-banking-industry/>. Federal Reserve Bank of New York. “The Role of Retail Banking in the U.S. Banking Industry: Risk, Return, and Industry Structure.” 29 Mar. 2007. Federal Reserve Bank of New York. 18 April 2012 . Fitch, Thomas. Banking, Finance, and Insurance. New York: Infobase Publishing, 2010. Harvard Business Review. Harvard Business Review on Finding & Keeping the Best People. Boston: Harvard Business Press, 2011. Holland, David. When Regulation was Too Successful--the Sixth Decade of Deposit Insurance: A History of the Troubles of the U.S. Banking Industry in the 1980s and Early 1990s. Westport: Greenwood Publishing Group, 1998. Koch, Timothy, and Scott, MacDonald. Bank Management. Belmont: Cengage Learning, 2009. Mowery, David. U.S. Industry in 2000: Studies in Competitive Performance. Washington: National Academies Press, 1999. Polski, Margaret. The Invisible Hands of U.S. Commercial Banking Reform: Private Action and Public Guarantees. New York: Springer, 2003. Reif, Joe, Ditterich, Kirsten, Larsen, Mitch, and Robert, Ostrea. Services--the Export of the 21st Century: A Guidebook for US Service Exporters. California: World Trade Press, 1997. Standard & Poors (S&P). “2012 U.S. Banking Outlook: Slow Growth And Europe's Woes Paint A Dim Picture.” 15 Dec. 2011. S&P. 18 April 2012 . Thakor, Anjan, and Arnoud Boot. Handbook of Financial Intermediation and Banking. Oxford: Elsevier, 2008. Van Hoose, David. The Industrial Organization of Banking: Bank Behavior, Market Structure, and Regulation. New York: Springer, 2010. Vasudevan, A. Money and Banking: Select Research Papers by the Economists of Reserve Bank of India. New Delhi: Academic Foundation, 2003. Weigand, Robert and Robert, Irons. “The financial performance of the US commercial banks (2001-2010).” Banks and Bank Systems 6.3(2011): 51-62 Appendix Figure 1 – Bank failures in the US banking sector, from 1944 to 2004 (Source: DeYoung 2007, p.42) Figure 2 – Total revenue of US banks, from 2001 to 2010 (Source: Weigand and Irons 2011, p.53) Read More