Industrial Structure of Banking - Essay Example

QUESTION ONE Based on World Bank dataset, there is agreat relationship between market structure and the financial stability as manifested by several factors. First, increase in competition, in the industry results into reduction in the franchise value, which increases therisk taking[Tor11]. This makes the bankslend more money in the economy, which then results in financial stability of the economy. Second, bank business models are undergoing a change best known as a departure from the traditional,banking,and this has posed a severe threat to the financial stability of the economy. For example, several banks no longer engage in credit substitution business and have allocated much of their intermediary function of monitoring and credit assessment to credit rating agencies. Also,the continuous increase in innovation, in the banking industry has resulted in changing the model of carrying out business in the banks, which has raised questions about the financial stability ofthe economy. Nevertheless, when these innovations are used prudently and monitored carefully they can increase the performance of the financial system without jeopardizing financial stability in the economy[Hua14]. Another model is the changing products offered by the banks in the banking industry. Products such as the selling of the Riester retirement products, which are less dependent on thematurity, transformation and changes in interest rates are good for financial stability. Third, the interconnection with the government is another market structure related to the financial stability of the economy. The interconnection comes in the form of governments’ protection of the too-important-to-fail banks, which are known as the systematic important banks. Referred to as systematic important banks (SIBs), the importance is due to theirinterconnectedness with the government, as well as complexity and size. Too-important-to-fail concept is due to the belief that the downfall of such banks would result ina negative effect on the financial system and the economy as a whole[Ada09]. As a result, the protections of these banks result in distortion of price and resource allocation. The creditors of these banks are ready to offer funding at lower costs allowed by theinstitutions risk profile. Additionally, they do not bear the full cost of thefailure of the banks, and this creates adanger to the financial stability of the economy[Ada09]. Fourth, the relationships between the banks and the financial markets have also proven important determinants of financial stability of the economy. Financial markets refer to the entity where stocks and other securities are traded[Mar10]. Banks are custodians of the investors’ funds. The financial markets generate prices whenever securities are bought and/or sold. When these banks want to make loans to the investors, they value these financial assets whereby the valuation and pricing of these financial assets are the main determinants of the financial stability of the economy (Dutt and Mihov, 2013). When prices are high,the banks are willing to lend more in the economy and this leads to the financial crisis in the economy since there is more money chasing few assets in the economy. On the other hand, when the prices are determined to be low in the financial markets, there will be alittle amount borrowed hence high financial stability in the economy(Anand and Alexander, 2006). Therefore, this links the relationship between the banks and the behaviour of securities in the financial markets and how the relationship affects the financial stability. The other market structure is a cross border listing, which refers to the process where banks stocks are listed in the securities market of other countries where it was not incorporated. These banks which are listed in other countries enhance the capital inflow to the economy. Too much inflow of these funds into the economy can lead to financial instability if not well monitored. Banks seek cross-border listing because of the removal of the trade barriers, a reduction in the transportation costs and innovations in communication and technology, which increase the demand for the international financial services (Davis and Steil, 2001). Furthermore, the size and mobility nature of the international capital flows creates an importance in monitoring to the strengthof the financial systems[Ada09]. More flow of these capitals may interrupt the financial stability and the robust amount may increase it. Lastly, network structure in the banking sector creates a market structure, which influences the financial stability of the economy. The intricate structure of linkages between financial institutions among the sectors in the economy and the entire financial system affects the financial stability of the economy[Flo07]. Mostly, the network is composed of the most connected banks, which process high proportion of the market value. For example, banks are sometimes involved in the unsecured overnight money market mostly known as theinterbank market[Fro01]. This transfer of funds may affect the financial stability of the economy if not monitored well. QUESTION TWO Similarly, the World Bank dataset reveals a relationship between market structure and financial development. First, high competitive market structures in the banking industry increases the level of competition in the economy[Dut13]. This in turn results into reduction of interest ratesin order to attract more customers to the bank. Moreover, banks are more willing to extend credit to the customers at a low cost. Most banks tend to be more concentrated at the same point in the economyin order to have the same opportunities as the other banks to ensure fair competition in the market[Kle10]. Thus, the banks will have access to the same information as the competitorsand this may result in acts such as reduction in the interest rates of borrowing so as to attract more customers to the bank[Hua14]. This is an indication of financial development in competitive market structures. Second, changes in the banking business model also have asignificant effect on the financial development. For example, delegation of the monitoring of the customer’scredit worthiness according toFloerkemeier&Hogler(2007) has been left to the credit rating agencies. This has created adevelopment in the financial sector as most of the bank can get access to the data on a customer from any bank before extending such a loan to the customer using the selective credit guidelines[YHu11]. Also,due to the innovations in the structural models, banks are now focused towards their customers’ satisfaction and can access their banking information from anywhere; hence, feel more satisfied with this rather than travelling to the bank to get such information. These changes in the structural models of the businesses have enhanced financial development as the customers can now be served at very low costs and borrow loans at affordable rate[Mar10]. Third, interconnection with the government is a market structure, which assists the very important banks from failing. Government relationship with the banking sector is an important market structure that determines the financial development in the economy. Governments formulate laws and regulations, which affect the financial development in the country[Kun01]. Governments can promote or discourage any activity of the banks in the economy to ensure financial development. For example, the market structures where government assists some banks in the economy that are more important to the governmentshow increased growth rate in theeconomy. Government assist these banks through offering grants, discontinuation of some regulation allow entry of other firms into the market so that they become more competitive in the economy hence increases financial developments[DCW10]. Fourth, the network structures of the banks in the banking industry also affect the financial development in the market. The interconnectivity between banks in the economy results in exchange of funds and information, which assist the banks to assess the risk in the financial markets[Kun01]. This always ensured that there are enough funds to the customers at all times and at any place when they need them This has also made it important for customers to transfer their funds without necessarily carrying it in the form of cash. This, therefore, has made transactions in the financial sector very fast and accurate[Gar06]. The network also assists the banks to use various innovations created by other banks and also to be more innovative to ensure financial development in the economy. Cross border listing is another market structure of banks in the banking industry that affects the financial development in the economy. With the cross border listing,the prices of the stocks can be determined in the both countries,and this helps to determine the financial developments of the banks within the country of incorporation and that of the foreign country. An analysis of the cause of the different changes can then be used to change the operations of the bank in the country where it is underperforming. This is an indication of the financial development in the financial sector, in the economy of both the foreign and the country of origin of the bank. The trading governments can also create favourable regulations such as exchange rate regulations which are theindications of the financial developments in the country. Fifth, the relationship between the banks and the financial markets are also determinants of financial development in the economy. The banks can determine the financial value of the various stocks in the securities market when they want to advance loans to the customers[Gar06]. This kind of market structure has enabled banks to assess the amount which is actually required by the customer to purchase such stock. This is a development in the financial sector as lending and borrowing nowadays is not based on the speculation of the amount that the purchase of stock requires[Kle10]. Last, banking systems have a structure where they consolidate as a result of merger and acquisition because of the motivation of the potential gain in efficiency from the economies of scale[Ada09]. This has led to an increase in monopoly power in the market, and thus, cause the interests rates increase in the economy and development in the financial sector to go down. Therefore, the deregulations and the intervention by the government to increase financial development leads to entry of other firms, and, therefore, creates high competition[Gar06]. This result in a decrease in the interest rates, in the market; hence,more growth in the financial sector. In conclusion, the market structure has both theeffect to the financial stability and the financial development. A part from the well-known competition and the stability of the market structure, there are also other structures such asbank business models, interconnection with government, network structures, cross-border listing activities and the relationship between banks and the financial markets that have proven the most important market structures to determine financial stability and financial development. References Tor11: , (Torre & Torre, 2011), Hua14: , (Huang, et al., 2014), Ada09: , (Adams, et al., 2009), Mar10: , (Anon., 2010), Flo07: , (Floerkemeier & Norris, 2007), Fro01: , (Frowen & Francis, 2001), Dut13: , (Dutt & Mihov, 2013), Kle10: , (Klein & Saidenberg, 2010), YHu11: , (Huang, 2011), Kun01: , (Kunt & Levine, 2001), DCW10: , (Wheelock & Mitchener, 2010), Gar06: , (Schinasi, 2006), Read More