Profitability of Banks: Commonwealth Bank of Australia - Essay Example

Profitability of Banks: Commonwealth Bank of Australia By Insert Presented to Location Date Due Introduction Banks are intermediaries of money resources, and as such; considered as the key pillars of monetary markets (Schwalbe 2006). The main fields of activity in the banking industry are divided into three lines: allocation of resources, resource mobilization and finally banking services. Therefore, identification of the performance of banks in the implementation of its tasks can actually present different weaknesses and strengths in banks. Because banks just like any other organization are after financial profitability, they strive to attain this key objective. It is thus essential for them to identify effective variables. Therefore, this paper looks at different at factors that lead to the profitability of the Commonwealth Bank of Australia. Overview the Commonwealth Bank of Australia The Commonwealth Bank of Australia is based in Australia, though it has many branches across Fiji, New Zealand, United States of America, the United Kingdom and Asia (Commonwealth Bank of Australia 2014). The bank offers a wide range of financial services such as retail, funds management, business and institutional banking, insurance, superannuation, broking and investment services. According to Commonwealth Bank of Australia (2014), the bank was founded in late 1911 by the Government of Australia. Under their Retail banking services division, it offers financial services to small business and personal clients. Under their premium business services, the bank provides services mostly to Institutional Clients, as well as International markets. Factors influencing profitability In the case of Commonwealth Bank of Australia, the factors influencing their profitability are divided into two external and internal categories. Internal Factors Capital Normally, in any economy, capital investment is treated as the interests or right of the owners or shareholders of an institution in the form of assets. This amount or capital is attained by cutting down the institutions debt from the total assets. In fact, one of the key reasons for the existence or presence of high ratio of banks investment is mainly to enable them to manage the risks associated with non-repayment of loan facilities by the borrowers, as banks usually employ their own investment to act as a protection or safeguard against insolvency or bad debt. For Commonwealth Bank of Australia, having adequate and sufficient investment is usually taken as one of the essential conditions for retaining a vibrant system of banking (Commonwealth Bank of Australia 2014). In essence, one of the key parameters of interest and profitability is capital adequacy ratio of the bank. This helps in ensuring that stability of its operations. Liquidity According to Zülch (2011), liquidity is the ability of the bank to obtain cash for meeting the current and necessary requirements. As Yin and Hock-Eam (2012) indicates, banks should have adequate liquidity to meet the increasing demands of loan holders and depositors. This undertaking will also help it gain the public assurance and acceptance. In the case of the Commonwealth Bank of Australia, there are effective systems of managing assets and liabilities and this has helped in decreasing the noncompliance of liabilities and assets as well as optimization returns. In addition, because of the inverse connection between profitability and liquidity, the bank manages to stay afloat by creating an ideal or perfect balance between the two variables. Operational Risk Management According to Maynard (2013), credit risk is the likelihood of not paying back borrowed money or bank resources by debtors. The Commonwealth Bank of Australia is usually confronted with this risk particularly when the borrowers due defaulting of loans repayment on the exact due date stipulated by the bank during loan application. Mainly, the bank calculates credit risk using the total ratio of all unfavorable receivables to the full loan expended or to be disbursed. This helps the bank in determining risky clients and those who are not. Defaulted credit reduces the level of profits the bank gets in a given financial period. Cost management As a matter of fact, the overriding goal of any organization or business is to grow the shareholder value. Undeniably, in contemporary conditions of business, the sustainability of any enterprise significantly rests on creating value for shareholders, who are also the owners of equity (Schwalbe 2006). Value for shareholders and profitability at commonwealth Bank of Australia goes hand in hand. In fact, as the company increases the profitability, it is creating value for shareholders as well. In other words, shareholders invest their money for profitability reasons. It must be understood that although creating the appropriate capital structure as well as enhancing the portfolio of the company is one of the most common actions to enhance value, the cost of management mainly by different units of the company is an important resource for profitability (Schwalbe 2006). In short, cost management in banking entails formulation of measures mainly by the top management to provide customers satisfaction whilst controlling and progressively minimizing cost. Costs are treated as liabilities in the income statement, thus reduce the banks profitability. Fig 1: The graph below shows the CBA return on Equity from 2008-2014 Source: (Commonwealth Bank of Australia 2014) This graph shows how much money the bank makes based on its shareholder funds. From the graph, it can be seen that despite the 2008/2009 financial crisis the bank was still making steady level of return of equity. The return has firmed up steadily for last three years. Bank deposits The Commonwealth Bank of Australia classifies bank deposits into different groups including current deposits and fixed deposits. Real and legal persons, as well as corporate bodies holding accounts with the bank, deposit their funds with the bank and receive checkbooks to use on checking accounts in appropriate time. Bank deposits significantly increases the profitability of the bank as the bank uses the deposits to do businesses. Personnel According to Pearson (2009), successful senior managers mainly in the service industry have established that in new economy, company employees, as well as customers must be the focal point or center of management attention. In addition, top management considers factors that in the present era will result in high profitability. Furthermore, one of the internal indirect factors affecting the profitability of the bank is enhancing the knowledge of personnel via holding training courses. In a study conducted by Mihalič, Žabkar and Cvelbar in 2012 to find the factors that determine profitability in the banking industry, the authors established that amongst internal factors, overhead costs, high capital and bank lending rates have no direct effect on increasing profitability. They also established that the indicators of financial structure of the bank and concentration of free competition have less positive impact on profitability of banks, but indicator associated with the developments on stock market has a positive influence on the profitability of banks. Payment of Loans From the analysis of the financial statements of the Commonwealth Bank of Australia, payment of loans by borrowers is not only the main activity of the bank, but also the primary source of its revenue (Commonwealth Bank of Australia 2014). The amount paid by borrowers is inclusive of the interest charged. Therefore, by taking and paying the loans fully, the bank increases it revenue and ultimately profits. In fact, one of the key reasons for improving profitability of CBA is that its loan quality is steadily improving. Similarly, the current percentage of home loans is more than three months overdue, which is one important measure that shows that the bank is moving in the right direction (Commonwealth Bank of Australia 2014). External factors Economic Environment The macro forces are particularly hard to manage than the micro forces (Hamilton & Webster 2009). Economic conditions, policies and systems are the vital factors that make the external economic environment and affect the performance of any organization. The type of the economy, available economic resources, the stage of growth of the economy, the allocation of assets, as well as income are amongst the very significant determinants of business approaches. In nations where income and investment are steadily rising, business ventures are normally bright and encourage further investments. Some categories of ventures are positively impacted by government policies and some unfavourably affected. For instance, a policy of protecting the home businesses in New Zealand greatly affected the Commonwealth bank at its inception, but it managed through by merging with the net bank of New Zealand (Commonwealth Bank of Australia 2014). These factors if not well managed affected the profitability of a business negatively. Political and Legal Environment Political and legal environment have a close link with the economic structure and economic policy. For instance, Russia has a centrally designed monetary system and this system cover such matters as, packaging, standards of products and promotion (Mason 2011). In other countries such as South Korea and United States, where emphasis is given to safeguarding the consumer interests, policies have become tighter. Some governments spell out certain values for the products to be sold in their countries whilst some even ban the marketing of some products. European countries, such as, New Zealand proscribe to the use of kids in commercial advertisements. In other countries such as India, advertisements must bear the statutory warning. According to (Mason 2011), these controls and policies if not well managed and adhered to might cost the company a lot to correct in the end. Socio-Cultural and Demographic Environment The cultural and social fabric is a vital environmental issue that should be kept in mind when formulating business policies. The saving and expenditure habits of persons, their language, tastes and preferences, customs as well as traditions, education are issues that affect the Commonwealth Bank in the international market (Pearce 2004). To succeed, the Commonwealth Bank has strategies that fit in the socio-cultural environment in countries where it has subsidiaries. Moreover, demographic factors like population growth rate, the size of the population, age composition, life expectancy, employment pattern and occupational status, influence the demand for services and goods. Most developing countries such as India, China and New Zealand are witnessing a population outburst and hence labour surplus to multinational companies like commonwealth bank. The population of New Zealand stands at 4.3 million and rising, therefore this gives some good labour to multinational companies (Pearce 2004). Therefore, the population growth rate is a significant environmental factor that affects businesses. CBA hybrid strategy The bank employs a hybrid strategy, which entails internationalization, diversification and customer centred. Customer Focus In the case of customer focus, the Common Bank of Australia is keen to grow its share of typical products offered to customers. Currently, if someone is a CBA client, he or she can deposit the cash with the bank (Commonwealth Bank of Australia 2014). At the same time, clients are allowed to borrow with the bank. The other most important thing is that despite doing all things with the bank, the customer is not prevented from going elsewhere for most of his or her wealth management services such as financial planning and insurance services. Fig 2: The Diagram shows the products offered to customers by CBA Source: (Commonwealth Bank of Australia 2014) From the diagram, it can be seen that deposits are highest at 66.4 percent, followed by lending and cards at 58.4 percent and finally wealth management at 12.3 percent. It therefore, goes without saying that other than traditional banking services, CBA wants a huge slice of the wealth management services currently organized financial planners and insurance companies. Internationalization approach Since most of the companies are not privileged in terms of resources, market size and opportunities; they have to move out and look for existing opportunities outside their home country. The Commonwealth Bank of Australia attributes most of its success in terms of profitability to overseas markets. The bank has branches in most countries in Asia, Europe, America and Canada (Commonwealth Bank of Australia 2014). One sure way for an organization to diversify the risks of a company is to consider overseas markets as a remedy for uneven demand. Oversees markets, counters fluctuations by opening up outlets for surplus production capacity. In fact, CBA is quick to openly point out that there are some other places other than the Australian market where the bank is usually more profitable. Fig 3: The figure shows the profitability of the bank in different countries of operation Source: (Commonwealth Bank of Australia 2014) From the figure above, it is very clear that the bank pursues its internationalization strategy and operates in different countries as shown in the figure. In addition, most of these countries of operation are more profitable compared to the home country. For instance, Indonesia, China, Russia, Canada and Indian markets are more profitable compared to Australian market. Conclusion Banks usually operate for the purposes of making profit. This aspect is driven by many factors. First, according to observations, banks are financed from both by internal and external sources. External sources of financing included shareholders money, who are strictly looking forward to getting their money back including returns. Thus, to achieve this, banks must ensure that products and services offered to clients meet their demands and satisfy their needs. In other words, customers are important stakeholders who can make the bank achieve or fail to fulfill its goals. When products are tailored to the needs of clients and are taken up, the bank in return earns something out of it mainly through fees or interests on loans. Other than customers and tailored services, bank personnel and cost management approaches also help in enhancing the banks profits. The profitability of the bank is also affected by external factors such as the prevailing economic condition in a country, political, legal and sociocultural aspects. These factors affect the bank both directly and indirectly. List of References Commonwealth Bank of Australia, 2014. Commonwealth Bank Group. [Online] Available at: [Accessed 9 March 2015]. Hamilton, L., & Webster, P., 2009. The international business environment. New York : Oxford University Press. Mason, W., 2011. Macroenvironmental Forces . [Online] Available at [Accessed 9 March 2015]. Maynard, J., 2013. Financial accounting, reporting, and analysis. Oxford: : Oxford Univ. Press. Mihalič, T., Žabkar, V., & Cvelbar, K 2012 A hotel sustainability business model: evidence from Slovenia. Journal of Sustainable Tourism, 20(5), p. 701-719. Pearce, D. W., 2004. Capturing global environmental value. London: Earthscan Publ. Pearson, G., 2009. Financial services law and compliance in Australia. Port Melbourne, Vic.: Cambridge University Press. Schwalbe, K., 2006. Introduction to project management. Boston, Mass.: Thomson Course Technology. Yin, C., & Hock-Eam, L., 2012. An empirical investigation on the forecasting ability of mallows model averaging in a macro economic environment. AIP Conference Proceedings, 1482(1), p. 402-407. Zülch, H., 2011. International Financial Reporting Standards (IFRS) 2011. Weinheim: Wiley-VCH. Read More