Are the German Banks Riskier than the European Competitors - Case Study Example

Are the German banks riskier than the European competitors? Table of Contents Are the German banks riskier than the European competitors Table of Contents 2 Introduction 3 German banks versus non-German banks 4 A brief Literature Review 4 Data Collection and Methodology 5 Results 6 Conclusions 7 Limitations and Recommendations of the Study 8 Reference 8 Carson, R. L. (1990) Comparative Economic Systems (Part III: Capitalist Alternatives) New York: M. E. Sharpe. 8 Appendix 9 Introduction Financial sector is one of the riskiest of all sectors in the world. One of the most vulnerable ones, this sector is easily affected by any shock either internal or external to the host country. Moreover, the financial sector is the one that decides the economic stability of a nation and determines the pace at which the nation will grow in future. This is the reason why most of the nations are so protective about their respective financial sectors and take a considerable time to analyze the impact of adapting corrective or expansionary measures for the same. In fact, the risk feature core to the financial sector of any nation is the reason why there is a large amount of arbitrage activities, which often takes the shape of gambling, taking place around it. The present study tries to deduce the element of risk present in the activities of non-German but European banks and that of the German banks. The German banks, after the unification of East and West Germany, had taken very stringent measures to ensure that their services became very popular among the customers and that more and more people availed to them, so that the nation’s financial activities will experience a boom and the depressing image of East Germany would be banished from ever from the heart of the nation. Moreover, the nation also needed money to replenish its previous losses incurred before the unification of the nation. The national government as well as the central bank of the nation decided to play it low and implemented policies that would ensure a smoother path for the domestic financial sector and ensure the customers a safety for their money. This feature will again attract more and more potential customers from shifting their base to German banks. On the other hand, the remaining part of Europe had never experienced as hard times as Germany did in its initial days, which is why they cannot be expected to take as much safety measures as would be adopted by the German banks. Hence, the risk quotient of the non-German European banks is expected to be higher than their German counterparts. But again, one point that must be kept in mind is that the changes did not come in one single day; Germany had taken a considerable amount of time to bring positive changes in its strategies, which is why, a time-series analysis might not yield results that comply with the present situation in a comparative perspective. German banks versus non-German banks The German banks, as already mentioned in the introductory part, are expected to be less risky than their non-German European peers in a race to win popularity among the mass. They indeed implemented many policies to assure the fact that the customers feel safe about their hard-earned money been deposited with the German banks, whereas, no such precautionary measure, significant in comparison to that of the former had been adopted by other European banks. The result of such negligence is that the latter is found to be more risky than the former and thus less popular among the general bank customers but more popular with the arbitragers or investors. The variable being chosen to prove this point is a comparison of the level of liquidity that is maintained by the German banks and their other European counterparts. The level of liquidity or leverage implies the total proportion of liquid assets that any organization has, in comparison to its total quantity of assets. The higher this proportion gets, lower will be the firm’s chances of ever losing its financial stability. In other words, it can be said that higher a firm’s leverage is, more financially solvent will it be and lower will be its chances of facing a short-run financial distress. Thus, to maintain a low risk quotient, it is always advisable to firms to maintain a high liquidity ratio, and avoid the chances of any financially weak situation. Again, as pointed out in the previous section, if the analysis corresponds to a time-series, there might be differences in the results, since Germany took some time to assess and then take further corrective and precautionary steps. A brief Literature Review According to Robbins (Robbins, 2000), after East and West Germany were united, the German banks tried hard to win back the trust and faith of the national as well as international customers. However, the point that must be taken care of in this respect is that the time frame was considerable a long one, before the German banks could make a mark of their efficiency in the minds of people. Data Collection and Methodology In order to carry on with the present analysis, data has been collected on the liquidity ratio maintained by German as well as non-German European banks. The liquidity ratio is calculated as, Liquidity Ratio = Amount of Liquid Assets / Total amount of assets with the bank. Annual data on all individually conceivable active and merged banks for years between 1994 and 2008 have been collected for the purpose. These individual data are then averaged so as to yield the mean value for the overall banking sector of Germany and of non-German European banks. There are in all 15 pairs of observations for the German and non-German banking sectors. These 15 pairs are subjected to an F-test with the help of statistical software STATA. The purpose of this test will be to derive a comparative analysis of the fluctuations in the liquidity ratio values between the two datasets of the pair. The ideal and appropriate statistic to measure the amount of fluctuations is the standard deviation. Standard deviation measures the amount of dispersion present in the overall values of a variable. Hence, the relevant null and alternative hypotheses in this regard will be, H0: Difference in the standard deviations of the liquidity ratio values is not significant, i.e., the ratio of standard deviations of the two variables is equal to 1 and H1: There is a significant difference in the standard deviation values of the liquidity ratios, i.e., the ratio of standard deviations of the two variables is not equal to 1. In STATA however, not only is the difference in significance noticeable, but the results also clarifies which standard deviation exceeds the other one. The F-statistic in this context is defined as, F = (SEuro/ nEuro)/ (SGer/ nGer) Where, S implies the standard deviation for the specified sample of observations. The acceptance or rejection of the null hypothesis will be relevant from the estimated results displayed in the STATA window. Out of the three alternative hypotheses, the one that corresponds to the highest probability will be the true case. Results The result of the estimated F-statistic has been provided in the appendix to the chapter. The estimated statistic is found to be equal to 4.9996. At degrees of freedom equal to (14, 14), the probability of occurrence of the estimated statistic is found to be the highest in the case when the critical F value exceeds the estimated ratio. Thus it can be said that the ratio is found to be true in most of the cases; rather, speaking technically, the ratio is found to be true in almost 99.76 percent of the cases. This indicates that not only is the null hypothesis (H0) rejected significantly, rather there is clear evidence that the ratio is found to stay below 1 in most of the cases. This in turn implies that, fluctuations in the liquidity ratio are lower in case of the non-German European banks rather than the German banks. Thus, empirical evidence proves the fact that there is a higher amount of fluctuations present in the liquidity ratio of the non-German European banks rather than their German counterparts. On the other hand, the values of mean levels of liquidity ratios for either sector are found to be, 31.44 and 15.52 for the non-German European and the German sectors respectively. This implies that the average value of the ratio is higher for the former and hence the solvency or liquidity position is sounder for the non-German banking sector as a whole. This again reflects the fact that the German banks are more financially stable than their other European counterparts. Conclusions The empirical evidence deduced in the previous section indicates that there is a greater extent of fluctuations present in the liquidity ratio of the German banks rather than their non-German European peers. Liquidity ratio implies the proportion of liquid assets to total assets of a given bank. The higher this ratio is, the higher will be the liquidity position of the concerned company and thus there will be a lower chance of the firm ever facing a financially distressful situation. Despite the fact that this ratio is so important, there are instances when firms often fail to divert their full attention in the area and this is where they go wrong. The present case however is a different one. It concerns the banking sectors belonging to two completely different backgrounds. While the non-German European banks had not witnessed any significant political upheavals in the post-war period, there had been constant discrepancies in the political arena for the German economy. The most remarkable political event of the nation post war was the fall-down of the Berlin Wall. Moreover, after the war was over, Germany lost all its political influence from an utter loss of both financial and human resources. The background of the war had made the world lose their faith in the German economy and no one was ready to involve them into any transaction as such. The German administration had a long way to go before it could again win back the confidence of its people as well as that of the people worldwide. This is the reason why a time-series analysis would reveal a somewhat false picture of what the German economy is today. The analysis in the present research paper considers a long time frame of 15 years, from 1994 to 2008. There had been a considerable change in the German economy over this period, this change is noticeable in almost all aspects of German society, even its financial or rather the banking sector as the present study finds. It is the effect of these changes why the fluctuations in the measure of dispersion is so prominent for the German banking sector rather than the non-German sectors. Even the mean value of the ratio is found to be higher for the non-German banking sector than that for the German peers. This again indicates that the liquidity position is better for the non-German sector than the German one. Limitations and Recommendations of the Study The present study has averaged the liquidity ratios of all individual banks for both the German and the non-German sectors. This however, smoothens out the individual discrepancies faced by the banks at micro-level. In order to study the case of German versus non-German European banks more minutely, it is important that there is no such aversion. There are two recommendations for further study into the area. Firstly, in order to get a clearer picture of the comparative risk situation of the German and non-German banks, it is important to consider a few more variables. Again, an analysis can also be considered among different segments of the banking sector itself, so as to find out how far each of them has fared over time. However, despite the limitations of the study, it can be said that the time series analysis is really a commendable one and provides matching evidence to the true story of the region. Reference Carson, R. L. (1990) Comparative Economic Systems (Part III: Capitalist Alternatives) New York: M. E. Sharpe. Appendix Results of the Estimated F-test Read More