Are the German Banks Riskier than the European Competitors - Research Proposal Example

Are the German banks riskier than the European competitors? The German banks, after a long period of political unrest, have unwound themselves by adapting to certain anti-risk monetary policy measures. This paper is an attempt to assess how far the policy measures have been successful, especially in comparison to similar measures adopted by the European counterparts. Thus the present paper is a comparative analysis of the risk measures of the German and non-German European banks, where empirical evidence has been used as the basis for comparison. Table of Contents Introduction 4 Literature Review and Theoretical Framework 5 Data Collection and Methodology 7 Results and Discussions 8 Conclusion and Recommendations 8 References 9 Barbar, T. (1999) ‘Deutsche looks to widen its horizon’, The Financial Times, March 8. 9 Helm, T. (2003) ‘Is there sufficient flexibility in the UK economy to respond to shocks if it joined the euro zone?’, The Telegraph, June 10. 9 Reszat, B. (2003) ‘Financial Reform in Germany’ in The international handbook on financial reform by Hall, M. (ed). Massachusetts: Edward Elgar. 9 Robbins, G. S. (2000) Banking in transition: East Germany after unification New York: Macmillan Press Limited 10 Bibliography 10 Carson, R. L. (1990) Comparative Economic Systems (Part III: Capitalist Alternatives) New York: M. E. Sharpe. 10 Green, W. H. (1997) Econometric Analysis (3rd Edition) London: Prentice Hall. 10 Groppelli, A. A. & Nikhbakht, E. (2000) Finance (4th Edition) New York: Barrons. 10 Appendix 11 Introduction Germany had undergone a long phase of political instability prior to the unification of the East and West German regions. Afterwards, the administration of the region had implemented various measures to ensure stability into the region from all aspects through the implementation of a large number of policies. Despite a significant amount of positive changes occurring in the domestic arena, when a comparison is made with other neighbouring regions of Germany, in Europe, it often appears apparently that the former is in a far worse and thus riskier position. The present study is an analysis of the financial aspect of the German and non-German banks, i.e., the extent of financial stability in the two regions. Financial stability can again be captured through an evaluation of the risk quotient characteristic of the financial sector of the concerned regions. The greater the risk underlying the financial situation in the region, the lower will be the financial stability, which can again prove detrimental for economic stability and thus prospects of future economic growth into the region. This is the reason why a rigorous study about the underlying risk factors in the financial structure of a region is of utmost importance for the administration and a relatively risky situation is a rather alarming matter for the national authorities. The present study involves an empirical analysis regarding the financial prospects of German and other non-German European banks; in other words, the paper tries to evaluate how far one group is riskier financially than the other one. The variable being considered to sort this analysis out is the ratio of total amount of liquid assets to that of the total amount of assets possessed by a firm. Comparison is made through using F-statistic, which relates the variations in the values of one group with those of another one, over the entire time frame and seeks out whether there is any significant difference in the innate characteristics of the two. Literature Review and Theoretical Framework Germany had historically witnessed a long period of political unrest which is likely to have laid its impact on a number of economic aspects of the nation hampering its natural development mechanism. One of the prime reasons behind the long-standing political unrest, had been the unification move triggered around the early 1990s (Reszat, 2003). However, there had been continued efforts on part of the national government to tackle the situation and thus establish peace and order into the domestic arena, in terms of security. Initially though, the desperation showed by the financial institutions had been proved quite untimely and exposed them to extensive market risks (Barber, 1999). The creation of Euro proved to be detrimental for Germany too, since it meant focusing on the greater Euro rather than on each unit that it comprised of (Helm, 2003). The government had since then, been adopting a number of attractive monetary policies that ensure that the citizens restore their faith upon the national banks. Some such policies include the opening up of the German national banks in the international market for the foreigners to invest their money in them, as was reported by the Deutsche Bank Chairman, Joseph Ackerman. This step has ensured a global reach to the German banks and thus is a major milestone towards attaining the faith of the local customers, besides broadening their availability to the foreign customers. In fact, there is more behind this measure than is visible to the common eye. With opening up their gateway in the international market, the German banks have also revived avenues to attract foreign investors into their sphere. Usually financial institutions that try to reach to the international customers as well tend to have a very steady financial structure (Robbins, 2000). Since investors seek such nations that have a strong financial stability, as that ensures economic stability by a large extent, the opening up in the international arena has resulted to the inflow of large quantities of FDI into the national premises. European banks as a whole are also quite reliable in nature as far as their financial aspect is concerned. This is evident from the huge number of branches of various European banks operating from every conceivable corner of the world and a transformation in their attitude of marketing (Rajan & Zingales, 2003). However, if the entire Euro region is dissected into a number of small segments, it cannot be established very strongly that each of them displays the same degree of security or reliability in their operations. This is because there are some regions that are politically disturbed even till date and thus financially risky. Since they belong to the European region, hampers the economic position of the region as a whole, despite the presence of a number of economically sound nations. Hence, the risk content or rather the financial soundness of the German banks and the European region as a whole can be considered to be at par with one another till further analysis is conducted. The present paper tries to capture the risk content of the financial institutions of the German and non-German European banks through assessing the diversifications in the proportion of liquid assets that the banks possess. Proportion of liquid assets, is the ratio of the amount of liquid assets with the bank to that of the total amount of assets that it possesses. The greater that the ratio is, the lower is the probability of the concerned firm about facing any financially distressful situation in the short-term, implying that a high liquidity ratio is a good indicator of a firm’s financial position. However, there are some other matters that must be considered before assessing about the financial soundness of a firm. Liquid assets though ensure that the firm possessing them are relatively shielded against any short-run financially turbulent situation, a high proportion of liquid assets also indicate that a large proportion of the firm’s assets is not yielding any returns, which might not sound very profitable. Liquid assets comprise of that portion of a firm’s total assets that does not yield any significant returns or extracts marginal yields, so that a high fraction of such assets is fruitless to maintain unless required. So, if a firm is found to be maintaining a low liquidity ratio consistently over a considerable period of time, without facing any threats of liquidation or bankruptcy, it suggests that the firm is operating in a rather stable environment and need not maintain a high liquidity ratio as such. The present paper takes up this case and seeks to find out whether there is any significant change in the proportion of the total liquid assets possessed by the German and non-German banking sectors, over the years. A consistent result would suggest the sector’s operation in a relatively stable and steady environment. Data Collection and Methodology Annual data from 1994 to 2008 has been collected with respect to German banks and their other European counterparts. This data comprises of information regarding the total amount of assets that each of the institution possesses as well as the gross quantity of liquid assets, like total amount of short-term deposits and funding, etc. with each of them. The liquidity ratio is calculated for the entire banking sector in each of the regions using the following formula. Liquidity Ratio = Liquid Assets/ Total assets possessed The banking sector in each region however has been manipulated so that they do not comprise of all the banks that the regions ever consisted of. Out of the entire dataset of banks in the European region, many had liquidated, dissolved or gone bankrupt over the period of fifteen years. Hence, including them into the study is irrelevant. Moreover, there were certain active banks as well on whom data was unavailable, and thus those banks have been omitted from the study too. After all the elimination and manipulation, the dataset is dissected into fifteen parts, for each of the fifteen years under study – the objective is to capture the changes that had undergone during the entire phase and then arrive at a final conclusion. After the dataset is divided, the average annual returns from the banking sectors in both the regions is calculated, with the banking sector comprising of the controlled dataset. The objective now is to find out the consistency in the returns from the banking sector as a whole, of the two regions. The two final datasets for each region, comprising of fifteen data points, is now merged in order to calculate the standard deviation of the data, so as to find out the variations in the average values in both contexts. Since, the prime target will be a comparison between the variations in returns in the two regions, the relevant null and alternative hypotheses in this perspective will be, H0: SDEurope - SDGerman = 0 and H1: SDEurope - SDGerman ≠ 0. With the help of these two standard deviation values, F-statistic is estimated. A significance test of the calculated F-statistic assists to find out the riskier one out of the two groups and hence, takes care about the null hypothesis. F-statistic is defined in this case as, F = SDEurope/ SDGerman In STATA, this calculated value is compared with the tabulated value at given degrees of freedom and finds out the probability of the former exceeding, equating or falling lower than the tabulated value. The probability which is found to be largest of the three is considered as the most conceivable one on further forecasts regarding the population, on the basis of the sample. Results and Discussions The F-statistic results, depicted in the appendix to the chapter reveal that the tabulated value is, in most of the cases, found to be greater than the estimated one at the given degrees of freedom. The estimated value of the statistic, viz., 0.2352 is greater than the tabulated value at (14, 14) degrees of freedom in 99.47 percent of the cases, implying that this is found to be the mostly occurring event according to sampling forecasts. This indicates that in most of the cases the ratio of standard deviations, as defined above, is found to be greater than 1. Hence, empirical evidence reveals the fact that standard deviation of non-German European banks is greater than that for German banks. Conclusion and Recommendations German banking authorities have been implementing various anti-risk policy measures in order to win over the trust of the national as well as many potential foreign customers. The standard deviation measures of the liquidity ratios reveal that the German banks have been rather successful in their motive than the entire Europe taken as a whole. However, the poorer performance of European banks as a whole can be assigned to the relatively turbulent situations in a handful of European nations, which have overridden the relatively peaceful environment enjoyed by the rest. Liquidity ratio is a trusted measure of the degree of risk that any firm undergoes, since it takes into account the financially distressful situation that a firm is experiencing in the short-term. However, there are some other measures as well which are equally trustworthy and could be taken into account for better outcomes, i.e., to gain stronger results. Such measures include the variables that measure the profitability or the value of the concerned firm. Thus, the idea for further researches in the area would be that after including all such conceivable variables so as to yield a stronger result. References Barbar, T. (1999) ‘Deutsche looks to widen its horizon’, The Financial Times, March 8. Helm, T. (2003) ‘Is there sufficient flexibility in the UK economy to respond to shocks if it joined the euro zone?’, The Telegraph, June 10. Rajan, R. G. & Zingales, L. (January, 2003) ‘Banks and markets: the changing character of European finance’. Available at http://research.chicagobooth.edu/economy/research/articles/183.pdf (Accessed January 14, 2004) Reszat, B. (2003) ‘Financial Reform in Germany’ in The international handbook on financial reform by Hall, M. (ed). Massachusetts: Edward Elgar. Robbins, G. S. (2000) Banking in transition: East Germany after unification New York: Macmillan Press Limited Bibliography Carson, R. L. (1990) Comparative Economic Systems (Part III: Capitalist Alternatives) New York: M. E. Sharpe. Green, W. H. (1997) Econometric Analysis (3rd Edition) London: Prentice Hall. Groppelli, A. A. & Nikhbakht, E. (2000) Finance (4th Edition) New York: Barrons. Mentre, P. (1984) The fund, commercial banks and member countries Washington, D. C.: International Monetary Fund Nikolai, A. L., Bazley, D. J. & Jones, P. J. 2009. Intermediate Accounting. 11th ed. Cengage Learning. Ross, S. A., Westerfield, R. & Jaffe, J. (2004) Corporate Finance New York: McGraw-Hill. Thompson, L. J. & Martin, F. 2005. Strategic management: awareness and change. 5th ed. Cengage Learning EMEA. Vance, E. D. 2002. Financial analysis and decision making: tools and techniques to solve financial problems and make effective business decisions. McGraw-Hill Professional. Appendix A.1 Annual Average liquidity ratio of the German and non-German banking sectors Years Liquidity of German banks Liquidity of European banks 1994 14.06830479 35.50381604 1995 14.69358175 35.24731202 1996 14.41093298 35.27887894 1997 14.29700859 36.16502507 1998 14.62946892 34.85470441 1999 14.62195395 30.29602144 2000 13.81260733 28.72426147 2001 14.80088358 29.9288983 2002 14.99373966 28.92091639 2003 14.09561878 28.04266095 2004 14.86642855 27.6403335 2005 15.42210689 28.56138394 2006 16.12439722 29.87722986 2007 18.20065588 30.51660713 2008 19.02964602 31.6069643 A.2 F-statistic for comparison of risk Read More