The Investment Bank - Case Study Example

Accrue To a Retail Bank Benefits or Drawbacks by Acquiring an Investment Bank Executive Summary For the merger of the medium size retail bank with the investment bank there are certain concerns that need to be addressed in the context of the market situations and that of the company analysis. The cost benefit analysis is necessary to find out the actual potential of the merger. Its effectiveness can be judged through the parameters like increased market power, reduced earning volatility, scale and scope of economies and reduction in expenses. The merger will create a lot of speculation in the market and the financial and the legal viability need to be checked before the merger. Table of Contents Executive Summary 2 Overview of the Market 5 Legal Acceptability 5 Benefits 6 Drawbacks 6 Financial Aspects 6 Benefits 7 Drawbacks 7 Scale and Scope of Economies 7 Benefits 8 Drawbacks 8 Cost and Profit Efficiency 8 Benefits 8 Drawbacks 9 Opportunity for Growth 9 Benefits 10 Drawbacks 11 Diversification of Risk 11 Benefits 11 Drawbacks 11 Financial Constrains 13 Benefits 13 Drawbacks 13 EPS (Earning Per Share) & P/E Ratio (Price Earning) 14 Benefits 14 Drawbacks 14 Diversification Operations 14 Benefits 15 Drawbacks 15 Potential Benefits 15 Disadvantages 16 References 17 Bibliography 20 Overview of the Market The globalisation has enlarged the competitive pressure in the market. In this highly challenging environment there have been many mergers and acquisitions to survive in the market. The basic reasons are financial stability and opportunity for growth. In such situations there are strong desires for mergers. As a result of the high risk of asset quality, these segments of investment banking have become unpredictable to the profit margins. And due to this reason there have been instances of mergers with retail banks (Furrer & Et. Al., 2009). Legal Acceptability A fair dealing can be extracted out in the merger with proper citation from the legal department of the origin country. The legal issues are generally related to the stakeholders and the structuring of the company. The other issue that needs to be focused are the mortgages of the consumers and the legal liabilities that retail and investment banks have. This requires to be dealt with and if not properly clarified before the merger this might turn out to be the biggest drawback (The US Government, 1999). Benefits As the retail bank is merging with the investment bank the legal benefit will be inclined towards the retail bank than the investment bank. The mortgage and liability issues will be favourable to retail bank because of diversification. Drawbacks The investment bank may get too confined in the legal issues and it may increase the overall operational cost of the bank. The structuring of shareholders might not be favourable to the investment bank. The share percentage may get decreased. Financial Aspects The merger will lead to enlarge the market share of investment bank that might result to increasing pressure of credit rates. The merger might result in increase in the efficiency gains that might be the cause for the descending pressure on credit rates. The merger has the influencing power to alter the configuration of liquidity stocks through transforming their allocation within the retail bank (Carletti & Et. Al., 2001). This merger might increase the aggregate accepted liquidity requirements of the retail as well as investment banking system. There is a probability that both the retail and investment bank might experience a liquidity shortage that can be either increasing or decreasing depending upon the cost of refinancing relatively to the cost of raising deposits. There are benefits as well as disadvantages associated with the merger (Carletti & Et. Al., 2001). Benefits The retail bank has the scope to increase the market share with merging with investment bank. This will not only increase the market share but also will provide in them an option of dealing with diverse financial products. This will help in increasing the assortment of services provided by the retail bank. Drawbacks There is a possibility of liquidity shortage in case of the retail banks merger with investment bank. The probability of liquidity shortage is expected to be in investment bank as the retail bank has financial instruments that generate more deposits every day. Scale and Scope of Economies The merger of retail bank with the investment bank phenomenon has been observed mostly in the view of economic of scale and activities lines, to achieve improvement in the performance. The merger will help in reducing costs through various techniques like information sharing, monitoring cost and other segments and help in improving economies of scale. The average cost can be reduced through the expansion volume of products that are similar in both the retail and the investment bank (Wyman, 2009). Benefits The merger will increase the product line of retail bank and also will increase the scope of performance and help in reduction of costs. The extension in the product line will provide an added benefit to retail bank in the competitive environment. Drawbacks Information and data management and control will be complicated and can lead to uncontrollable situation. In recent times management of information and control is vital for success of an organisation. Especially for the retail bank information plays an important part in managing various issues generally related to consumers and shareholders. Cost and Profit Efficiency A study conducted by Rym Ayadi and Georges Pujals in the European market has found that the cost and profit efficiency on the retail and investment bank mergers have substantiated development in cost efficiency and relatively smaller amount of improvement of profit efficiency for the domestic operations whereas in case of cross border transactions, there was no development of cost efficiency and profit efficiencies also showed very little improvement. This shows the potential benefits in domestic market and disadvantages in the cross border operations when a retail bank merges with investment bank (Ayadi & Pujals, 2005). Benefits In the domestic market there is possibility for the retail bank to increase their profit efficiency. This increment scenario will help the organisation to look for further growth in the market. Drawbacks In terms of international operations the retail bank will not be able to generate more profit efficiency as compared to domestic operation. Opportunity for Growth Figure 1 (Dullien, 2009). Figure 1 represents the data of 115 countries; showing average current account balances in percent of GDP (Gross Domestic Product) and average annual growth rates of per-capita GDP for the years 1990 to 2005. This shows the growth of private credit is systematically correlated to higher economic dynamics. Therefore, it can be said that there is an opportunity of growth for the invest bank in merger with retail bank (Dullien, 2009). Figure 2 (Dullien, 2009). Figure 2, shows the positive correlation between private credit growth and per capita GDP growth and annual change in GDP per capita in percentage. This shows that there is a positive linkage in merging with the retail banking system to grow with the economic development (Dullien, 2009). Benefits As there is an opportunity to increase the GDP rate, there is every possibility that the retail bank will also grow with this increase. The increase in per capita income will lead to growth in retail bank. Drawbacks If the GDP and per capita income does not be favourable this will have a negative effect in retail bank and the cost of merger will be more. The cost of merger will not be effective. Diversification of Risk If the merger between retail and investment bank takes place then the main motive is to reduce the risk through diversification. The extent to which the risk can be reduced depends upon the correlation between the incomes of the integration entities (retail and investment bank). The positive correlation brings lesser reductions in risk and the negative correlation carry larger reductions in risk. Benefits With the merger technique there is every possibility of reducing the risk of retail bank. The liability risk will be reduced and its effect will be seen in the balance sheet that will attract more investors. Drawbacks The investment bank’s liabilities might increase the level of risk of retail bank instead of decreasing the risk. Financial Constrains The financial constraints can be removed through the exchange of shares. It will provide an opportunity to get the inflow of cash and increase the financial stability and help in the long run of operations of the investment bank. The retail banking has products that facilitate in the inflow of cash which is positive for the market growth for the mergers and provides the opportunity for the investment bank. Benefits The structuring of share and exchange of share provides the opportunity for retail bank to get benefited from this structure. It will also help in increase of shareholder fund. Drawbacks The dividend policy might get changed due to structuring of the shares. The retail bank might need to increase the dividend pay. EPS (Earning Per Share) & P/E Ratio (Price Earning) In the proficient financial market, the market price of a share should be equivalent to the value generated by the “discounting cash flow technique”. If it is below than the prescribed limit, it is not going to benefit and the merger will not be effective in terms of EPS for the financial bank (Dermine, 2008). Benefits The restructuring of shares and combination of share will help in increase in EPS as well as P/E ratio. This will help to attract more investors towards retail bank. This will increase the cash inflow. Drawbacks The EPS and P/E of the investment bank might negatively affect the retail banks performance and affect the shareholders of retail bank. Diversification Operations Apart from the services related to investment banking, it can have significant presence in the retail banking and brokerage business. The operations will be diversified and the investment bank will have the opportunity to enter in this segment of retail banking (IBS Centre for Management Research, n.d.). Merger between retail bank and investment bank will lead to strong strategy for entrance into the new market which will be a positive aspect to explore the new opportunities. In the entry strategy to the new market, it will provide an added advantage to compete with the local as well as international banking industry. Benefits The diversification will provide the retail bank to enter potential market with diverse product and services offerings. The operations will be increased and generate revenue for retail bank. Drawbacks For the short run period it is cost to retail bank but in the course of long run the cost will be minimised. The overall process will require more time and predicting the future market is difficult. Potential Benefits In the high competitive market to reduce the risk of asset quality the merger with retail bank will be a benefit. The retail bank merger will increase the efficiency gains because of the credit rates and increase the aggregate accepted liquidity requirements. If the cost of refinancing relatively to the cost of raising deposits is managed appropriately then the liquidity shortage will be decreased. The overall performance of the investment bank will increase and there will be reduction in cost with the help of economies of scale. The risk of various natures will be reduced through the diversification. The financial constrains can be removed through the share structuring (Business Insights, n.d.). Disadvantages The mortgages of the consumers and the legal liabilities of the retail bank might turn out to be unfavourable to the investment bank. If the allocation of the liquidity stocks of retail bank is not in favour this might be a trouble for the investment bank. If cost of refinancing is relatively higher than cost of raising the deposits, it will generate liquidity shortage. For international operations the profit efficiency might not be effective. There are possibilities of financial crises in short run (Kroszner, 1998). References Ayadi, R. & Pujals, G., 2005. Banking Mergers and Acquisitions in the EU: Overview, Assessment and Prospects. SUERF – The European Money and Finance Forum Vienna 2005. [Online] Available at: http://www.suerf.org/download/studies/study20053.pdf [Accessed November 19, 2010]. Business Insights, No Date. The Top 10 Global Retail Banks: Growth Strategies and Best Practice of the Leading Players. Financial Services Management Report. [Online] Available at: http://www.globalbusinessinsights.com/content/rbfs0064m.pdf [Accessed November 19, 2010]. Carletti, E. & Et. Al., 2001. Bank Mergers, Competition and Financial Stability. Bank for International Settlement. [Online] Available at: http://www.bis.org/cgfs/hartmann.pdf [Accessed November 19, 2010]. Dullien, S., 2009. Central Banking, Financial Institutions and Credit Creation in Developing Countries. United Nations. [Online] Available at: http://www.unctad.org/en/docs/osgdp20091_en.pdf [Accessed November 19, 2010]. Dermine, J., 2008. Bank Valuation: With an Application to the Implicit Duration of Non-Maturing Deposits. International Journal of Banking, Accounting and Finance. [Online] Available at: http://www.insead.edu/facultyresearch/research/doc.cfm?did=43063 [Accessed November 19, 2010]. Furrer, B. & Et. Al., 2009. Banking & Climate Change: Opportunities and Risks. An Analysis of Climate Strategies in More Than 100 Banks Worldwide. [Online] Available at: http://ec.europa.eu/enterprise/policies/sustainable-business/corporate-social responsibility/reporting-disclosure/swedish-presidency/files/surveys_and_reports/banking_and_climate_change_-_sam_group_en.pdf [Accessed November 19, 2010]. IBS Centre for Management Research, No Date. JPMorgan Chase - A Tale of Two Mergers. Acquisition of Bank One. [Online] Available at: http://www.icmrindia.org/casestudies/catalogue/Business%20strategy/JP-Morgan%20Chase%20-%20Merger%20Business%20Strategy%20Case%20Study.htm [Accessed November 19, 2010]. Kroszner, R. S., 1998. Potential Conflicts of Interest in Universal Banking. Graduate School of Business of The University of Chicago. [Online] Available at: http://faculty.chicagobooth.edu/finance/papers/banktest2.pdf [Accessed November 19, 2010]. The US Government, 1999. Large Bank Mergers: Fair Lending Review Could be Enhanced With Better Coordination. US Government Accountability Office. [Online] Available at: http://www.gao.gov/products/GGD-00-16 [Accessed November 19, 2010]. Wyman, O., 2009. The Next Wave of Cost Reduction in Retail Banking. Financial Services. [Online] Available at: http://www.oliverwyman.com/ow/pdf_files/OW_EN_FS_Publ_2009NextWaveCost.pdf [Accessed November 19, 2010]. Bibliography American Bar Association. Section of Antitrust Law, 2006. Bank Mergers and Acquisitions Handbook. American Bar Association. Benton, E. Gup, 1989. Bank Mergers: Current Issues and Perspectives. Springer. Bank for International Settlements, 2001. The Banking Industry in the Emerging Market Economies: Competition, Consolidation and Systemic Stability. BIS Papers. [Online] Available at: http://www.bis.org/publ/bppdf/bispap04.pdf [Accessed November 19, 2010]. Viverita, No Date. The Effect of Mergers on Bank Performance: Evidence from Bank Consolidation Policy in Indonesia. Field of Research: Banking. [Online] Available at: http://www.wbiconpro.com/112-Viverita.pdf [Accessed November 19, 2010]. Liaw, Thomas K., 2005. The Business of Investment Banking: A Comprehensive Overview. Wiley. Read More