Factors that Influenced the Profitability of Firms in the Financial Sector - Term Paper Example

THE FACTORS THAT INFLUENCED THE PROFITABILITY OF FIRMS IN THE FINANCIAL SECTOR ACROSS THE EUROZONE IN This paper addresses the financial turmoil in the Eurozone with specific focus on the banking and financial institutions. The literature review covers some of the academic literature that gives a detailed analysis of the origin and the extent of the financial crisis. This include some of the strategies and steps that have so far been implemented by some selected nations with main focus on Portugal, Greece, Italy, Spain and Ireland the strategies that have been used by the states in dealing with the turmoil. Some of the causes and repercussions of the crisis have been addressed to include the impact on major economies in the world such as United States. The theoretical model of the financial crisis has been defined and stated to give an overview of the turmoil in the entire Eurozone. Some selected financial ratios have been used from the data provided to explain the observations and the interpretation thereof for the ratios. Some of the presentations have been used to deliver recommendation to the existing and potential investors as to the cautions they must bear in mind while making investment decisions. Introduction The European Union has since 2009 had problems with the sovereign debt and economic crisis. This has been considered as the strongest threat to the world economy. Most analysts and investors are more worried that some Eurozone states could fail to honor their debts in a confused manner that susceptibilities in the Europe’s financial sector could instigate an intensive financial crisis that could see the Eurozone enter into a prolonged economic downturn. This might eventually lead into one or more nations exiting the Eurozone. The financial turmoil has on the other hand translated into a political turmoil. Numerous national states have collapsed as a direct or indirect outcome of the turmoil and the crisis has put a strain on the relations amongst the European financial institutions and leaders (Senge, 2010; p. 139). This paper will address some of the common variables that show the extent of the financial crisis by the year 2010 and the interpretation thereof. Literature Review Currently most of the challenges to the Eurozone concentrate on the increasing levels of public debt and the state deficits in some selected Eurozone nations. As stated earlier there are some selected Eurozone states which include Greece, Ireland and eventually Portugal which have been forced to seek funds from other Eurozone states and the International Monetary Fund with an objective to prevent lapsing on their debts. Despite the help received by the countries there has been consistent restructuring of their debts leading to considerable losses. For the private investors and creditors they are more worried that other states might follow suit and restructure their debt despite the Eurozone officials being anxious that they might take Greece as an extraordinary case (Standard and Poors Corporation. 2009; p. 49). Besides investors are also keen in regard to Spain and Italy which in line with their magnitude they are taken as more categorically vital compared to Portugal and Greece. Notably Italy’s debt is bigger than the joint debts to Ireland, Greece, Spain and Portugal. As investors have transformed into more tense concerning Spain and Italy, they have called for higher rates of interests for purchasing and getting hold of more Spanish and Italian bonds. More to the point, the Italian and Spanish states have transformed their debts at the current high rates of interests; their levels of debts have further risen where doubts have emerged in line with the sustainability of the national debts in these nations (Graeber, 2011; p. 39). Increasing the concerns in regard to the public finances in the Eurozone externalities there are specific drawbacks in the financial system and the banking system of the Eurozone. Most of the Eurozone banks have side bonds where most financial analysts are worried that they is insufficient capital to integrate the losses on the investors’ holdings of the government bonds in case any of the Eurozone states incurs a default or conducts debt restructuring. The turmoil has also sparked off capital flight from the financial institutions in some of the Eurozone nations. In addition some banks have been noted to find it hard to seek loans from the private capital markets which have led to increased fear that the banking turmoil in the Eurozone could have a worldwide consequence (Standard and Poors Corporation. 2009; p. 48). Insufficient economic development in Europe, especially in the periphery is creating hard conditions for the nations to rescue themselves out of their debts. Notably, in 2010 it was predicted by the IMF that Europe will fall further into recession in 2012 thus contracting the economy by 0.3%, prior to the modest growth reversion in 2013. The insight for some nations might even be much critical. The economy of Greece is predicted to have dipped by almost 20% amid 2007 and 2012. Whilst other countries such as Ireland it was forecasted that the economy would grow by 0.5% by 2012 as others are predicted to already in recession. The rate of unemployment is especially high in Europe’s periphery where it is forecasted that Greece has 19.3% while Spain has 24.2% by year 2012. It is alarming to note that Spain and Greece has over half of the young population of the working age group being jobless (Harford, 2012; p. 49). Unending trade deficits in the sideline nations are on the other hand making it hard for these countries to execute the response based on the export led growth to the turmoil. The marginal nations are pursuing the structural reforms like liberalization of the constrained labor markets to establish more competitive economies and reinforce exports, but the outcome of these policies may be conceived specifically over the long-term way. Some financial analysts are of the opnion that nations in the Eurozone have pursued less policy steps to strengthen the local demand and increase prices which might probably assist in increasing their imports from the side-line (Senge, 2010; p. 137). More widely, the turmoil has made the Eurozone structure be vulnerable of which most economists have discussed in details. The Europe continent has a mutual monetary policy and currency without necessary making an economical union and thus it lacks an authority for making a common budget or a channel to transfer the economical aspects over to the member nations. Potentially, in the constrained fiscal union, a main budget authority would manage the spending in various Europe’s member states and eventually use economic transfers to align out unbalanced shocks within the European continent. Such steps are presently being discussed in the Eurozone even though they are politically contentious (Shilling, 2011; p. 69). The main trading partner of the Eurozone; the United States financial system has also been badly hit due to the financial turmoil in the Eurozone. The Europe’s turmoil has had and might persist to hold serious impact on the U.S economy via numerous ways. One possible way is through the banking system especially the vulnerability of the financial institutions of the United States to the Eurozone. It was noted that one of the U.S financial institutions; MF Global Inc. had filed for bankruptcy in 2011 in the month of October which was owed to its susceptibility to the Eurozone turmoil and the progress in the effect of the Eurozone on the security market of the United States. However, the process of quantifying and determining the effect of the financial turmoil in the Eurozone on the banking system of the U.S is quite a hard task (Harford, 2012; p. 48). One particular source of information on the Banking exposure by the United States is the Bank for International Settlements (BIS) which happens to file data and reports on the subject. BIS alleges that direct and other probable U.S financial exposure to Greece, Italy, Spain, Ireland and Portugal in 2012 March accumulated to about $ 770 billion or approximately 7.5 percent of the United States potential and direct vulnerability in the foreign nations. Nevertheless, these information does not replicate hedges or securities that banks in the U.S might have in position to reduce their susceptibility, do not reflect the vulnerability of the non-banking financial institution like the pension schemes, insurance funds and the money markets. Besides they do not comprise of the methods the turmoil could be translated via the banking system like the U.S banks that are vulnerable to the French financial institutions which are in turn susceptible to the Greek financial institutions (Lien, 2011; p. 117). In January 2012 it was reported that five banks in the United States inclusive of the Goldman Sachs and JP Morgan Chase had over $80 billion of vulnerability to Ireland, Portugal, Greece, Spain and Italy. Fortunately the use of credit default swaps to counteract the probable losses by about $30 billion placed the net exposure to about $ 50 billion. An evaluation of the exposure establishes that the money markets in the United States scaled down the risks to the European continent by over 50% from a previous 31.1% in 2011 to 12.2% in 2012. An evaluation by a famous credit rating agency in 2011 November argued that huge U.S financial institutions have been graded down to direct exposure to limited markets in the past year and that the resultant exposures are controllable, but further issues a warning that banks in U.S might be highly affected if the case continues to go beyond the Eurozone nations (Gill and Raiser, 2012; p.57). Theoretical Model The pressures on the market against various Eurozone nations went up in the course of 2012 summer when there was an increased concern that the turmoil was widening from Portugal, Greece and Ireland which are three considerably small economies compared to Spain and Italy which are fourth and third biggest economies in Europe. Various growths in September and August have so far cooled off the markets, inclusive of the declaration by the European Central Bank for a new bond purchasing project to restrain the state bond rates of interests, the 12 German constitutional court declaration in September in support of the long-lasting European rescue fund with specific conditions, pro-Europe counterparts performing well in the elections in Netherlands and the European Commission presenting a proposal for a unit banking leader (Graeber, 2011; p. 37). More widely, majority of the essential problems in Europe persist which include insufficient economic development, high rates of unemployment and the internal trade deficits and many have more doubts in the future of Europe. More analysts and policy makers are widely criticizing as to the case of whether will sustain in the Currency Union and posing question concerning to whether other nations might exit in case Greece exits. Other nations are still hopeful that eventually European supervisors and institutions will follow suit to maintain the Eurozone bond and that the EU would come out from the turmoil much stronger and more incorporated (Castells, Caraça and Cardoso, 2012; p. 123). Presentation and Interpretation of data ROE - Return on Common Equity which is derived as: ((Net Income – preferred dividends) / Average Total Common Equity) x 100 can be analyzed as follows; According to the data given the highest Return on Equity recorded is 108.9284 which was recorded by the Lang & Schwarz firm that is categorized under the financial institutions. The lowest ROE is 230.3090 recorded by Geniki Bank SA. There is a big variation between the financial institutions’ Roe which is a serious indication that some of the financial institutions especially those with less than zero Return on Equity are likely to be declared solvent due to failure to get enough returns on equity to sustain the business hence most would opt for debt bailout which might be rare to find. On the other hand the companies owned by the central state might have an edge over the private firms due support received from the state through the central bank. Debt to equity which is derived as; (Short Term Borrowings + Long Term Borrowings / Total Common Equity) x 100 is a critical indication of the exposure of the firms in the financial sector in terms of the debts or equity held by the firm. The highest ratio observed in the data is 3255 recorded by Commerz Bank. This is an indication that the financial institution is financed by mostly debts which might be a risk to the potential and existing investors. The lowest figure recorded is Zero which illustrates that the firms having zero debt to equity ratio are much safer than those with much higher figure. The assets owned by the investors are considered safe. Conclusion From the results and interpretation shown above it is apparent that most of the financial service companies are in danger of collapsing due to the existing financial turmoil. The ratios reveal that most of the companies shown in the Eurozone have critical doubts in the manner in which their debts, equity, assets and most commonly the shares are managed. The message that has been so far sent to the investors is that their funds or investments are at risk if they chose to invest in any of the financial institutions. If nothing is done to avert the situation, it might imply that some countries might pull out of the Eurozone to have their currency as opposed to the common union of the banks. Bibliography Castells, M., Caraça, J. M. G., & Cardoso, G. (2012). Aftermath: the cultures of the economic crisis. Oxford, Oxford University Press. Graeber, D. (2011). Debt: the first 5,000 years. Brooklyn, N.Y., Melville House. Gill, I. S., & Raiser, M. (2012). Golden growth: restoring the lustre of the European economic model. Washington, DC, World Bank. 157 Harford, T. (2012). The undercover economist. New York, NY, Oxford University Press. Lien, K. (2011). The little book of currency trading how to make big profits in the world of forex. Hoboken, N.J., John Wiley & Sons. http://site.ebrary.com/id/10469839. Senge, P. M. (2010). The necessary revolution: working together to create a sustainable world. New York, Broadway Books. Shilling, A. G. (2011). The age of deleveraging investment strategies for a decade of slow growth and deflation. Hoboken, N.J., Wiley. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=624610. Standard and Poors Corporation. (2009). Standard & Poors credit week. Ephrata, Pa, Standard & Poors Corp. 48 Top of Form Bottom of Form Read More