Banking Industry Sector: Standard Bank Ltd - Case Study Example

Banking Industry Sector: Standard Bank Ltd here) here) here) 5th December, Table of Contents Abstract 2 Introduction 3 Literature review 4 Financial Analysis 6 Financial Ratios for Standard Bank Ltd 8 Discussion 10 Limitations of the models used 11 Conclusion and Recommendations 14 Bibliography 15 Abstract This research is a study into the banking industry and uses Standard Bank Ltd as a case study. A brief but detailed introduction into the industry is given as well as some history of the sector. In this analysis, Key Performance Indicators will be used together with financial models to analyse both the industry and Standard Bank. KPIs are introduced in the introduction section and later elaborated further in the literature review. Porters five forces model and the balanced scorecard models are also elaborated further in the literature review section. Their context of usage and background are as well given and their significance is also explained. A financial analysis is carried out and historical data is input in a spread sheet to give the desired ratios and KPIs. These metrics are then used to give trends and formulate modelled results. These results are later discussed in the discussion section where the modelled results are explained further. It is always important to give limitations of formulas used. Limitations of the two models used are given and explanations of how to overcome these limitations are discussed as well. Finally, recommendations to improve the ratios and produce better models are outlined. Introduction Different business sectors have steadily grown over the last several decades. This expansion can be attributed to factors such as globalisation, development of new technology, product and service innovations and availability of resources. Resources such as human and financial capitals greatly determine an industry’s performance. The banking industry has grown tremendously and has become one of the most lucrative investments for investors. Over the last century, numerous players have joined the sector and led to liberalisation of the financial services industry. This research paper is about an analysis of the banking sector. The choice of this sector was motivated by the fact that banking products are more or less similar across the board. The result of this is that there exists cut throat competition among industry players and two models will be used to analyse the business environment that exists in this sector. There have been several emerging issues raised by bank regulatory authorities. In most cases, these issues are either as a result of practices to be beat competition or competition related. Key Performance Indicators have for some time been used in financial services sector to analyse the industry’s performance as a whole as well as the performance of the players involved. An entity can use these KPIs to bench mark its performance against the industry’s and use them to formulate strategies to beat competition. Through financial modelling, an entity can test its business strategies and make amendments where necessary. Through use of financial ratios, entities can determine key trends and use them to change or improve business operations. Standard Bank Limited is a financial service institution operating banking and foreign exchange services. Continuous product innovation and service improvement has seen this financial institution grow and survive the recent economic recession that seriously hit most financial institutions. Literature review Over the last two decades, diversification has been witnessed in the banking industry. Banks and other financial institutions have ventured into investment banking and are agents for transactions involving stock exchanges. Lately banks and financial institutions have ventured into mobile money transfer services where they act as agents. These activities come along with new systems and requirement for new staffs. The end result is an increase in organisations operations. From a management point of view, it is very crucial to have in place structures and processes that can be used to determine the efficiency and productivity of these increased activities. This is where Key Performance Indicators find their use. Theoretical financial models are used by management in carrying out analysis of these operations. According to the Chartered Institute of Management Accountants, banking industry has been facing numerous challenges majorly because of the financial crisis that has been. Business went down and the only way to survive was to come up with new products that had to be aggressively marketed to bring in the revenues required to beat strategic targets. Those players who had a perfect understanding of the industry had a competitive advantage. This is because they were able to develop strategies to align their businesses with their set models. Such strategies made entities to be more sensitive to the industry KPIs (Chartered Institute of Mangement Accountants, 2014). Being an industry player, Standard Bank Ltd has witnessed increased operations in its activities. With its recent product differentiation campaign, the bank was able to attract high-end customers with its prestige banking product. Recently, the bank has rolled out its improved electronic banking service which will be used hand in hand with mobile banking service. These are expected to greatly increase the bank’s operational efficiency as well as reduce the number of customers who visit the bank branches for their transactions. Standard Bank Ltd uses different KPIs at branch level and at organisational level. Number of transactions per teller, percentage of new funded accounts and loan amount processed by each credit officer are the KPIs used at branch level. Current ratio, Return on Equity ratio and Debt Equity ratio are some of the KPIs used at organisational level. Analysing these KPIs alongside Porter’s five forces model is a common technique in this industry (Roulet, 2013). The Porter’s five forces model could be perfectly used to analyse the banking industry where cut-throat competition exists. Since this model analyses both internal and external forces in a business, it can give a clearer picture of business trend as well as assisting management in strategy formulation. Use of this model to analyse the banking industry requires a lot of caution as the industry is a complex one. The five forces used are quite significant in the banking sector. The level of competition by players has its effects in the same way that supplier power has its influences. The other factor is that since banking products are basically the same across the board, the degree of product substitution is high (CGMA, 2014). The balanced scorecard method that uses specific KPIs can also be used to model for the banking sector. Past organisation’s data can be used in this model to develop business strategies. One huge advantage with this model is that it makes the set KPIs to be part of daily operations in an organisation. This means that every business activity will be done in a way that the cumulative end result will deliver a favourable figure for the KPIs set. All this is done in a balanced way and hence the name “balanced scorecard” (Youxu et al , 2014). This model is also based on an industry’s need to have continued learning and development from within. The recent economic recession left banking industry players with some lessons learnt. This model expects banking entities to come up with more innovative and competitive products so as to be able to survive in case of a repeat of the same crisis. The end result is that there will be advancements that will make business better (Organisation, 2013). Financial Analysis Balance sheet for Standard Bank Ltd ($ millions) 2011 2012 2013 Assets 2,000,000 2,100,000 2,450,000 Cash and deposits 1,100,000 1,150,000 1,350,000 Accounts receivable and accrued revenue 200,000 265,000 330,000 Investments and accounts with affiliates 50,000 50,000 50,000 Portfolio investment 50,000 55,000 60,000 Loans 400,000 425,000 450,000 Bank customers liabilities under acceptances 130,000 90,000 135,000 Other assets 70,000 65,000 75,000 Liabilities 1,500,000 1,550,000 1,850,000 Deposits 1,000,000 1,050,000 1250,000 Accounts payable and accrued liabilities 150,000 175,000 225,000 Loans and accounts with affiliates 150,000 125,000 165,000 Bonds and debentures 50,000 75,000 90,000 Other liabilities 150,000 125,000 120,000 Equity 500,000 550,000 600,000 Share Capital 275,000 285,000 295,000 Retained Earnings 225,000 265,000 305,000 Standard Bank Ltd Income Statement 2011 2012 2013 Operating Revenue 175,000 190,000 220,000 Services fees 85,000 89,000 95,000 Insurers premiums 5,000 6,500 8,000 Annuity considerations 9,000 9,200 10,500 Interest 65,000 66,100 76,500 Dividends 6,000 10,200 18,500 Other operating revenue 5,000 8,100 11,500 Operating Expenses 107,000 104,000 109,000 Salaries and Wages 45,000 45,500 46,000 Interest 57,000 51,250 52,000 Other Operating Expenses 5,000 7,250 11,000 Operating Profit/ Loss 68,000 86,000 111,000 Interest expense on borrowing 5,500 6,100 6,300 Gains or losses 150 200 185 Profit before income tax 62,350 79,700 104,515 Income tax 17,000 21,500 27,750 Net Profit 45,350 58,200 76,765 Financial Ratios for Standard Bank Ltd Profitability Ratios 2011 2012 2013 Return on Equity= Net Profit/ Shareholder Equity 45,350/ 275,000 = 0.165 58,200/285,000= 0.204 76,765/ 295,000 = 0.26 Return on Assets= Net Profit/ Total Assets 45,350/2,000,000= 0.023 58,200/ 2,100,000= 0.028 76,765/ 2,450,000= 0.031 Net Profit Margin= Net Profit/Total Revenue 45,350/175,00= 0.26 58,200/ 190,000= 0.306 76,765/ 220,000= 0.35 Gross Profit Margin= Gross Profit/ Total Revenue 68,000/175,000= 0.39 86,000/190,000= 0.45 111,000/220,000= 0.505 Liquidity Ratios 2011 2012 2013 Current Ratio= Current Asset/ current liabilities 1,700,000/1,300,000= 1.307 1,840,000/ 1,350,000= 1.36 2,130,000/ 1,595,000= 1.335 Quick Ratio= Cash/ Current liabilities 1,100,000/ 1,300,000= 0.85 1,150,000/1,350,000= 0.85 1,350,000/ 1,595,000= 0.85 Working Capital= Total Current Assets- Total Current Liabilities 1,700,000- 1,300,000= 400,000 1,840,000-1,350,000= 490,000 2,130,000-1,595,000= 535,000 Debt/ Worth Ratio= Total liabilities/ Net Worth 1,500,000/ 500,000= 3.0 1,550,000/550,000= 2.81 1,850,000/600,000= 3.083 (Troy, 2008) Discussion The analysis above uses historical figures for Standard Bank Ltd for the past three years. The figures are used to calculate performance indicators in form of ratios. These results will be used and then inferred to the whole sector. The figures in the analysis have been used to model figures for the next four financial years and from these projections of the banking sector can as well be determined. Assuming Porters five forces model, the industry looks attractive from the profitability ratios. Return on Equity and Return on Assets indicators indicate a positive growth. When this rate is used to project the results for the next three years, there is an indication of growth. This could be due to increased business activities that have an impact of increasing bank’s revenues. Such trends will attract more players into the sector and this will have the effect of increased competition. From Porter’s model, the level of competition is very crucial for investors when deciding whether to venture into an industry. With the current competition level, new entrants could be discouraged to venture into the banking sector as already most players are executing aggressive growth strategies. This will only serve to increase the level of competition according to Porter’s five forces model theory (Rice, 2010). According to Porter’s model, an industry is affected by the availability of substitutes among the existing players. Bank products have readily available substitutes since they are similar across the board. However, the cost of switching from one product or service to another might be significant for individuals. This means that even when the quality of the product is not satisfactory, individual customers will not switch quickly. This could discourage potential players from venturing into the industry especially if their strategy gives a short time to meet the organisation’s objectives (Rothaermel, 2013). The balanced scorecard method can as well be used to produce a model for Standard Bank but a lot of caution is needed since there is not much historical information provided. The ratios can be used to formulate a more balanced approach that will meet the organisation’s objectives. This model will focus on improving these ratios. This can be achieved through a careful evaluation of all the bank operations. Once an evaluation process is carried out and the goals for the model set, then operations can be balanced so that they all become efficient and effective (Niven, 2011). Limitations of the models used The two models used above have their limitations. Some of these limitations are as a result of assumptions made in the models. Porter’s five forces model assumes that a business entity, on itself, cannot have any impact to the industry as a whole. In the case of our selected organisation, the model assumes that the banking industry in its entirety controls what happens in individual business units and not vice versa. This is not absolutely true as there have been instances where the bank Standard Bank Ltd has innovated products that have been pace setters in their category. When Standard Bank Ltd introduced prestige banking, all the other banks followed and came up with the same product but branded differently. Porter’s Five Forces model does not cover how to analyse multinational operations especially those with diversified investments within a common pool. The model fails to analyse the relationships that exists between such investments. During the time when Porter was developing this model, markets were not as complex as they are today. This is true because Porter assumed the existence of a perfect market (Dess, 1993). Standard Bank Ltd operates in a highly regulated industry. Banking regulatory authorities are very strict and expect total compliance by all members. This is because they understand that transactions involving money are very sensitive. In such an industry, Porter’s model might give a wrong analysis. There are instances when a company gets into an industry and brings changes in the whole industry. The result might be opening up new opportunities or making an industry become more lucrative. In such cases, more players will be attracted into the industry. Porter’s five forces model fails to consider such a situation. Standard Bank Ltd might choose to venture into investment banking in some parts of the world. Since the bank has a good reputation in investment banking, the result could be transformation of this sector in the different countries to become more lucrative hence attract more investment bankers. Balanced Scorecard method as well has its limitations. This model method is applied to almost every activity in an organisation. Since it is used for strategic management purposes, it is very important that it is understood perfectly. Those in management have to perfectly understand both organisational activities and the balanced scorecard method in order to properly apply it and succeed in striking the required balance. There might be expenses and time spent in understanding this model. Time is required to make necessary plans and formulate an industry’s or organisation’s objective so that the model can be applied. In instances where the management is not able to model their organisation results, an expert can be hired to implement the model. This means that the company will incur more costs to pay for an expert’s services (Gomes, 2013). A balanced scorecard requires complete information for it to work properly. This is because this model uses an organisation’s historical data and then adds the data that is required to meet the set objectives. Inaccurate information leads to incorrect modelled figures and the strategies formulated will fail if the model is implemented. In most cases, the information used in balanced scorecard method is from the most important areas to an organisation (Milad Abdelnabi Salem, 2012). This brings in another weakness of the model as the model does not give the total overview of an organisation which is critical for strategic planning. It is very important that a business strategy gives a full picture of the organisation at the time when the strategies will have been fully implemented. This model lacks in this aspect and thus not very appropriate for strategy formulation. Finally, a balanced scorecard method might not be readily embraced by employees in an industry or organisation. This is especially if the strategies laid out will require a change from their popular ways of carrying out operations. This could mean that man hours will be required from every employee. This problem can become more serious if the top management does not appreciate the value for this model as they will not commit to its implementation (Rompho, 2011). Standard Bank Ltd has used this model for strategic management and planning but its inherent limitations did not make it successful. The organisation lacked personnel who could successfully implement this model and the necessary information and data were not available. There was also resistance from employees because of the intensity of some banking activities and the hours involved in any service industry. Conclusion and Recommendations From the modelled results, the business is at risk of facing liquidity problems. This is because of the stagnating quick ratio. Other ratios indicate that business activities for Standard Bank are growing and a stagnating current ratio could only predict liquidity problems. In order to overcome this risk, the business needs to increase its current cash amounts and cash equivalent instruments. It is very important that financial service providers have favourable liquidity ratios. The current ratio form the analysis shows a projected negative growth in current ratio. This could be attributed to increasing current liabilities with stagnating current assets or decreasing current assets. The projected negative current ratio growth means that in the future, Standard Bank Ltd might not be able to adequately meet its immediate cash needs. In order to improve this, operations should be aimed at increasing the current assets. The management could call on the sales team to issue out more loans to customers thereby increasing the amount loaned out to customers. In conclusion, the banking industry is an interesting one with as many opportunities and as few opportunities as perceived by an investor. 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