Credit Lending and Decisions - Essay Example

Credit Lending and Decisions Student Name Institutions Course Date Credit Lending and Decisions Introduction In the wake of global financial crisis, a number of influential credit rating agencies have faced increased scrutiny (Alexander, 2014). Banks need to be closely observed more than any other economic unit. This is due to the fundamental role banks play within the economy in a capital formation. The biggest banks in the world have been continuously losing grounds to their rivals from China. This is clearly depicted in the latest ranking of Banker when it ranked 1000 top banks. The paper aims at identifying the parameters used in comparing the virtual performance of the major banks and what the parameters convey. The paper also seeks to compare the performance of the major banks in Australia with other rival banks in other parts of the world as establish the implication. Analysis Banks from China are threateningly thriving ahead in the list according to the latest rankings (Farthing, 2015). China alone has three banks appearing in the top five. Bank of China has tremendously improved by moving to the fourth place from seventh. China Construction took the second position. The banks of China that appeared in the top four are the most profitable banks in the world. When the profits from every bank in China are combined, they will double those of the rivals from the US and at the same time be ten times more than those of the banks from the UK. By 2008, both the US and the UK banks made more profits compared to their counterparts from China (Farthing, 2015). The parameters for determining the bank performances According to the European Central Bank (2010), there are several parameters that agencies use to rate the top banks. Bank performance measurements focus on the ability of the banks to produce profit that is sustainable. Profitability is usually the first defence line of banks against losses that are unexpected. This is due to the fact that it makes capital position of a bank firm and at the same time improving the future profitability via the retained earnings investments. If an institution consistently makes loses, its capital base will ultimately be depleted and as a result, putting debt holders and equity at risk. As much as the institutions for banking were increasingly complex, their performance drivers included efficiency, earnings, leverage, and risk taking. Though it remains clear that banks have to generate earnings, the volatility and composition of the earnings are important. Efficiency reflects the ability of a bank to make revenue from assets and at the same time make profit from some income source. Risk-taking is manifested in the earnings necessary adjustments, for instance over the cycle credit-risk. Leverage can fail a bank because of losses that are unexpected (European Central Bank, 2010). There are many parameters used to determine the performance of banks globally. The parameters can be distinctively divided into economic, market-based and traditional performance measures. The traditional parameters for bank performance The traditional measures of performance are the same as those applied by other industries. The most widely used parameters, however, are a return on equity (RoE), cost-to-income ratio or Return on assets (RoA). Additionally, with the intermediation importance, a function for banks, there is a typical monitoring of the net interest margin. The RoA refers to the year’s income that is then divided by the sum of assets- usually the average annual value (European Central Bank, 2010). RoA = net income / average total assets The RoE, on the other hand, is a performance shareholder value measure that is internal (European Central Bank, 2010). By far, this is the most popular parameter of bank performance. This is so because it directly assesses the shareholder’s investment financial return. It relies on public information because it can be easily availed for analysis. RoE provides for a comparison between different economic sectors and different companies. At times, RoE can face decomposition into drivers that are totally separate. A process referred to as “Dupont analysis”. RoE is in this case calculated as RoE = (total assets/equity) * (turnover/total assets) * (result/ turnover). The first portion refers to the net profit margin whereas the last reflects the financial multiplier for leverage (European Central Bank, 2010). RoE = net income / average total equity The ratios of cost-to-income are indications of the institution's ability to generate from a particular stream of revenue. However, the charges for impairment cannot be added in the numerator. The ratio of cost-to-income = operating expense / operating revenue And finally, the income generation has (NIM) net interest margin as intermediation capacity bank functions (Karri, 2015). NIM = net interest income / assets Economic parameters of performance Karri, (2015) states that the economic performance parameters put into consideration the shareholder value creation development and it as well aim to assess the economic results a company generates from the economic assets that are available, for any particular year. The parameters mainly concentrate on efficiency viewing it as a central performance measure, but generally contain high information requirements. Among the economic performance parameters, there are two identifiable indicators: Indicators that relate to the total investment return. This has its basis on the opportunity cost concept with EVA (economic value added) being most popular. Indicators associated with the underlying risk level that the activity of the banks is related to. For a bank to succeed, a manager has to weigh the trade-offs that are complex between risk, growth and return that favor the risk-adjusted metrics adoption (Karri, 2015). Risk-adjusted return on capital (RAROC) is the over economic capital result that is expected. It allows a bank to make allocations to individual units of business regarding the individual risk of the business. As an evaluation tool for performance, it assigns businesses capital on the basis of the economic value added that is anticipated. This parameter has things in common with EVA. They both consider the cost of capital of the bank. However, RAROC is more advanced hence adjusts the value-added relating to the needed capital (European Central Bank, 2010). Market-based parameters of performance Market-based performance parameters focus on the manner a particular company’s activities are valued by the capital markets (Karri, 2015). This is in comparison to the estimated economic or accounting value. The following are the commonly used metrics: The TSR (total share return) - which is the dividends ratio and stock value increase over the price of the market stock. The P / E (price-earnings ratio) – refers to the financial results ratio of a company over the share price. The P / B (price-to-book value) – this relates the value of the market of the equity of stakeholders its value of the book. The CDS (credit default swap) – refers to the insuring cost of an ensured bond within a particular period on the institution. Capital adequacy This is also a common performance parameter for top banks. According to (Karri, (2015), it is an indicator of whether a bank has got the capital that is enough to absorb that are unexpected. It’s needed to maintain the confidence of the depositors and at the same time prevent the banks from being bankrupt. It’s hence very fundamental for banks to maintain the confidence of depositors and at the same time prevent bankruptcy. Capital adequacy is a reflection of the overall condition of the financial ability of a bank. It as well reflects the management’s ability to meet the additional capital need (Karri, 2015). The performance of Australian major banks based on these parameters as compared to the world rivals The banks of Australia have performed tremendously in the world especially after the euro crisis (Allen & Powell, 2010). The financial sector of Australia by far is worth more than the financial sector of Eurozone. For instance, the banks did not load up on a lot of debts when the European did. The banks of Europe also made their real estate loans that were bad, but the banks from Australia did not. Contemporarily, the European banks, unlike the banks from Australia, sit on several debts. Such parameters clearly indicate that the Australian banks are doing extremely better than the other global banks that rival them. The financial sector Europe for that matter fell majorly in 2008 while the financial sector of Australia did not. However, it is still not clear why the economy of Europe has ever since kept crumbling while that of Australia has not (Allen & Powell, 2010). The economy of the banks of Australia has remained steadfast and has performed well against the traditional, economic and market-based parameters. In 2013, for instance, the majors of Australia made a combined profit of $37.8 billion as compared to the 2012th $33.0 billion. This is an indication of 14.7 per cent improvement. Using the performance parameters, the banks that made up the big four are ranked most profitable in the world. This was propelled by lower charges of impairment, disciplined models of costs and higher lending abilities. The results have however faced challenges that are environmentally characterized with a revenue growth that is restrained, a fluid regulatory change pipeline and ongoing margin pressure (Smith, 2013). There are strong evidences demonstrating the Australian Banks resilience at the time of the Global Financial Crisis. The five biggest Australian banks indicated a profit that approximated to $8billion in 2008 second half year. Contrastingly, the top five banks in the US experienced losses of almost $50 billion as compared to $20billion UK’s lose (Rodgers, 2015). The credit risk perspective Credit risk perspective considers the default risk on a debt that is likely to arise from the failure of a borrower to make the payments that are required (Bologna, 2010). The risk, in the first resort, is of the lender that includes the lost interests and principles, increased costs of collection and cash flows disruption. The banks from Australia are considered to have widely prospered better during the GFC (Global Financial Crisis) than the other global banks. They have continued to display earnings that are solid, strong credit ratings and good capitalization. Nonetheless, the banks in Australia significantly deteriorated in terms of assets of the market value. The Australian banks, therefore, after the GFC the default probabilities of the Australian bank fared just a little better than the other global rivals. This is based on asset fluctuations of value that are very extreme. The risk that a bank faces that a borrower won’t pay a loan is a key concern in the banking industry. There are two episodes that dominate the experience of the Australian credit loss. They include the 1990s major losses recession as well as the losses after and during the GFC. It is indicated that these two losses were as a result of lending businesses. There were very minimal housing loans credit losses after and during the GFC in Australia. During that period, it is indicated that business sector condition more than household sector contributed to the Australian credit losses (McDonald & Eastwood, 2010). Conclusion In conclusion, the banks have experienced economic challenges globally. The banks that were mostly affected by the Global Financial Crisis were those in the Eurozone. However, the Australian banks have strived to consistently improve their global financial positions since the Global Financial Crisis making very steadfast positions in the banker’s rankings. Nevertheless, according to the latest rankings by the bankers, Asian banks have performed extremely well with China producing top banks in top 1000. In the top five alone, China managed to produce three banks and indicating other tremendous improvements. The banks that are most profitable in the globe contemporarily are the top four banks of China. The European banks should therefore swiftly strategize their strategic plans so as to come back very competitive as well. The performance of the banks, however, is determined to a large extent by the economic strength of the nations where the banks are. List of references Alexander, P. (2014). Top 1000 World Banks 2014. Global banking profits jumped in this year’s Top 1000 World Banks ranking to exceed their pre-crisis peak.So is the sector back in good health? Not universally so, reports Philip Alexander., pp. 114-130. Allen, D. E., & Powell, R. (2010, September). The Fluctuating Default Risk of Australian Banks. School of Accounting, Finance and Economics, Edith Cowan University , pp. 1-45. Bologna, P. (2010). Australian Banking System Resilience: What Should Be Expected Looking Forward? An International Perspective . International Monetary Fund , pp. 1-23. David. (2015, August 1). Bloomberg: The World’s Strongest Banks 2015. Retrieved September 11, 2015, from topforeignstocks.com: http://topforeignstocks.com/category/top-banks-list/ European Central Bank. (2010, September). Beyond Roe- How to measure bank performance. Appendix to the report on EU banking structures, pp. 1-44. Farthing, T. (2015). The Banker Top 1000 World Banks 2015 ranking WORLD Press: IMMEDIATE RELEASE. Retrieved September 10, 2015, from thebanker.com: http://www.thebanker.com/Top-1000-World-Banks/The-Banker-Top-1000-World-Banks-2015-ranking-WORLD-Press-IMMEDIATE-RELEASE Karri, H. (2015). A comparison study of financial performance of public sector banks in India: An analysis on Camel Model. Arabian Journal of Business and Management Review (OMAN Chapter) Vol. 4, No.8, 1-17. McDonald, A., & Eastwood, G. (2010). Credit risk rating at Australian banks. Australian Prudential Regulation Auhority, pp. 1-32. Rodgers, D. (2015, June). Credit Losses at Australian Banks: 1980–2013. Reserve Bank of Australia, pp. 1-66. Smith, B. (2013). Major Australian Banks: Full Year Results 2013. Majors deliver a strong foundation as they position for future challenges, pp. 1-27. Read More