The Advantages and Limitations of Universal Banking - Essay Example

Banking and Management] Assess the advantages and limitations of “universal banking” OR "all purpose financial s" Contents Contents 2 Introduction 3 Definition: Universal Banking or "all purpose financial institutions" 4 Assessment of the advantages and limitations from the financial statements of banks 5 Measuring and evaluating the performance of banks 5 1. Determining the long-term objectives 5 2. Maximizing the value of the firm 6 3. Key financial ratios 7 4. Risk management 8 5. Efficiency analysis 9 6. Corporate governance practice 9 Conclusion 11 References 12 Introduction The universal banking model requires the banks to develop into all purpose financial institution with the offering of commercial services, investments services, mutual funds, insurances, etc under the same umbrella. The commercial banking services and the investment services are offered by the western banks through separate categories of financial institutions. The economic reforms and globalization of trade and investments have led to the increasing demand of the investment products in the world-wide markets. In order to tap the opportunities of international economic investments, the Chinese banking sector has undertaken the strategies of integrating investment services, advisory and underwriting service, home finance and asset management under the same umbrella of the commercial services provided the banks. The universal banking service offered by the Chinese state-owned banks has certain advantages as well as the limitations. On one hand, the aspect of universal banking enables the banks to increase their sales revenues and profitability by catering to the investment demands of the worldwide markets apart from the commercial services. The limitations of offering universal banking products and services lay due to the fluctuation of international economic conditions and the fluctuation of interest rates, exchange rate that would increase the risk exposure of the investment services. Definition: Universal Banking or "all purpose financial institutions" The concept of universal banking includes a wide range of financial services provided by the banks in order to cater to the regular banking as well as the investment needs of the customers. The aspect of “all purpose financial institutions” is related to offering comprehensive service to the customers that also help the banks to diversify the risk of their business. The various banking products and solutions that are offered under the system of universal banking includes savings and deposits accounts, loans and credit services, management of assets, investment service, underwriting services, financial analysis, advisory services, processing of payments, etc. However, banks may choose to offer specific products and services in a universal banking system depending on their specializations. The Chinese banks have been recently named by a magazine as the one of the world’s largest and profitable banks in the world (Linda and Julapa, 2000, p.33). However, this does not mean that the Chinese banking sector is more resilient to the complexities of international economies. Although developments in the Chinese banking sector have occurred since the last twenty years, the financial reforms have been slow as compared to the overall economic progress. The model of universal banking is appropriate for the Chinese banking sector as compared to its European counterparts which enables it to develop its potential for survival and further growth in competition to the foreign banks that entered China due to the opening up of the financial sector as part of the country’s economic reforms (Loechel and Li, 2009, p.4). Assessment of the advantages and limitations from the financial statements of banks The advantages and limitations of universal banking could be assessed from the financial statements of Chinese state-owned banks. Measuring and evaluating the performance of banks The measurement and evaluation of performance of Chinese state-owned banks due to the adoption of universal banking model in the country has been explained in terms of the following parameters. 1. Determining the long-term objectives The state-owned Chinese banks like the Industrial and Commercial Bank of China, Bank of China, etc have been voted among the world’s largest and profitable banks when the banking sectors of European, US and UK underwent periods of crisis after the global economic recession (Allen, 1999, p.47). When the western policy makers have recommended the separation of the commercial and investment banking businesses in their economy in order to deal with the direct impacts of financial crisis, the Chinese banking sector have walked in the opposite directions in relation to the international context (James, Caprio, Gerard and Ross, 2008, p.67). While the profits of the Chinese banks like Bank of China, Industrial and Commercial Bank of China could be attributed to the loan and credit services due to the relatively favourable interest margins offered by the Central Bank of China, the Chinese state owned banks would find it difficult in the long run to sustain its profit margins in the international context due to the policies of liberalization and fluctuation of currency conversion rates (Blundell-Wignall, Atkinson, Lee and Hoon, 2008, p.22). The long term objectives of achieving sustainable business profits has, therefore, led the Chinese state-owned banks to undertake the policies of universal banking. As the Chinese state-owned banks like ICBC and BOC realized that the advantages of wider interest spread in the loan and credit segment would not be sustainable in the long run due to the risk-price mechanism of the western banks and fluctuation of interest rates in the international markets, the policies of universal banking have been undertaken by the Chinese banks in order to fulfil their long term objectives of profitability and growth (Chen, 2009, p.26). 2. Maximizing the value of the firm The steps taken by the Chinese state-owned banks in undertaking universal banking practices opposite to the policies of western banks are aimed at maximization of the value of the firm. The core business of bank of China has been the commercial banking business. In order to maximize the value of the firm, Bank of China has embarked on policies of integrating investment services with the commercial banking business. The review of financial statements reveal that out of a total volume of assets amounting to RMB 12680 billion, the gross loans given by the bank is RMB 6864 billion while the securities offered under the investment services amounting to RMB 2210 billion. This shows substantial engagement of Bank of China in investment products apart from the credit lending products. The investments services of the bank include trade and underwriting services, investment securities, collateral services, brokerage services, etc (Chinese Academy of Social Sciences, 2001, p.38). Due to the engagement of the bank in investment services in line with the increase in investment in various economies, the value of the firm has also increased. This could be found from the rising share prices of Bank of China, increase in company valuation and dividend per share of the bank. The increase in valuation of the company has led to the maximization of profits allocated to the shareholder from RMB 64 billion in 2008 to RMB 139 in 2012. This information reflects the advantages of universal banking practices. The same trend has been followed by the other state-owned banks of China that maximized their values in the long run (Dimon, 2009, p.28). 3. Key financial ratios The review of key financial ratios of Bank of China, Industrial and Commercial bank of China from their respective financial statements justifies the importance of universal banking solutions offered by the state-owned banks of China. The increase in the investments by entities, firms across various markets in different business sectors as a result of globalization has led to the increase of sales of investment products of the state-owned banks of China which has been lucrative in the international markets due to the integration with the commercial banking services under one umbrella. The advantages of the model of universal banking could be understood from the key financial ratios revealed from the financial statements of the Chinese state owned banking institutions. Due to the transition towards offering universal banking products, the return on assets has increased from 1.01% to 1.19% during 2008 to 2012. The return on equity of Bank of China increased from 14.36% to 18.01% during 2008 to 2012. The capital adequacy ratio has increased from 13.45% to 13.63% (Bank of China Limited, 2012, p.7). Similar results have been found in the key financial ratios of Industrial and Commercial Bank of China (ICBC). The capital adequacy ratio has been rising and has reached 13.17% in 2011 and 13.66% in 2012 which is more than the minimum requirement of 8%. The return on equity for ICBC increased from 19.43% in 2008 to 23.02% in 2012 which is due to the benefits of the universal banking model adopted in the Chinese banking sector (Industrial and Commercial Bank of China Limited, 2012, p.7). 4. Risk management The universal banking model requires the Chinese state-owned banking institutions to engage in comprehensive financial service offerings in a comprehensive manner. This requires the Chinese state owned banks to undergo the risks of offering services of asset management, underwriting services, security investments, mutual funds, insurance, portfolio services, etc which is due to the limitations of universal banking system. The returns for the investments are subject to the fluctuation of domestic and international economic conditions, interest rate risk, exchange rate risk, market risks, etc. In order to manage these risks, the Chinese state-owned banks have undertaken the policy of risk management (Jonghe and Olivier, 2009, p.35). The risk management practices followed by the Chinese state-owned banks include the identification of risk in the investment services provided the customers and offering investment solutions that maximize the return on the investments and mitigate the risk. The approaches followed by the state-owned banks include communication of risks across various banking divisions and following the risk-price mechanism through effective collaboration of the services under the universal banking model (DeYoung and Rice, 2004, p.18). The Chinese state-owned banks have set up risk management committees that have adequate knowledge on capital markets and builds balanced portfolio of services offered to the customers. The banks undertake techniques of hedging to reduce currency exchange and interest rate risks. The technological support to the operations of the state-owned banks helps them to under risk management practices effectively (Ebrahim and Hasan, 2004, p.74). 5. Efficiency analysis The analysis of the efficiency of the Chinese state-owned banks from their financial statements reveals that due to the universal banking system, the banks are able to minimize their cost per unit of the product and solutions offered to the customers. Although the interest expenses in the investment services are higher than the commercial banking services, the integration of the technological support to the universal banking system has helped the Chinese state-owned banks to reduce the costs per unit of the output. This has increased the efficiency of the Chinese state owned banks in generating higher revenues and profits as a proportion of the costs incurred in the operations of the bank (Foos, Norden and Martin, 2009, p.39). This indicates technical efficiency and economic efficiency of the Chinese state-owned banks as a result of the universal banking system. The banks have been able to attain higher efficiency of revenue earnings. The gap between minimum feasible costs and the actual costs incurred by the banks have reduced as a result of the universal banking system (García-Herrero, Gavilá, and Santabárbara, 2006, p.52). The ratio of actual profit to the maximum attainable profit has become closer to unity due to the benefits of the universal banking model. The measurement of the performance of Chinese state-owned banks using the techniques like least square econometrics production model reveals that the total universal banking service have given rise to total factor productivity and efficiency of the Chinese banking sector (Laeven and Levine, 2007, p.61). 6. Corporate governance practice The universal banking system has increased the gamut of banking services provided by the Chinese state-owned banks in order to adapt to the changes in line with the international economic and financial needs. This has led to the increasing concern over the corporate governance practices of the banks (Sauders and Walter, 2006, p.35). The Board of Directors and the senior management of the Chinese state-owned banks have assigned accountabilities to their business heads and employees for undertaking responsibilities that maximizes the returns to the shareholders and mitigates the risk (Loechel and Zhao, 2006, p.84). The banks have maintained transparency in their strategies of investments services offered to the clients. The management has stressed on ethical practise in providing advisory services and offering balanced portfolio, asset management, mutual funds and other investment services to the customers (Nurullah, Sotiris and Staikouras, 2008, p.25). The Chinese state-owned banks have emphasized on transparent communication to their stakeholders on the various activities undertaken in their offering of universal banking products. The Chinese state-owned banks have strengthened the aspects of legal compliance, audit, risk management and best practices as part of their efforts for corporate governance (Ruozi and Ferrari, 2013, p.91). This has helped to increased mutual faith between the banks and the stakeholders that have helped them to attain sustainable business in comparison to their western counterparts. Conclusion The review of the financial statements of the Chinese state-owned banks revealed that the banks have undertaken the strategy of universal banking with the long term objectives of attaining sustainability in relation to the position of their western counterparts. The integration of the investment services and the commercial services have enabled the Chinese banking sector to offer comprehensive solutions that fulfilled their investment and financing needs of their customers under the same umbrella. Due to the rise in the international economic investments in the age of globalization, the Chinese banks have been able to offer increasing services to their customers that have resulted in the increasing efficiency of revenue earnings, cost optimization and profitability. The key financial ratio of the Chinese state-owned banks reveal that due to the advantages of the universal banking system, the return on assets, return on equity and capital adequacy has increased. The limitations of the universal banking have exposed the Chinese banking sector to fluctuations of the international currency and interest rate fluctuations. In order to manage these risks, the banks have undertaken risk management practices and effective corporate governance in order to maximize the value of the firm and the stakeholders. References Allen, R. E. 1999. Financial Crises and Recession in the Global Economy. London: Edward Elgar Publishing. Bank of China Limited. 2012. 2012 Annual Report. [Pdf]. 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