State of Banking Before and After Financial Crisis

Introduction:

Banks play a very important role in financial system. Most businesses have a need for a line of credit or other financing with a bank (Editorials, Street directory). A stable financial system can help a nation’s economy grow steadily than it would in an unstable financial system. From loans to investments, financial institutions are exposed to all kinds of risks in the market. Risk is universal in the financial industry and everything that a financial institution does requires thorough Risk Management Practices (RMPs). The recent financial crisis has brought out the existing flaw in the banking system which probably no one had forecasted few years before. In the past, first the economy used to slowdown which would result in financial crisis but this time it is other way round. During the current financial crisis, banks and other financial institutions, particularly in the U.S, have collapsed which has resulted in slowdown of global economy.

Research Question/Main Problem:

This research will try and bring out the changes that have happened in operations of banking, over past 5-6 years, from huge profit making business to managing risks efficiently.

Aim and Objective:

The dissertation aims to look at the developments in banking sector in both, a developed and developing economy, so that the positive points from both the economies can be brought forward and negative points can be addressed and rectified. The study also aims to highlight some of the key reasons of financial crisis. It is very hard or rather impossible to imagine carrying out business in the absence of banks or financial system. Hence, it is very important to study and conduct a research about the crisis that have impacted the financial industry, so that some lessons can be learnt and in the future, and mistakes can be avoided.

If the study is limited to one country, sample might not be large enough and hence the research looks at two different economies of the world (Heffernan, 1996). Therefore two countries i.e. UK and India have been selected for the study. It will help to identify how banks have managed their business during cyclical upturn, peak & in crisis. The study also intends to highlight the trend of banking activities. And will also draw attention on how the proportion of risk has changed over the past years. Highlighting changes in key ratios will give a clear picture of what has happened and what can be expected in the future. It would be important to compare the balance sheets of some of the major banks of both the countries from the year 2004 till 2009 & to check the percentage increase or decrease in their activities in order to come to a conclusion and provide suggestions/recommendations.

Brief Literature Review:

Since this study deals developments in banks and their performance over last few years, ratio analysis would be best suited for the study. These ratios are easily available on Bank-scope website (www.bankscope.com). These can also be cross checked from respective bank’s annual reports which are available on the internet. Heffernan’s (1996) study on performance of banks in 1980s indicated that some of the bank’s assets grew faster than nominal GDP, which means that banks were highly profitable. However, in late 1980s and 1990s there were asset quality problems in some of the large banks which had to write off non-performing portfolios. Because of which there was increased regulatory pressure and banks had to move towards fee-earning business i.e. securities underwriting and trading. It was during this time that international business was growing but was not profitable for banks because of high operating costs. However, banks found ways of reducing their costs by issuing their own CDs and introduce new products which were not capital intensive and resulted in fee income. Thus like other sectors, banks too used international trade and globalisation to increase their profits and diversify their risks. But, there have been one financial crisis in at least in every decade. Globalisation has been blamed for some of the previous financial crisis. There have been few economists who have argued that policies of the government resulted in the crisis and not technology. Asian crisis of 1997 is one such example (Krugman, 1998.). International organisations like WTO, World Bank, IMF promote globalisation and international trade for the development and welfare of under developed and developing economies. It has opened up global economy and countries like China and India have grown faster than expected. Globalisation has also reduced the sense of isolation which was felt before in developing countries. But in many countries, like the African nations, globalisation has not been beneficial or has not reached and hence most African nations remain underdeveloped (Stiglitz, 2002). Globalisation resulted in innovation of various risk reducing financial products and strategies like Futures, Options, Derivatives and Securitization. This study will help to understand how some of these products and strategies which were supposed to reduce risk, resulted in downfall of global economy.

Sub-problems:

The sub problems of this study are:

Global economy before financial crisis – this will help to understand how banks were making huge profits; Economic and financial globalization and the expansion of world trade have brought substantial benefits to countries around the world (International Monetary Fund)

What led to Crisis? – this problem will help to realise what was happening in the banking world which went unnoticed till the time crisis hit some of the major banks; One of the key issue was the rising defaults on subprime mortgages in the US that triggered the global financial crisis (Subprime Fallout, Financial Times)

Steps taken by international bodies like World Bank, WTO, UN, etc to rescue Global Economy – Though the most acute phase of the global financial crisis has passed, recovery remains fragile.  Persistent risks to economic health include high unemployment and low growth in developed countries and scarce international financing for developing countries. The poorest countries continue to need assistance to move beyond the crisis (Financial Crisis, World Bank report); World Bank is also expanding its cooperation with IMF, UN to promote inclusiveness, innovation, efficiency, effectiveness, and accountability (World Bank reform, World Bank). Since crisis in the USA impacted all major economies, rescue steps taken by some international organisations are important to take note of;

Impact of financial crisis to UK & Indian economy and steps taken by govt. & central bank individually & along the guidelines of Basel, bring out flaws if any. Bank of England and Reserve Bank of India have taken several steps to ensure that respective economies continue to grow and remain stable (BoE and RBI).

Research Methodology:

Punch (1998) has indicated that quantitative research is concerned with the collection and analysis of data in numeric form. It tends to emphasize relatively large scale and representative sets of data, and is often, falsely in our view, presented or perceived as being about the gathering of facts. Whereas qualitative research is concerned with collecting and analysing information in as many forms, mainly non-numeric, as possible. It tends to focus on as much detail as possible and aims to achieve depth rather than breadth. All qualitative research seeks understanding of data that are complex and need to be approached only in context (Morse et al, 2002).

A correlation study, quantitative research method, examines the extent to which differences in one characteristic or variable are related to differences to one or more characteristics or variables. A correlation exists if, when one variable increases, another variable either increases or decreases in a somewhat predictable fashion. This study will collect numbers (data) that reflect specific measurements of the characteristics in question (Leedy, 2009). This type of study will be particularly useful for comparing ratios of different years and it will give out a clear picture of how operations of banks have changed over past few years. The good thing about this type of study is that the results are hard to manipulate as the data used would be a published data.

Case study, qualitative research method, refers to the collection and presentation of detailed information about a particular participant or small group, frequently including the accounts of subjects themselves. The case study is ideally suited to the needs and resources of the small-scale researcher (Loraine, et al. 2001). It is a form of qualitative descriptive research, which looks intensely at an individual or small participant pool, drawing conclusions only about that participant or group and only in that specific context. A case study researcher often begins to analyze the data during the data collection process (Leedy, 2009).

As stated by Loraine B, et al. (2001) the drawbacks of case studies are: The very complexity of a case can make analysis difficult because of the holistic nature of the case study. The researcher needs to show connections between various events but not lose sight of the whole picture. While the contextualization of aspects of the case strengthen this form of research, it is difficult to know where context begins and ends.

However the advantages of case studies are linked to their disadvantages, which are: They allow the researcher to show the complexity of social life and good case studies build on this to explore alternative meanings and interpretations.

This study will be a combination of qualitative and quantitative research methodology. In the past, both studies, qualitative and quantitative, have been conducted in order to determine the main reasons of bank failures (Heffernan, 1996). Since the main research problem deals with key financial ratios, quantitative research method would address it the best. However, the sub problems of this topic would require qualitative research as they are more theoretical involving case studies and previous examples of bank failures to better understand what really went wrong and how things could have been avoided. This study will undertake qualitative research in the form of comparative case study because the study will be looking at various issues that have resulted in the downfall of banks and banking operations in respective countries.

Data Collection and Analysis

Data will be collected via secondary sources such as websites, annual reports of banks, International Monetary Fund, World Bank, Financial articles, Journals. The main quantitative analysis will be focused on the banking sector of the two countries and see if any trends or flaws can be highlighted. The data will be analyzed with the help of tables and graphs which would be explained. On the other hand qualitative analysis of comparative case studies will be mainly focused on sub problems which will lead the researcher in answering the main research problem.

Conclusion/Potential Results

This study might be able to bring out the current approach of banks towards various risks. The study might also be able to point put the best practices that are followed by the banks in the sample countries. The study will also try to point out flaws, if any, in the existing structure and operation of banks and recommend corrective steps.