Interim Report Project Title Finance Essay

According to the voice of banking and financial services (2013), the UK banking sector is unique due to its remarkable size, efficiency, breadth, dynamism and diversity. In fact, UK banking industry ranks as the third largest, following the USA and Japan. The domestic markets mainly focus on personal and corporate lending, while the international markets are to enable the fine functioning of global capital markets and provides investment management services to overseas corporations especially the multinational companies, governments including China, and individuals particularly the affluent investors throughout the world. The total employees in the banking sector are merely 3.5% of UK's total workforce, while the sector services about 95% of the population. In 2005, the total assets were €5526 billion, while the lending and deposits were, respectively, €3284 billion and €4984. The selected banks are the HSBC Holdings plc, Royal Bank of Scotland Group, and Standard Chartered PLC, which are dominating the banking industry in the United Kingdom.

Rational for of ratios used in the analysis

Considering that the financial ratios are easy to use and understand this paper use multiple ratios including the financial ratios and the non-financial ratios to compare the financial positions and operating performance of different banks. Rinastiti and Philip (2004) once developed a model to divide the ratios into five groups. They are the profitability ratios, the asset utilizations ratios, the long-term solvency ratios, short-term solvency ratios, and the market value ratios. With respects to the banking sector, it is different. The banking industry, as is in the service sector, is specific since it has no or small amount of inventory but large amount of financial assets. Then it is possible for large amount of capitals, reserves, bad loans, and other special accounts. Then the ratios used in this paper are not similar to those in the manufacturing sectors or the retailing sector. Due to the unavailability of several groups of data, the main ratios are listed in the table below:

Table 1 five groups of financial ratios

Ratios

1

Return on average ordinary shareholders' equity

2

Risk asset ratio - Tier

3

Risk asset ratio - Total

4

Core tier 1 capital

5

Advances to core funding ratio

6

underlying cost efficiency

7

Employee engagement

8

Risk-adjusted revenue growth

9

Basic earnings per ordinary share

10

Dividends per ordinary share growth

11

Return on average total assets

12

Book value per share

13

market share

14

Net asset value per share

Preliminary competitive analysis using five forces

Threat from new entrants

Threat from new entrants, in accordance with Porter (1998) refers to the pressures that potential new entrants may pose to a company, which is likely to increase the competition. According to the voice of banking and financial services (2013), the UK bankers are advantageous because of remarkable size, efficiency, breadth, dynamism and diversity. As a consequence, due to the large amount of capital that is used in the banking industry, threat from new entrants is modest.

Threat from substitute products

Threat from substitute products in accordance with Porter (1998) refers to the pressures that the substitute products pose to a company, which may be featured by higher quality, efficiency and effectiveness. According to Berger et al (2003), the significant global integration is under way particularly in the banking sector. With the globalization and the degradation of cross-border Corporation and investment that removed multiple regulatory barriers to inter-national banking, as well as the innovation in the financial market, the substitute products are available to the domestic customers and the overseas customers. Then there is considerable threat from the substitute products. Moreover, in the United Kingdom, there are a wide range of other consumer financial service organisations such as the building society, Abbey and so on.

Bargaining power of the buyers

Bargaining power of buyers in accordance with Porter (1998) refers to the pressures that consumers are likely to propose to a company to bring down the prices or ask for higher quality and more efficient and effective services. With respect to UK banking industry, buyers mainly include the wholesalers and the consumers. Then for the consumers, they have limited bargaining power, while the wholesalers especially the large wholesalers have great bargaining power in accordance with the game theory.

Bargaining power of the suppliers

Bargaining power of suppliers in accordance with Porter (1998) refers to the pressures that suppliers are likely to propose to a company so as to raise prices. With respects to the UK banking industry, the suppliers are mainly the domestic investors, savers and the overseas suppliers. Notably, the overseas corporations, governments with currency surplus, and individuals who are in general the affluent investors throughout the world have different bargaining power largely depending on the amount of capital they provide.

Intensity of competitive rivalry

Intensity of competitive rivalry in accordance with Porter (1998) is depending on the number of companies in the market and the production and the needs of the products or services. With respect to the UK banking industry, the retail and commercial banking markets are dominated by Barclays plc, HSBC Holdings plc, Lloyds Banking Group, Royal Bank of Scotland Group, and Standard Chartered PLC with businesses and branches around the world. For the small banks, there is fewer advantages.

Prior competitive analysis using PEST analysis

Political and legal factors

According to the voice of banking and financial services (2013), the UK government has set out a number of robust plans to stimulate the economy, as well as firstly safeguard the economy from the damage impacts of the recent financial crisis. Accordingly, there are a number of strong, sensible and proportionate growth oriented regulations to support these plans. In particular, the financial sector has more plans. So as to sustain the ability of banks to lend to the economy and satisfy the needs of a wide range of consumers, there would be a balanced approach that is applicable to renew the banking sector. Then the British Bankers' Association and Accenture, along with senior bankers, successful business leaders, politicians, prestigious academics and influential commentators, has discussed the UK banking sector and the way forward in this volatile time. It is considered that global recession especially the European recession and further weakness of sovereign debt are likely to have repercussions for the UK economy, as well as direct and indirect impacts on UK banks. Then, most European countries began to initiative to strengthen financial regulation and bank balance sheets. Moreover, the European financial transaction tax and other proposals are thought to be influential to the UK banking industry.

According to Treanor (2013), the Bank of England recently discussed its newly granted powers to force commercial banks to hold more capitals against the potential bubbles, which is drastically dangerous in today's economy. Taking the 2008 financial crisis into consideration, it is useful to curtail the risks of bankers to build up the capital. Moreover, this act is also in line with Bank's Financial Policy Committee (FPC), when it starts to use its new tools. More specifically, some particular sectors should especially hold more capitals including the commercial property. There is already legislation that are recently under through the parliament, indicating that this power is likely to granted to the Financial Policy Committee in the coming meeting. As a consequence, the banking industry is expected to have a lower growth rate due to this act. In line with the general rule, one additive percentage increase in the capital usually increases the costs of borrowers by as high as 25 basis points, which in turn would decrease the bad loans. However, the Gross Domestic Product would be cut down by about 35 basis points. In addition, the regulators also require that the bank should ascertain that customers are capable to pay back loans before the mortgages are to be approved has sounded the death knell for these specific loans. In brief, these acts are on one hand unpopular with some banks due to the decreasing growth rates expected. On the other hand, it is inevitable and banks should actively react to the potential impacts of such regulatory regime.

Economic factors

On one hand, the financial crisis has profound influential on the whole economy throughout the world, especially in the banking industry. Financial Services Authority (2009) pointed out that this crisis is mainly due to the inadequate capital and liquidity. As a consequence, in the short run, most bankers prefer to have capital so as to prevent from losses and support lending that is mostly used in the real economy, eventually reacting to the existing slow down. Further, the crisis reveals the macro-imbalances and financial market developments and innovations. The macro-imbalances are mainly due to the oil exporting counties such as Iran which lead to substantial fluctuation in oil prices and the operating expense of vehicle, and the rapidly developing countries such as China, which are with large amount of account surpluses and extremely high saving rates. Adversely, account deficits are in other countries such as USA and UK, which has respectively the largest and third bank sector. Recently, the exchange rates between the surplus countries and the deficiency countries are committed to be soundly managed or even be fixed. The financial market innovation is one of the main reasons of the recent banking crisis. This is largely stimulated by the macro-imbalances. The origination, packaging, trading and distribution of securitised credit instruments are more and more popular in recent years. This directly or indirectly influences the banking industry, increasing the risks. According to the voice of banking and financial services (2013), the European economies especially the Eurozone countries and their banks will continually exert direct and indirect but great influences on United Kingdom and its banking sector.

The head of the International Monetary Fund, on the other hand, asserted that the Eurozone shows signs of recovery, representing regional growth in the coming year (Wearden, 2013). Admittedly, the attitudes of International Monetary Fund's representatives may be useful to restore the consumers' confidence as well as the bankers, the borrowers, and the lenders. Similar to the positive expectation, the common would promote their confidence in the private sector, which is crucial to recovery. Similarly, according to the voice of banking and financial services (2013), the financial and economic crisis has exerted great influential on UK banks during the past several years. Both the bankers and the governors have taken timely and effective actions to strengthen the balance sheets and adapt their business models to the new environments. The growth rate of UK in 2012, as a consequence, was much higher than those of its neighbours in the Europe especially the Eurozone. As is shown in figure 1, the real interest rates in UK is decreasing in the past several decades, indicating less profitability for banks.

Figure 1 UK real interest rates (20 year bonds, yield at May 25 or nearest week day)

Source: Bank of England Real Yield curve calculations

In addition, according to the Guardian (2012), recently, the Consumer Price Index showed a down trend in the past years. But it is still above 2%. At the same time, Retail Price Index showed similar trend. On the other hand, in 2012, the GDP growth rate was primarily negative. In 2011, the GDP was € 1,750,395.00, representing a slight growth of 1%, while in the year of 2009 the GDP was € 1,573,466.00, representing a drastic negative growth rate of -4%. But at the end of the past year, the GDP growth rate began to be positive, representing recovery of the economy, which is encouraging to the banking industry.

Figure 2 UK CPI and RPI headline indicators, %

Source: the Guardian, 2012

Figure 3 United Kingdom GDP growth rate

Source: www.tradingeconomics.com.

Social and cultural factors

the main task for UK banks is to balance the different needs of a wide range of customers and the society. Both the needs of individuals and the macro economic growth rate should be taken into consideration. In this sense, the social and cultural factors should be seriously considered, since the needs of the customers are highly depending on these factors.

Technical factors

UK's banking industry has greatly evolved with technologies especially the information technology. In 2006, the expenditure on IT investment amounted to $ 23 billion, much above that of other countries. These investment set out the e-banking age. As a consequence, it becomes the biggest single driver of UK banking industry. From 2004 to 2008, the compound annual growth rate (CAGR) of IT spending in UK banking sector was as high as 8.1 %.

On one hand, the technological improvements considerably streamline the information collecting and distributing processes, promoting the efficiency of the banking sectors. More specifically, the online channel, especially the multi-delivery channel, is convenient to all kinds of the customers due to the broadened access to the Internet and the strengthened safety of online transactions. Moreover, the phone banking, internet banking and automatic banking are popular among most peoples. Automatic teller machines (ATMs) are a typical innovation in the past years in the banking sector. From 1994 to 2004, the ATM network doubled to 50,000 in merely 10 years. These allowed more branches of the banks at lower costs and shorter time to launch new products. The information technologies have, on the other hand, made it possible for the financial market innovation more and more complicated. The explosive and complex financial market innovation is likely to bring considerable risks to the banks. Further, the increasing use of alternative banking channels (European Central Bank, 1999) has greatly changed the traditional way of understanding and undertaking banking activities both from the customer's perspective and from the bankers' perspective.

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