Financial Intermediation and Bank Stability - Essay Example

Financial Intermediation Table of Contents Summary of the Journal Article 3 Discussion of the Importance of the Work Presented in the Journal Article5 Explanation of Any Methodological Issue 8 Ethical Considerations 9 Recommendations 10 References 13 Summary of the Journal Article Economy is unique and regarded as one of the decisive financial indicators for any developing nation. It contains different degrees of market power, banks (local or domestic as well as foreign), large brand names of business, side by side small enterprise of businesses along with their increasing competitiveness, changing banking structures, efficiency towards economic progress and overall economic stability. With this concern, the study of Ariss (2010) would help to determine the implications about the degree of market power, cost as well as profit efficiency of banks and more importantly overall firm stability. In addition, the study would also reflect about how the policymakers have made deliberate efforts to ease up different financial markets, encourage foreign competition and deregulate interest rates (Ariss, 2010). Globalisation is another issue in today’s economic concern. Increasing competitiveness would be the result of increasing the level of globalisation, as this tends to promote foreign investments by developing domestic businesses and improvising the performance of domestic banks. In relation to the above context, the study of Ariss (2010) mainly depicted the implications of changing banks’ structure and their prospects towards rapid development in contemporary world. Ariss (2010) reflected in the study that the banks could improve their profit efficiency with commanding a high price mark-up over the marginal costs, but it could not help in terms of cost efficiency levels. Apart from this, the study of Ariss (2010) also inferred that when the banks are able to gain market power, it can reduce various risks that emerge while performing distinct operations and likewise confirm firm stability. In this particular issue of stability, the study of Ariss (2010) discussed about the methodology of distinct economic variables including market power, regulatory environment, cost efficiency, sustainability in economic market and alternative efficiency with portfolio characteristics. The aforesaid study of Ariss (2010) indicated the acquisition process prevailing in the economic market including merger between domestic business and foreign investments or business to develop sustainability programme in competitive business setting of developing countries (Ariss, 2010). More importantly, with regards to the above context, the study of Ariss (2010) revealed that the occurrence of worldwide crisis in financial sectors would demonstrate the role of a country towards developing its uproar hitting financial markets for obtaining significant benefits. According to Ariss (2010), the introduction of various laws like investor protection based laws ensure that the banking segment would remain competitive by facilitating the banks to form the tendency of increasing market power, which would be preferable for ensuring long-term sustainability (Ariss, 2010). Based on the viewpoints of Ariss (2010), the concepts including market power and bank efficiency are correlated with one another. This can be justified with reference to the fact that during the prevalence of market power, the managers employed within different banks might pursue attaining the predetermined targets other than profit maximisation and thereby lessening cost-efficiency. Formation and development of distinct policies are deemed to be much important for ensuring banking stability in terms of working over the increased degree of banking competition. These particular policies would be responsible for making sure about proper mixture of increasing rate of banking competition and improving financial sector stability (Ariss, 2010). It has been earlier mentioned that the article of Ariss (2010) is mainly about the examination of how distinct levels of market power affect the factors concerning bank stability along with efficiency with respect to the evidences derived from various developing nations. It can be apparently observed that in order to reach into a valid conclusion relating to the above stated subject matter, the study conducted a detailed analysis of the composite interactions persisting between the variables of market power, entire stability of the banking firms and profit efficacy among others. After the conduct of the analysis, the study found that the increase in the distinct degrees of market power, bank stability along with profit efficiency also gets mounting despite incurring significant losses in terms of cost (Ariss, 2010). Thus, it can be affirmed in this similar concern that the policy makers may take into concern the above discussed variables in order to liberalise different financial markets and encourage foreign business market competition among others. Discussion of the Importance of the Work Presented in the Journal Article There exist certain significant elements possessing different special attributes that tend to develop market power in the banking sector. In this regard, such elements are reckoned to be bank efficiency and entire firm stability within any developing country (Ariss, 2010). According to Ariss (2010), the implications of market power particularly in the segment of banking could be determined in terms of promoting foreign competition as well as deregulating interest charges for encouraging the banking firms to enter into new business markets with low competition. The seminal article of Keeley (1990) supports the views of Ariss (2010) by stating the fact that market power in the context of banking segment would get developed by the traditional competition-fragility. A bank could lessen the information irregularity based problems coincided with market power as well as develop on-going relationship with individual firms as well as lenders. The findings of the above stated two articles clearly elaborated that banks would be responsible for making huge economic considerations, generating greater level of market competitiveness and promoting business market competition (Ariss, 2010; Keeley, 1990). By supporting the facts mentioned in the study of Ariss (2009), Keeley (1990) and Ntuli & et. al. (2013) in their respective studies demonstrated that with the formation of a positive relation between bank size and market power, larger banks would be more influential and likewise hold central position in the respective markets than the smaller banks. The prime reason for this is that the smaller banks mainly operate within the primary or the local markets wherein the competition level is low, while in contrast, the larger banks desire to perform operations in international levels with stronger competition (Ntuli & et. al., 2013). According to Keeley (1990), foreign investments would undoubtedly help in introducing undercapitalised financial based mechanisms in the developing nations. Financial consolidation might provide certain benefits to the customers. While discussing about the importance of the work being presented in the journal article of Ariss (2010), it must be mentioned that the gaining momentum of globalisation is anticipated to generate maximum opportunities towards improvising the economic base of any country. With the help of this factor i.e. increased level of globalisation, larger banks should take advantages from foreign investors as well as incorporate certain effective strategies in their respective operational procedures. Serious policy concerns may arise that could affect prospective collusive activities and create the situation of abnormal profitability. The profitable situation would certainly ensure the growth of economic environment prevailing within any developing nation. However, at certain timers, it becomes anomalous because of anti-competitive market concern along with extremely concentrated market that could generate a negative perception towards the customers. Thus, necessary efforts to be made and actions to be taken for making greater concentration over the respective markets and likewise maximum abnormal profitability in an effective way (Girardone & et. al., 2007) According to Miller & Jeon (2005), bank correlation could get related with banking profitability by ensuring maximum profitability and supporting the market power rather than formulating an efficient structure of banking operations. This positive correlation would vary state-by-state basis. Bank profitability would correlate positively with bank concentration after adjusting economic environment as well as existing business market conditions. Related research of other authors like Miller & Jeon (2005) clearly highlighted the interrelatedness persisting between bank competition, efficiency as well as stability. The perceptions of this particular study might get changed on country basis relating to the factors concerning business market competition and efficiency of banks. This can be justified with reference to the fact that this journal should incorporate with every term of financial possibility, correlation, consolidation, market competitiveness, profitability, consistent, consolidation and other related financial indicators. Apart from the above discussed aspects, the determination about how distinct degrees of market power mainly impose adverse effect on bank efficiency as well as stability is the other important work, which is being presented in the journal article of Ariss (2010). While determining this fact, the study of Ariss (2010) obtained a detailed understanding about the facets of foreign competitors, prevailing interest rates, size of banks, increasing business market competition and correlation with foreign investments among others (Ariss, 2009). Explanation of Any Methodological Issue When concerning the methodology considered based on the journal article of Ariss (2010), the following depicted baseline model was followed as a form of ‘cross-section regressions’: Y= f (Market Power; Portfolio Characteristics; Regulatory Environment) In relation to the above model, ‘Y’ was treated as an independent variable, measuring the cost efficiency of the financial institutions, alternative profit efficiency and most vitally, overall stability (Ariss, 2009). In its methodical implementation, Ariss (2009) uses a number of models and frameworks, which included Abba Lerner (1934) introduced Lerner index, indicating a firm’s market power. Lerner defined it as, L = P – MC/P Where, ‘P’ is recognised as a symbolic concept of market price and ‘MC’ to be the marginal cost. Range of index would be 0-1 under the condition of P=MC and L=0, which would indicate that firms have no market power. Additionally, Lerner index would indicate market power in accordance with the perception of individual firm or any business. This would help to measure mainly the monopoly market power. The lack of deriving appropriate measures with respect to other market structures apart from monopoly market power could be one of the disadvantages associated with the issue. Additionally, Ariss (2009) also refers to Altman (1968) incorporating the Z-score or Z-index, which describes another measurement of predicting the probability of a firm’s bankruptcy that may prove to be helpful for the calculation of control measurements of corporate income and ensuring positive health of firm’s sustainability (Fernandez & Garza-Garciab, 2003). On a further note, Altman’s Z-index was applied in Ariss (2009) to predict the probability of a firm’s bankruptcy to control the corporate income level (Bikker & et. al., 2006). From a critical view, although the effectiveness and reliability of these methods seem to reside at a higher level, application of all these tools together increased the complexities of the research. In addition, it also obstructed the utmost comprehensibility of the study and hence, affecting its internal validity. Nevertheless, the empirical evidences noted in Ariss (2009) was wide-ranging but the degree of complexities in the data analysis process as applied, inhibited the required degree of transparency to the study findings. The study also presents a detailed account of the method applied; however, it fails to attribute the limitations inherited therewith, through sufficient elaborations and justifications. Certainly, these gaps lead to the disadvantage of this research in expanding the existing notions within the domain. Ethical Considerations Ethical considerations mainly appear in the context of any journal’s methodology part, which is related to its overall research findings (Goyal & Joshi, 2011). Similar to other researches, ethical practices were also identified to get considered within the journal article of Ariss (2010). This can be justified with reference to the fact that the sample data required for the study excluded continuous observation for three long years relating to the major variables of the research study. Moreover, the study also excluded the negative values of loans applied or obtained by various banks for generating positive results and avoiding any sort of discrepancy. It can be claimed certain valid ethical practices have been duly considered in the aforesaid study for reaching into a valid conclusion. In this regard, one of such ethical practices could be reckoned as considering the number of observations relevant to the subject matter of the research study. Identifiably, 4670 observations have been made in the study so as to avoid any sort of complexity associated with the procedure of data collection (Ariss, 2009). Nevertheless, it must also be considered in this regard that Ariss (2009) presents no information with regard to the ethical considerations affecting the research process, which further hinders the internal validity of the research. While elaborating the ethical considerations associated with the study of Ariss (2010), the author has attempted to make sure that the subject of the research study has received full disclosure of the assigned risks and potential advantages, alternatives as well as extended opportunities. In addition, the researcher anticipated working over the maximisation of benefits and the reduction of risks that might emerge from the research (Ariss, 2010). In this particular situation, the researcher must remain fair in the distribution of topics and justify the same for deriving positive results. These norms would always be following by the researcher while conducting future researches about different topics. Recommendations It has been earlier mentioned that the research study focused on examining how different attributes of market power influence bank stability as well as efficiency in this competitive business setting. It will be vital to mention that there might lay certain potential reasons of rising competition amid the banks. Economic competition would change the banking force towards more efficient as well as innovative way concerning the development of new products along with delivering better banking services. Competition also inclines to put descending pressure on lending rates while increasing deposit rates and benefiting both the borrowers and the entrepreneurs along with the depositors. The study of Ariss (2010) clearly highlighted that complex interactions persisting between the variables including profit efficiency and entire firm stability is one of the major implications of market power in the context of banking sector with clear focus on the developing nations. Specially mentioning, such implications may result into affecting the prevailing financial conditions in the form of weakening banks’ license value. This situation might also lead towards increasing risks of systematic fragility along with promoting contagion risk based factors at large. In terms of recommendations, it is vital to mention that certain policies need to be introduced as well as revised for ensuring wider banking stability as well as increasing banking competition. Methodologically, it will be essential to mark all variables in an appropriate way along with making proper execution of all the data obtained from the reports of several banks belonging to developing nations. There exists another issue of ethical consideration, wherein utmost attention requires to be paid for ascertaining positive outcomes and deriving positive future results. Correspondingly, it must be noted that the research would have been better in terms of its internal validity, provided that augmented significance was delivered to its ethical considerations along with the persistent research limitations in the process. Reduction and greater simplicity enthused in the project could have also helped it in increasing comprehensibility. A major gap identifiable in the research was the gap in identifying future scope of the study specifically, which if identified would have contributed further to the value of the research. According to the journal, my understanding conclude that a developing economy comprise variables like, market power, banks (local or domestic as well as foreign), large brand names of business, besides small enterprise of businesses along with their increasing competitiveness, changing banking structures, efficiency towards economic progress and overall economic stability in a more visible manner. Globalisation is another issue with increasing competitiveness that developing economies face, as this tends to promote foreign investments by developing domestic businesses and improvising the performance of domestic banks alongside. Along with these issues, developing countries also face another concern related to ethical considerations. Correspondingly, my opinion to the issue implies that all these factors should be used in a positive way for future economic sustainability and progress as well, whereby the developing economies must remain open to innovation and continuous developmental changes. References Ariss, R. T., 2009. On The Implications of Market Power in Banking: Evidence from Developing Countries. Journal of Banking & Finance, Vol. 34, pp. 765-775. Bikker, J. & et. al., 2006. The Impact of Bank Size on Market Power. DNB Working Paper, pp. 2-42. Chortareas, G. E. & et. al., 2007. Introduction. Banking Sector Performance in Latin America: Market Power versus Efficiency, pp. 2-28. Fernandez, R. O. & Garza-Garciab, J. G., 2003. Literature Review. The Relationship between Bank Competition and Financial Stability: A Case Study of the Mexican Banking Industry, pp. 2-15. Girardone, C. & et. al., 2007. Introduction. Banking Sector Performance in Latin America: Market Power versus Efficiency, pp. 2-28. Goyal, K. A. & Joshi, V., 2011. Social and Ethical Issues in Banking Industry Recommendations. A Study of Social and Ethical Issues in Banking Industry, Vol. 2, Issue. 5, pp. 49-57. Hannan, T. & Berger, A., No Date. Abstract. The Efficiency Cost of Market Power in the Banking Industry: A Test of the Quiet Life and Related Hypotheses. [Online] Available at: https://ideas.repec.org/p/wop/pennin/94-29.html [Accessed April 13, 2015]. Miller, S. M. & Jeon, Y., 2005. Bank Performance: Market Power or Efficient Structure? Department of Economics Working Paper Series, pp. 4-26. Ntuli, M. & et. al., 2013. Investigating the Effect of Bank Competition on Financial Stability in Ten African Countries. International Business & Economics Research Journal, Vol. 12, No. 7, pp.755-767. Rettab, B. & et. al., 2010. Impact of Market Power and Efficiency on Performance of Banks in the Gulf Cooperation Council Countries. International Research Journal of Finance and Economics, Issue. 50, pp. 190-203. Saurina, J. & et. al., 2007. How Does Competition Impact Bank Risk-Taking? Federal Reserve Bank of San Francisco Working Paper Series, pp. 2-33. Tabak, B. M., 2012. The Impact of Market Power at Bank Level in Risk-Taking: The Brazilian Case. Working Paper Series 283, pp. 4-33. Read More