The achievement of workplace equity in the United States employment field remains one of the most difficult cases that courts have to deal with. The key people that have been affected by workplace discrimination being mostly marginalized individuals, people of color and women. There have been prevalent discrimination in employment, consumer markets, the transportation industry, and education throughout the United States (Turner, 2020). Despite the United States being a country with complex labor history, the nation is still struggling to reconcile some key past atrocities. Among them are the slavery and Jim Crow that has articulated and advocated for justice and equity for all. Workplace discrimination remains a key challenge despite efforts to implement a national policy on equality in employment opportunities.
This case study aims to evaluate some of the key questions that entail: Why workplace discrimination remains a central justice issue in American culture? Secondly, how does the Title VII of the Civil Rights Act help to alleviate challenges brought about by workplace discrimination? Thirdly, what are the ways that can be used to address the gap in awareness that may lead to employer liability? This study is significant because it will help provide insight into a critical aspect facing the court system in the United States since Title VII of the Civil Rights Act was enacted. The paper follows a thesis that aims at studying race discrimination in the workplace since Title VII was enacted.
Literature Review
According to Astrada (2017), America has been facing a period marred with an oppressive employment system of legal segregation and slavery for almost ten decades. However, the author provides an insight into the matter by claiming that the policy concerning workplace discrimination took a dramatic turn in the early 1960s upon adoption of the Title VII of the Civil Rights Act by Congress (Astrada, 2017). The move served as the first legislative stand that propelled the nation towards realizing the national policy on the aspect of employment equity, at the moment when the nation is experiencing a situation where employers subject black employees to a different working environment as compared to their white counterparts, it is clear that the countrys decision on ultimate equity in the workplace is still dwindling. Therefore, it is clear that most workplace discrimination acts are manifested in masked and subtle discrete forms rather than in the explicit form championed in the Title VII of the Civil Rights Act of 1964.
According to Martin (2018), the court system in the United States remains divided on their evaluation of the difference in employment discrimination action that is a requirement in establishing a prima facie case of inequality (Martin, 2018). The majority of the courts claim that there have been advantageous changes within the workplace environment that have constituted workplace discrimination actions (Astrada, 2017). However, other courts such as Fifth and Third Circuits have disagreed with this fact while interpreting Title VII of the Civil Rights Acts as a key determinant for reaching an ultimate workplace decision.
Methodology
This case study incorporated various qualitative methodology paradigm that entailed critical concepts to address workplace discrimination. The study involved collecting various sources of evidence through evident quantitative means such as using key research methods; among them were interviews, observations, surveys, and secondary and primary sources such as newspaper articles and journals.
Findings and Discussions
According to a report conducted by the majority of the scholars, it was revealed that the amendment of Title VII provided claims for jury trials and damages. Therefore, employers were forced o abide by the legislation completely, thereby changing the stance of the American workplace (Martin, 2018). However, since the amendment of the Title VII of the Civil Rights Act in 1991, there have been many adjustments among them. The authors of Title VII did not incorporate in their amendment as they did not see the need. Title VII of the Civil Rights Act of 1964 ended up creating the EEOC commission that was tasked with enforcing laws regarding harassment and job discrimination in the US (Turner, 2020). According to this research, EEOC processes over 80000 workplace discrimination cases, with nearly 50000 local agencies investigating cases linked to workplace discrimination complaints (Cabrera, 2021). With the growth in workplace discrimination cases, there has been a need by the EEOC to clarify all the policies regarding job discrimination as broad as possible.
Conclusion
In summary, the paper has demonstrated that the Title VII of the Civil Rights Act has helped alleviate challenges brought about by workplace discrimination by forming the Equal Employment Opportunity Commission (EEOC). This federal unit has been tasked with enforcing laws regarding harassment and job discrimination in the US. In a review, the court system in the United States remains divided on their evaluation of the difference in employment discrimination action that is a requirement in establishing a prima facie case of inequality. The majority of the courts claim that there have been advantageous changes within the workplace environment that have constituted workplace discrimination actions. Therefore, there is a need for future research to establish how the EEOC can fully address all the challenges related to workplace discrimination before the piled up cases can be arraigned in Court.
Cabrera, Y. (2021). The Ultimate Question: Are Ultimate Employment Decisions Required to Succeed on a Discrimination Claim Under Section 703 (a) of Title VII?. FIU Law Review, 15(1), 97.
Employees of financial institutions have been considered for quite some times as being among the top earners in the country. Indeed, financial service organizations have defended their compensation and bonus structure, claiming that it helps them attract, recruit and retain the best talent. In addition, these organizations have previously claimed that their employee are remunerated based on their performance.
Therefore, employees will be motivated to work hard and in return create long-term value to all the organizations stakeholders. On the other hand, it would be expected that when an organization underperforms, the employee will similarly be affected and hence their bonus reduced (Pert & Clark 2010)
However the recent events, prior and during the global financial crisis, have clearly proved that this has not been the case. Most financial institutions were heavily criticized for their continuous persistence of highly rewarding their employees, especially top executives, despite their poor financial performance. In deed, there is clear evidence to support this augment.
For instance, despite Citigroup and Merrill lynch, suffering losses of not less $ 27 billion dollar, they still paid bonuses; the first one paying $ 3.6 billion and the latter $ 5.3 billion. Likewise, Morgan Stanley, Goldman Sachs and JP Morgan Chase, in the year ending 2008, paid out bonuses that were higher than their annual earnings.
To be specific, Morgan Stanley paid $ 4.5 billion dollar despite making $ 1.7 billion. Similarly, JP Morgan chase paid 8.7 billion dollar after making $5.6 billion and, last but not, least, Goldman Sachs paid $ 4.8 billion while the earning was $ 2.3 billion (Pert & Clark 2010).
Such actions lead to a public outcry by various stakeholders; including shareholders, the media, regulators and even some of the staff. In addition, it strained the relationship existing between these institutions and their customers, with most of them perceiving the organization as to lack accountability and integrity.
Certainly, the institutions have come to the realization that the previous systems of incentive do not serve their intended duty of creating the long-term value. It is for this reason; they have opted for other alternatives, such as Bonus banking, which they believe will create both short-term and long-term value by building greater relationships with stake holders such as customers and employees (Pert & Clark 2010; Watkins & Warren 2010).
Aim
This report will therefore aim to investigate the potential of bonus banking. It will study the benefits of this compensation by comparing it to the previous system. Studying UBS, a financial institution which has opted for this approach, will give a clearer picture.
Case Study: UBS
UBS is among the largest financial services organizations in the world. Priding itself with more 150 years of experience, this organization offer wealth management, investment banking and asset management services for corporate, institutions and high net worth individuals around the world.
In fact, it is considered as the second world largest private wealth manager. The organization, whose headquarters are in Zurich and Basel, Switzerland, is cited as the biggest in that country. In addition it has over 50 offices around the world, most of them in major financial cities. The bank is also a major employer with about 65,000 employees directly under it (UBS 2010).
Just like any other major financial service organization, this institution was had hit by the global financial crisis. By august 2008, it was established that it incurred the biggest lost among its peers in Europe. Actually, it was faced by double tragedy. Apart from the effects of the crisis, the organization was charged with allegation of helping its US client evade taxes.
These allegations had profound effects on it. They threatened its continuity and hence the government opted to unveil a substantial bail out plan to help it stay afloat. This did not escape the eye of the general public.
In view of the possibility of its action affecting its relation with existing and potential new clients, the institution opted to adopt some reforms. Accordingly, a bonus banking system was adopted since it appeared as the best option to counter the perception of greed associated with the institution (UBS 2010; Irv 2009; Kamil & Rai 2009).
UBS Bonus Banking System
According to Christie (2009), bonus banking is an incentive practice whereby a certain amount of annual earned bonus is banked in a special account referred to as a bonus account. The banked bonus is paid in specified proportion in the years following.
Its major difference with the heavily criticised bonus plan is the fact that negative bonus also known as mulus can be declared and subtracted from the accumulated bonus. This usually happen, if the employees underperforms and is generally reflected in the organization, especially financially (Pert & Clark 2010; Christie 2009).
UBS bonus banking system was motivated by the belief, that if properly executed, executives will no longer work for the short-term interest motivated by the annual bonus. This system will target senior executives, division leaders and high risk traders, who are in charge of trading a substantial amount of the institutional capital.
The annual bonuses, both in terms of shares and money, earned will be held in special accounts for five years. This stipulation is believed, by its designers, that it will ensure the categorized employees to act in line with corporate strategy, and hence enable the organization achieve both its short and long-term.
It diminishes the possibilities of the executive operating with an intention of quickly making short-term gains which will see their annual bonus increase (UBS 2010; Irv 2009; Heineman, Goodman & Downes 2009).
The employees will be expected to act within the set policies. Performance will be measured and negative bonus applied; if the performance target is missed, are breach of trading rules is experienced, or whereby personal misconduct affects the organization.
On the same font, if a financial loss is experienced by the company or any of its division, or any cases whereby asset write-down occurs, the employee in charge will incur a negative bonus. Persistence negative performance can result in completely wiping out bonuses previously earned in terms of shares or a two-third reduction in the amount earned in cash (Irv 2009).
Incentive Plans and Customer relationship
There is, if any, a very thin line between the customers and investors in financial service organizations, such as UBS. For example, all its clients in its investment bank arm double up as investors. Perhaps only in its Swiss Bank UBS, which offer retail services, one can at very minimum observe the difference.
Nevertheless, due to the sensitivity involved in offering the financial service, building a relationship between the institution and the customers can be an uphill task. The connection between executive compensation plans, and global financial crisis affected the relationship negatively. Customer, especially at the UBS, need to feel that their interest is protected and the risk is minimized (Irv 2009; Watkins & Warren 2010).
UBS and other banks targeting corporate and high net worth individuals have mastered the art of managing customer relationship. Having this group, as a niche market, call for perfectionism. This is because they are usually well aware of their rights as customer and have the capability of easily moving to another FSO that they feel will suit them adequately.
Nonetheless, the previous bonus incentive plan has had some benefits. To begin with, if properly linked with the organizations mission and vision, the incentive would have served as platform of attracting, recruiting and retaining the best talent. This group of employee would therefore be motivated, posses customer relationship skills and hence ensure the institution enjoys a high revenue and rate of return.
Despite attracting great talent at UBS, and various strategic manager outlining the employee incentive plan will help achieve both the short-term and long-term, the approach fell short of expectation. Indeed, this compensation plan was not focused on longer-term objectives. It failed to link the risk and reward and therefore allowed employee to take short term approach that ensured performance in the period appeared favourable.
Eventually this affected negatively the organizations by putting the clients investments and deposit was at risk. At one point, the risk was too much to bear and the clients opted to end their business. It took the intervention of a former and retired Chief Executive to convince them otherwise (Pert & Clark 2010).
With the new bonus banking system, the relationship between the institution and its clients is expected to improve in the long-term. Employees, especially executive, who a responsible for decisions and actions that can significantly affect the organizations, will automatically be directly affected by both the short and long-term performance of the organization.
The potential to either gain or lose bonuses depending on their performance is viewed by many clients as form of increasing both institution and employees accountability. Employees just like clients and investor can directly lose both money and shareholdings (Pert & Clark 2010).
Nerveless, as cited by Christie (2009), Bonus banking can at times fail to motivate employees. One reason for this is because the system does not allow for employees to enjoy the immediate reward of their effort. In addition, are form of insecurity develops considering the bonus earned previously can be significantly reduced and sometimes claw back applied.
For that reason, employees might be reluctant to put extra-effort and hence result in either average or just above average result. This performance will be observed by the clients and potential harm any profitable relationship.
Incentive Programs and Sales People
Without a doubt, sales people play an integral role in any organization. The importance of their duties is further propelled when the institution in question offer financial and investment services. When the organization deals with ultra high net-worth and/or just high net-worth individuals, the sales people need to be equipped with the resources, knowledge and motivation needed to handle this unique group of client.
Such is the case at UBS. This institution implicitly states that its sales force support its business in a very significant way. It is the sales people who regularly come in contact with clients and potential clients and in the process offer financial and investment advice. Similarly, they are responsible of ensuring the existing clients are retained and potential new customers procured (Levil and Curtis 2010; UBS 2010).
However, to ensure that this group of employees maintain a consistent high performance, sales managers have opted to adopt various recognition and sales incentive programs.
Sale incentive program usually target to reinforce a certain behaviour that an organization perceive to be contributing towards its objectives (Levil & Curtis 2010). Levil & Curtis (2010) claims, there is enough evidence to support the premise that an effective incentive programs can increase sales team performance by approximately 30 percent.
The program adopted at UBS aim to retain the best talented sales people while at the same time encourage them to engage in practices that maintain and increases their business. Judging by the number of awards this organization has received through out the countries it operates; it was considered to be on the right track (UBS 2010).
A sales manager, nevertheless, faces quite some challenges while designing an incentive program. They can range from the internal impact they have on the institution, to external influence. For starters, it is an expensive endeavour. Official figures estimate that businesses in the US spend about $ 9.5 billion and $101 billion on non-cash and cash incentives respectively.
Therefore managers have to ensure the program adopted serve the organizations both short-term and long-term goals. Both the institution and the sales people want to recoup their investment, and earn their returns at the shortest time possible. This therefore increases the chance of entering in practices that might affect the organization and stakeholder negatively; especially customers.
To be eligible for the incentive reward, sales people have to hit a certain sales target. They can at times be tempted to apply even unscrupulous practice to close a sale deal. Sales manager therefore need to be well aware of this issues since they can have negative legal implication on the institution. For example, customers have various rights, such as right to information.
This is particular important to financial service organization such as UBS. Legislation across Europe and other countries entitled the person issuing investment opportunity to provide the client with prospectus and/or statement of investment. These documents are meant to clearly elaborate the nature of the investment; such as the background, potential return and risk involved.
Sales people, to increase their chance of reaching the target, can decide to withhold any information that might make their client reconsider the offer. A good example is belittling the risks involved and exaggerating the potential return (UBS 2010; Glick 2009; Levil and Curtis 2010).
Sales managers also need to consider the tax implication of any incentive program adopted. Employers therefore should be ready to declare the value of any benefits and incentive enjoyed by this group both in terms of cash and non-cash. In the US, the legislation set and govern by the IRS specify this benefits to be taxed as ordinary income.
Effectively taxing the incentives and high bonuses especially those rewarded to senior sale executives can potentially reduced the negative public perception. Although this cannot be a solution by itself, the financial institutions need to contribute a larger percentage of the money which is used to bail them out in moments of crisis (Cleverley & Rai 2010).
Conclusion
Financial services organisations have been forced to change their incentive compensation plan in order to balance between short and long-term. This was necessitated by the fact that, the recent financial system was closely associated to the bonus systems that previously existed.
As a result, the relationship existing between these organizations and other stake holders such as customer and even some employees was negatively affected. Accordingly, companies such as UBS have opted to adopt bonus banking so to ensure long-term value is created. Employees, just like customers and shareholders, will have to directly lose in case the organization underperforms.
Reference List
Christie P. (Mar 2009) Is bonus banking the answer to banking? Financial World, March 2009.
Cleverley, B. (2008) Tax Consideration in a Sales Incentive Program: Avoid Future Legal Surprises. Corporate information, 12(7), pp. 123-42.
Glick, R (2009). Comparing the Recent Global and the 80s Asian Financial Crisis. Economic Paper, 4(2), 7-22.
Heineman B, Goodman, N and Downes, K. (2009) Balancing Long and Short term Goals to achieve the corporate strategies: Lessons from the Meltdown. Leeway journal of finance, 12(25). 32-40.
Irv, M. (2009) Will the Bonus-Mulus System restore UBS Public Perception. Centre of Finance, 2(1), pp. 10-23.
Kamil, H and Rai. (2010) Effect of Financial Crisis on Foreign Banks Lending. The NIS bank Working Paper, 10 (102).10-34.
Levi, N and Curtis, M. (2007) Respecting Consumer Right When Closing the Deal: Salespeople Motivation. Consumers right and Information guide, 8(2), pp. 12-28.
Pert, L and Clark. (2010) The Role of Executive Compensation Plan in the Global Crisis. International journal of economics, 20(8), pp. 10-45.
Success in life is only guaranteed by proper planning. Proper planning at the individual and even organizational level requires appropriating all available resources or capacities and identifying in what way they can best be used for maximal gains. It requires scanning the environment and identifying anchors that can be relied on for success. This paper presents my roadmap to a successful career in the banking sector. Apart from my career plan, it also presents general views on how recruitment is done. Most importantly, the paper presents a self-evaluation in relation to what happens in the job market.
Career Plan
We live in a very fast-paced world. Our world of today has numerous opportunities but not much security, especially the security of tenure. In the days of my grandparents and even parents, the security of tenure was assured. People used to work hard at school, then they would get jobs in organizations and managed to grow within the given organizations until retirement. Due to technological and socio-economic changes, the job market is more unpredictable with the coming of each day. It is for this reason that creating a dynamic career plan is very crucial.
As technological and social-economic changes make the security of tenure untenable, people are tending towards entrepreneurship and being multi-skilled. The recent world recession proved yet again how unstable even old secure professions like mechanical engineering could be. In the recent recession, from which economies around the world are steadily pulling out, many people were got off guard. It just happened that all of a sudden banks were making losses due to bad loans or credit.
Failing financial institution necessarily translated into many other companies fortunes dwindling. The most stable of brands like General Motors were threatened with indefinite closure due to losses.
My career plan is as in the figure below:
Career Plan.
My career goal is to find a job in a bank and gradually grow through the ranks as I gain financial management related skills and experience. I hope to one day become a top manager in a bank, and after some years of successful operations, I plan to start my own business and become an employer. I look forward to a career in banking because my training has been in banking-related studies. Additionally, I have also had attachments in financial institutions.
Short Term Career Objective
My short term career objective is to gain entry into a banking institution after graduation. From what I have read in job advertisements, most employers or recruiters seeking people who have some experience. Looking for a fulltime job immediately after graduation, I have come to understand, can be very frustrating. Despite having the necessary knowledge, having some experience in the industry plays a critical role in earning one the dream job.
The internship is the best way towards bolstering ones chances in the job market. I realize that banks do not employ fresh graduates on a permanent basis. I, therefore, hope to work for some time as an intern as I gain experience for long term engagement.
I understand that finding internship sites can be tricky, but I bet I am lucky enough. My father is in the banking industry, and thus securing internship will not be a very challenging ordeal. In the labor market of today, networking plays a critical role in landing a job. Networking is done with family members, relatives or friends. Social networks also play a critical role in finding jobs. After six months or one year of internship, I will have developed enough skills and accumulated enough experience to be trusted with a full-time job.
My second short term career objective will be tried as much as I can to experience work in most banking sections. This is crucial because in the first two years of my career will be about developing skills and experience for more demanding responsibilities. Once I have identified the function that best fits my aptitude or capacity, I will devote my energies to being the best at my work specialization.
The road to a successful career will have its own challenges. I know that the organizations I will work with will have own internal culture and politics. There will be challenges e.g. personality clashes, people who are envious, work related challenges and even economic or market-related hardships. I have a number of strengths that will enable me to handle the challenges; the most important ones are a good disposition and the skills gained in school.
I presume I will be successful in the workplace because of the work ethic I have developed. Employees ought to be focused on delivering on organizational objectives as they receive remunerations in return. Rose (2008, p.58) advises that to deliver on organizational objectives, one has to have the right kind of attitude and a dose of enthusiasm. Workplaces have their own challenges. It is easy to get negative due to attitudes of superiors, other workmates or challenges posed by the work requirements. To succeed, I will have to focus on remaining positive despite challenges and other forms of oppositions or negativities.
I realize that success at the workplace is largely dependent on integrity; one can only succeed if he or she is able to win the trust and confidence of colleagues and supervisors. I will endeavour towards being straightforward and truthful in my dealings. Leading a life of integrity should definitely endear me to colleagues and supervisors. Having won their trust, getting promotions or salary increments will not be a bid deal or problem.
Courtesy and politeness are the attributes I will develop. Being courteous and polite is not the same as being a weakling or submissive. As a matter of fact, my personal commitment to assertive relations will remain undeterred. Assertiveness is critical because it helps in being clear in communication. Proper communication entails that one is able to listen as well as express his or her own personal feeling or opinions respectfully (Rose 2008, 105). By being courteous and polite to all (even junior employees), I will be able to learn a lot. It will help me towards being in touch with all happenings in the organization and thus aligning myself properly. Many people loose it in organization due to living in ivory towers and not interacting with most of the employees.
Apart from proper personal etiquette, I plan to work hard in my future position as an employee in a bank. Hard work does not only earn the respect of others, it often brings a lot of gratification at a personal level. Working hard is not about being a busy bee but rather working smartly towards effectiveness and efficiency in my assignments. Effectiveness comes with having the right skills and know-how while efficiency comes with applying the skills in a timely and fashionable way. With the banking knowledge gained in college and experience gained from attachments, I hope to be able to fair well as an effective and efficient employee.
Middle Term Career Objective
My mid term career objective is to be able to scale to career heights as an employee. I personally plan to specialize in financial management; particularly portfolio management. Training is going to be very important in my career development. Once I have earned some full time job, I hope to enroll for further studies; for more specialized studies. Through studies, accumulated experience and personal development, I trust to see my self scale the heights in a banking career.
New skills play a critical role in career progression. Like indicated in the introduction, we live in dynamic times that require refreshing ones knowledge as often as possible. To grow and develop oneself or to remain relevant in a financial management field one has to be alert and studious. Those who succeed in any industry are people who are able to forecast future organizational needs early enough. Forecasting helps so that an employee may be able to align his or her skills with the future needs. By doing so, an individual becomes indispensable.
Apart from industry knowledge, it is generally advisable to gain knowledge in other areas or fields so as to be an all round individual. For example, after sometime, I would like to learn some new language or learns some creative art or sport. All the new things learnt help in making life exciting which directly influences my career life.
Long Term Career Objective
My long term career objective is to become an entrepreneur i.e. start my own business. At the apex of my career, I plan to switch from being an employee to an employer. Entrepreneurship has for more than a decade been a global buzz word. My desire to be an entrepreneur stems from my knack for creativity and innovation. I cherish creativity and innovation because without those gifts, we remain stagnated as a race. Becoming an entrepreneur and creating a system in which others can self actualize would be very gratifying for me. It will be the highest point in my self realization or actualization.
I hope to create a business empire in the financial sector of the economy. I realize many people would like to save and invest. In the coming years, the culture of saving and tending towards entrepreneurship will be more entrenched. However, not all will be smart enough as to realize how best and where best to invest. The kind of knowledge, experience and skills, which enable an individual to know how best and where best to invest, is developed over a long time.
The years I will spend working in a bank or banks will be critical towards developing skills and experience necessary for an entrepreneurial venture. My fancy is to be able to help people build wealth. Doing something of interest helps in building passion in an individual. Being self employed has many challenges. There are risks and hard decision to be made. Before business picking up and establishing brand resonance, the start up requires a lot of investment and energy in marketing. However, all my working life will be preparation towards the same; thus it should not be extremely challenging finally when I get to it.
Recruitment and Selection
Recruitment is a process that involves identifying and choosing the right candidate to fill a given vacancy (Edenborough 2007, p. 2). Recruitment is the process by which organizations attract, select and retain workers. The aim of recruitment is to avail enough qualified individuals or people into the organization. Sourcing for manpower is critical because without manpower organizational processes are not possible.
Recruitment is the most basic function of any human resource department in an organization. Through proper recruitment procedures, skilled employees are retained in the organization while new talent is identified and brought into the organization. Recruitment is prompted by current or projected labor needs in an organization (Armstrong 2006, 157). Some human resource departments do recruitment directly while others contract external organization or human resource consultants.
Recruitment Procedures
Each organization has its own procedures and policies that guide recruitment. The policies and procedures ought to be in tandem with legal provisions to avoid malpractice that may lead to lawsuits against the firm or a poor reputation (Armstrong 2006, p.10). The policies and procedures also ensure that only qualified candidates are selected. Setting of recruitment policies and procedures is a critical function of the human resource department.
A recruitment policy defines the code of conduct followed by recruiters when recruiting. For example, typical recruitment policy requires recruiters to advertise all available vacancies internally before external advertisement unless warranted by some rationale (Beardwell& Tim 2007, 64). Recruiters are also required to ensure all job applicants are replied to as fast as possible. Proper recruitment policy also aims at ensuring potential candidates are provided with all necessary job details and associated conditions.
Courtesy is stressed and all recruiters are encouraged towards efficiency and effectiveness. Recruitment policies and procedures ensure that all individuals invited for interviews are given fair, thorough and respectful evaluations. There are often claims of discrimination in recruitment. Organizations strive towards avoiding any forms of discrimination by setting good policies and procedures. Sex, age, physical disability or religion should not by any chance disqualify individuals for jobs they can do.
Recruitment Methods
Recruitment methods are largely grouped or characterized into two i.e. traditional recruitment methods and contemporary/internet based recruitment methods (Edenborough 2007, p. 2). Traditional recruitment involves an organization placing advertisements in newspapers or other Medias and allowing prospective candidates to send in their papers. A panel reviews the applications, sieves to identify the right candidates for interview, notifies the candidates for interviews and conducts the interviews. Contemporary recruitment procedures are more holistic as they go beyond traditional procedures to engage candidates in tests and other real activities that would help gauge their suitability.
Companies like KPMG provide a comprehensive recruitment procedure which consists of candidates going through an assessment center. Various activities such as in tray activities, presentations, group work and one on one interview are undertaken. Assessment centers are used because it is the most holistic recruitment method. IBM on its part engages its candidates to a written test, then a technical interview, an HR interview and occasionally group discussions are added to the process. The process is designed so that it determines knowledgeableness, technical competences and general competence.
Recruitment methods can be looked at in terms of external sourcing methods or internal sourcing methods. The external sourcing methods aim at attracting candidates from outside while internal methods tap into skill already existent in an organization. In external recruitment, an organization can do the selection itself or engage the services of an external recruiter or recruitment agency. Internal recruitment often involves posting information internally about availability of a vacancy. External sourcing is more demanding and expensive than internal sourcing. It involves such costs as advertisement, reviewing numerous applications.
Recruitment takes into account three stages. The first stage is identifying or projecting labor needs thus being able to define vacancy requirements. According to Armstrong (2006, p. 164), this involves preparing job descriptions and specifications; deciding terms and conditions of employment. A job description sets out the basic details of the job. It defines the reporting relationships i.e. who reports to the post and whom does the person holding the position report to.
The job description, further, defines the overall objective of the job and the main activities or tasks carried out (Edenborough 2007, p. 90). The job description also spells out clearly any other special requirements or features. For recruitment purposes, information may be provided on the arrangements for training and development and career opportunities.
The job descriptions are advertised with specifications on the kind of person that would fit into the job. The personnel specifications define the educational level, training level and general educational qualifications required. The personnel specifications also outline the experience and personal competences required for proper handling of tasks in the given post.
Once the job description has been defined, ways of attracting potential candidates are devised and engaged. Attracting candidates often happens through advertising vacancy in appropriate media. Attracting candidates requires first reviewing and evaluating alternative sources of applicants. Applicants can be sourced either from inside and out of the organization. Once the right source of applicants has been identified, the human resource department advertises the vacancy on its own or engages the services of agencies and consultants. Primarily, it is a matter of identifying, evaluating and using the most appropriate sources of applicants.
Sometimes vacancies are advertised only to attract few applications. In such like a case, organizations re-evaluate the job description or the targeted source of applicants. If the job was advertised internally and it attracts little or no response, chances are the required skills are not available internally or the terms and conditions are not appealing or good enough. Therefore, lack of enthusiastic response to job advertisement should lead to thorough research to establish what is wrong (Armstrong, 2006, 79).
Organizations do not always advertise job vacancies. For technical or strategic positions, sometimes organizations head hunt the right candidate. Referrals are very important in head hunting. Experience and technical competence requirements often necessitates that organizations employ agencies to head hunt the right candidates. As concerns choice of candidate attraction method, the organization or human resource department considers such factors as cost to be incurred, speed considerations and availability of required potential candidates.
Selection
The last step or stage in recruitment is selection. Selection is the final choosing of employee from the many candidates identified and tested (Edenborough 2007, p. 12). Selection often is done as per a given criterion. The universal criterion is that the candidate who has the best qualities for the job is chosen. This requires that the necessary characteristics of the right candidate be established upfront.
There are many selection methods used in organizations. The most popularly used method is interviewing. Interviews are a powerful tool at the hands of recruiters. It is during an interview that the recruiting officers get a personal encounter with the candidate. It is through interview that the candidate has the opportunity to market what he or she is in terms of character, skills and competencies (Beardwell & Tim 2007. 117).
Therefore, it is only in an interview session that the recruiters get to meet the given individual per se. This goes along way to inform the recruiters such that objectivity is arrived at. To the extent that interviews are properly arranged, organized and carried out, to that extent the employers get the right kind of people who can fit into the organizational goals and objectives. Therefore, issues involving who does the interviews, where and how are crucial in recruitment.
There are different forms or types of interviewing. Interviewing can be done directly or indirectly, individually or in a group, in a structured or unstructured way (Edenborough 2007, p. 206). Interviewing is direct when a candidate and the interviewers meet face to face. Indirect interviewing is done via telephone. A candidate is called and informed of interview time. The interviewer asks the candidate relevant questions and records the candidates answers.
In direct interviewing, the exercise can be individual based or group based. Individual interviews are where a candidate meets with the panel of interviewers alone. Group interviews are where candidates are put in the same place and interview questions put to them as a group.
Most organizations currently use modern methods of selection. The modern selection methods require combination of interviewing with other methods such as tests, assessments, presentations and exercises (Beardwell & Tim 2007, p. 140). Depending on post, practical tests to demonstrate skill are administered. At KPMG tests are done through a candidate being given a case study. If interviewing for a financial or knowledge intensive post, a case study or exercising involving interpretation of information may be employed. Presentations often require candidates to make a presentation on given topics or scenarios. For example, a candidate going for a sales management position will be given a case study so as to demonstrate how he or she is to employ knowledge and experience in delivering on sales targets.
Often, once vacancies have been advertised, recruiters receive numerous applications. Their work is to sift through the numerous applications and identify suitable candidates. The suitable candidates receive invitations for interview while the unsuitable receive only acknowledgement of receipt or regret letters. The applications are evaluated based on the set job needs or requirements. Applications can at times come in at an overwhelming rate. It is at the discretion of the recruiters to choose what to evaluate and when. It follows, therefore, that applicants have to present their applications in an attractive way. Clean or neat, well organized and planned applications are more appealing than others.
Recruitment is not complete until the selected candidates have been informed and invited to sign contracts. A vacancy is only filled once a candidate passes the interviews, tests and assessments and is given an offer letter. The offer letter indicates that the candidate has succeeded in impressing the recruiters and has thus been offered the job. However, the offer letter in itself is not legally binding. The candidate has to sign a contract that stipulates terms and conditions of the offer. Once contract documents have been signed by both parties, the recruitment exercise is considered successfully completed.
Self Evaluation: Psychometric Test Reports
I am confident to succeed in my career plans. My confidence results from how I have been fairing in activities at university as well as the indications on the psychometric test reports. I have developed my capacity through training and experience from previous work. Apart technical knowledge accumulated from class units, I have good working knowledge of Microsoft Word for Windows, Excel Spreadsheets and Internet, which I developed from my previous work and study experience.
The type at work psychometric test report indicates that my preferred work style is coordinator. According to the report coordinator style people tend towards being organized, systematic, responsible and dutiful. Coordinators are principled people who strive for clarity and deliver on their promises. They are generally uncomfortable with uncertainty and tend towards converting whatsoever is uncertain into something more concrete and understood. Coordinators value order and discipline a lot that they have some difficult dealing with change.
The report on my work style is accurate. I am the kind of person who values order and discipline. I like it when people are principled and behave with integrity. Maybe my focus on being right and truthful makes me somehow inattentive to the needs and feelings of others. However, I am generally an individual others do not find very imposing. I have been a very resourceful team member on different activities at the university.
The report goes further to indicate that coordinators find satisfaction in fulfilling duty and responsibility. Work for coordinators is a duty or a responsibility. As a result of their sense of responsibility and duty, they like a disciplined work place and stick to traditional values. Building order through clear structures and systems is what drives coordinators. On the work environment, the report indicates that coordinators like a disciplined and ordered work environment. Such an environment should allow for hands-on work. They have a knack for details and would want to see tangible results from their efforts.
I tend to agree with the report because I find myself as a pretty focused individual. I like to do my work on time and to specifications. I think I would like a job with measurable results at the end of it. At the end of an assignment, it brings a lot of joy if there is some result I can show for the work or effort employed.
I am certain my choice for a career in banking best suits me. The report indicates that coordinators enjoy work that requires tough-minded analysis, and in which one is able to influence. The work also ought to have measurable or quantifiable results or outcomes. A banking career thrives on proper analysis of business data. Financial management as a field requires serious analysis of market trends as to know what is profitable in the long run and in the short run. Coordinators also have a knack for detail which is critical in a banking career. A simple comma in a figure and a big financial mistake is in the offing.
When it comes to working style, coordinators are very disciplined and awesome time managers. They tend towards being conservative. Although the report talks of coordinators not being great initiators, however once convinced of need for change they strongly champion it. Basically, I manage my time well enough. Although I do not fancy any for of recklessness, I appreciate creativity and innovation. Change when properly appropriated makes sense to me as opposed to chaotic change. I therefore fully agree with the report with regard to my working style.
In the university, I have been a member of different teams working on different presentations. In some teams, I have been a team leader while in others, I just played active roles. The psychometric report affirms my leadership tendencies as it indicates that coordinators assume leadership naturally, are outgoing and direct. In relation to others, they normally come out as leaders or people who can be relied on. They easily assume responsibility and take the needs of others as their duty.
The work type report made me convinced that I am best suited for a banking career. The career requires focused and responsible people. It provides systems that rely on clear policies, rules and structures. It is a career that enables one to employ analysis while at the same time realizing tangible results. From previous work experiences gained from university work such as group work and presentations, I feel I am ready for my career.
On verbal reasoning skills my score was 24%. This score indicates that I was only better than 24% of other individuals who had taken the test. Although the test may have had its errors, the low score is generally an indication that I have to work some more on improving my verbal skills.
The report on learning styles indicates that I am an activator. As per the reports description, an activator is geared towards tangible ideas, tends towards practicality as opposed to abstract considerations, is hands- on and works at a fast pace, enjoys interaction and likes things well ordered, wrapped or sealed. The report is a good account of me although I tend to imagine that I am very creative and innovative. But as the report indicates, one possess some qualities form the other learning types.
On the numerical reasoning test, I scored 27%, which is somehow weak but it is to a great extent accurate. I am not very good with complex numerical applications especially when speed and accuracy are required. I would have to improve my numerical skills for a successful career in banking.
Communication
Successful business is only possible with proper communication. Effective and efficient communication in the market is what gives organizations a competitive edge. Organizations need to communicate because brand resonance is only possible through proper market communication. Even internal harmony in any organization is only possible if information is distributed in an efficient and effective way.
Some of the common information distribution methods that are employed in organizations include; verbal communication, formal reports, memos, ad hoc conversations, reporting within organization and peer sharing. The choice of an information distribution method depends largely on who is communicating, to who, when, why, urgency of information, required security or confidentiality level, required storage needs or reference needs, and availability or affordability of means communication.
Communication Styles
There are a number of communication styles employed by individuals. The most popular ones are direct communication, indirect communication and circular communication. Direct communication is where the conveyer of a message is direct and to the point. Clarity and conciseness is often the aim of direct communication. In this style of communication meaning is conveyed explicitly as it is and there is not effort to veil any nuances. At the university, we use direct communication when answering to or doing assignments. Direct communication helps save time and is widely used in formal or official communication. However, between friends, direct communication allows for expression of ones real or raw feelings without having to coat them in any way.
Indirect communication is a style used to hush the brunt of information being delivered. For example, to avoid hurting or embarrassing someone in public, one can use indirect communication style. In indirect communication, one passes a message in a non-direct way thus the message is vague and often subjective in interpretation. Meaning in indirect communication is as implied in the message or what the communication suggests.
Circular communication style is also known as the contextual communication style. In this style, a speaker gives content that aims at portraying a given point. However, he or she does not clearly state the point. It is assumed by the speaker that from the content, the recipient of the information will decipher the main point. The information is delivered in a cyclic way i.e. the information has a locus or a context around which it is organized but it is for the recipient to discern the locus or context and thus get the point. This kind of communication style is used when explaining something or in the context of relationships among buddies.
There are other communication styles but they are depended on direct, indirect and circular style. The idea focused style is where of key interest is the interrelation between ideas and the meaning being portrayed. Idea focused style detaches ideas from feelings thus aiming only at objectivity and calmness. The speaker and receiver are impersonal and all ideas are to be respected. This kind of communication style is used in intellectual discourse where individuals strive for objectivity as opposed to subjectivity.
Communication is a critical aspect of a job search exercise or recruitment exercise. The applicant has to communicate that he or she is the right person for the job and justify why he or she thinks of self as best suited (Edenborough 2007, p. 18). The recruiters have to be able to communicate what they are looking for succinctly. They also need to employ communication tools that will help them understand candidates as accurately as possible.
In most recruitment evaluations, recruiters look into the communications skills of the applicant. It is a fact that an individual who can communicate well is most likely to win a job interview. People who can communicate are trainable. Some jobs like sales are highly depended on communication skills. One can only communicate effectively about a subject if he or she understands the stuff he or she is discussing well enough. Therefore, the candidate who communicates candidly is most likely the most qualified for the job.
The two important documents for a job seeker are a cover letter and Curriculum Vitae. A cover letter is basically an official letter communicating intent or interest in the advertised position. In writing the cover letter and the Curriculum Vitae, direct communication is encouraged. This means that an individual has to be direct and to the point. It often introduces the candidate, expresses interest in the job, informs of how the applicant got to know of the positions availability and clearly outlines why the candidate should be considered.
The cover letter ought to be kept official, brief and neatly organized. Curriculum Vitae (CV) are a powerful document for a job searcher. It helps in introducing applicant before he or she appears to recruiters in person. It is what gives detailed information about the candidate and is often used to judge candidate suitability.
Some job advertisements specify that they do not need Curriculum Vitae but resumes. A resume is a briefer document that covers basically the applicants academic background and skills. Like in the CV, it is important to only include information that would be relevant to the position applied for. While CVs are detailed, resumes are brief and to the point.
One on one or face to face communication skills come handy during direct interviews. In direct interviews, the recruiters meet the client and ask him or her questions. The recruiters listen to what the applicant says but also the non verbal messages he or she communicates (Edenborough 2007, p. 21). The trick with interviews is being able to remain calm, clear, concise, correct and consistent. When answering interview questions, it is good to be clear about what the question seeks to establish. Some question aim at testing applicants knowledge. Others seek to identify applicants competencies while others seek clarification on information provided in the curriculum vitae.
Most often interviewees forget that an interview is supposed to be a dialogue. By not engaging the interviewers, applicants miss an opportunity to interact that would have helped them come out more favorably. As illustrated in sample question and answers on Job Bank USA (1995, p. 1), in answering interview questions, it is advised that one connects or remains relevant to the issue at hand. However, by employing such communication styles like indirect communication one can ably wade against killer questions put across by interviewers. Circular communication style comes in handy when asked open ended questions and the interviewers are not clarifying them well enough.
Conclusion
I am confident as I make myself ready for a career in banking. My confidence stems from the fact that my career plan is vividly clear to me. In the career plan, I was able to set both short terms, mid term and long term career objectives. I was able to outline some of the likely challenge I might face at the work place and how I would counter the same through personal etiquette, technical training and being alert to change.
This paper also covered the different recruitment procedures used in companies such as IBM and KPMG. Further the paper presents a self evaluation and a discussion on communication styles. Having evaluated what happens in recruitment, I feel well prepared to handle recruitment requirements. The self evaluation bolsters my belief that I am well suited for a career in banking. Finally, a discussion on communication styles has helped me reflect more on the kind of communication strategies I need to successfully engage the job market.s
Appendices
Reflective Statement: Assessment Centre Activities
Most organizations use assessment centers in their staff recruitment. The assessment centers offer myriad processes aimed at testing different competencies. Assessment centers often come after interviews but some organizations bring them before interviews. The purpose of the assessment centers is to observe the applicants for a longer period before a final selection. In the assessment centers, a candidate is observed by several assessors for some time as he or she interacts with others or handles given challenges/ tasks.
Assessment centers are taken in high esteem as being most objective or accurate selection method (Edenborough 2007, p. 143). I am also convinced that assessment centers are a more accurate selection method because an individual is observed over a longer period of time unlike in the 20 to 30 minute interviews that would traditionally be allocated to candidates in an interview. I also believe assessment centers are more objective because an individual is given a chance to demonstrate what he or she can do as opposed to just claiming without proof or being doubted from what is said in an interview.
From the assessment center activities done at the university, I realized that one can enjoy the exercise as long as he or she approaches the activities with an open mind and confidence. What is critical is to have the selection criterion in mind. It is not good to act out but as long as what is being looked for is clear and you have it in you, it is not hard to bring it out thus show the best and earn a dream career.
The assessment center activities go beyond mere industry knowledge to assess behavior and competencies. The activities that range from presentations, group work, individual exercises, and interviews are a holistic way of evaluating a candidate. In a way, the different activities help especially candidates who could be tensed. Sometimes due to tension, people blow their interviews. However, when the activities are many and varied the effects of tension are mitigated and one has a superb opportunity of helping assessors understand his or her capability.
In essence Assessment centers can be lots of fun because they involve interaction in social events. In the informal events, a candidate meets various people; employees, assessors and candidates mixed. With an open mind and a positive attitude, one gets the opportunity to learn a lot about many different things especially the organization into which one aspires to work. I realize that the best conduct in search informal events in assessment centers is to be free, respectful to all and of good cheer. It is also good to exercise moderation and guard from any excesses because assessors learn a lot on the candidates during the informal sessions.
Being attentive in assessment centers is very critical. When one is alert, he or she is likely to pick all cues that will lead to success in the assessments. For example, there are informational sessions e.g. when managers or supervisors talk about organization in introduction. Secondly, either an assessor or managers gives a brief overview of goals or aim of assessment center activity. In those information sessions, one can pick exactly what the assessors are looking for and more information about the organization.
Given it is a long exercise with many stages I think remaining focused although is critical. There are different stages and some people loose it when they loose focus along the way. It is easy to forget the bigger picture of why one is at an assessment center. The big picture is proof oneself worthy of the job. The focus thus should be on using own potential or capacities in the different stages or activities as to proof worthy of employment.
Making mistakes in some of the stages is inevitable; however, no mistake is too grave to cost performance in all remaining stages. There could be a temptation of getting disorientated due to a mistake made at some stage. The ability to pull oneself together after a mistake is likely to be more impressive to assessors and even place a candidate far above the rest.
Having experienced assessment center activities at the university, I realized that preparation before going to an assessment centre is critical in determining success. Preparation would include gathering as much information as possible about the organizations. Secondly, it is good to have as much information about the industry as possible; especially recent trends or happenings. It is also good to read widely about the different activities engaged in at different assessment centers.
Reading about the activities helps an individual to prepare psychological as well as intellectually. Reading widely comes in handy in the discussions and presentations. Where role plays are concerned, it is great just to let go of all fears and unleash the best of oneself. Most crucially, it is important to understand the selection criteria. All the activities in the assessment center are aimed at testing a selection criteria related competence.
Reference List
Armstrong, M 2006, A Handbook of Human Resource Management Practice, 8th Ed, Kogan Page, New York.
Beardwell, J, & Tim, C 2007, Human Resource Management: A Contemporary Approach, 5th Ed, Financial Times, Prentice Hall, New York.
Edenborough, R 2007, Assessment Methods in Recruitment, Selection & Performance: A Managers Guide to Psychometric Testing, Interviews, Kogan Page, Philadelphia.
Job Bank USA, 1995, Communication Skills Interview Questions, Job Bank USA. Web.
Rose, E 2008, Employment Relations, 3rd Ed, Financial Times, Prentice Hall, New York.
The world of business is facing increasing competition due to the rising numbers of new entrants who share existing customers with present firms. It is therefore necessary that, firms that are currently in the market should constantly improve in response to the changing market and customer needs.
This competition is also observed in the banking industry due to the emerging technologies and innovations like mobile phone and internet banking. These are the major threats in the industry and to get by, well formulated plans have to be put in place by existing banks1.
Firstly, the bank should improve its public relations and customer service to be able to maintain existing clients. This can be accomplished by the provision of suitable and timely customer care solutions; in addition to that, necessary efforts should be taken to reach out to unwilling clients. The customer care departments should be highly efficient in service delivery to ensure customer satisfaction and loyalty. This builds a unique form of link between the bank and the clients thus the firm is able to create a strong customer loyalty2.
Secondly, in order for the firm to maintain the existing clientele, the bank should be more active. For example, it should adjust the available bank loans and accounts, by adding more benefits on the holders like increasing interest rates on savings and bank deposits. Besides, launching a promotion based on every day deposits of cash in personal accounts, will keep the existing customers through the offer of attractive prizes and free samples.
Additional products should be supplied to the market to raise extra capital, while those shares bought by the old clients should be sold to them at a discount to promote loyalty3.
The bank should make sure that it carries out a complete over howl of its inside and outside environment to sustain its position in the industry. The over howl should involve Internal transformation and use of benchmarking as well as the involvement of independent system auditors to implement modifications.
They perform an audit of the banks internal control system, and grade the firm in accordance to industrial standards like the ISO 900. These evaluations aid the firm in identifying its position in the industry in comparison to other similar firms. Furthermore, to exploit its strengths in the market promotes retaining the existing customers through providing unique products like mortgages with convenient repayment plans4.
The customer needs should be the priority of management during planning and resources allocation. The management should also take up professional advice to improve service delivery to the clients and hire new professionals where necessary.
Moreover, they may use risk managers who will advice the management during projects of any impending risks and how to manage and avoid them. The bank should put in place a plan to ensure specific needs of main customers are met, by offering them multy city cheques to facilitate service accessibility from anywhere.
It can be better if the firm will consider the alternative of doing what other banks in the industry are doing. Nearly all the services provided in the banking industry are identical in nature.
Consequently, the bank should consider giving its clients somewhat customized services but analogous to those offered by the competitor banks to avoid losing clients and being out dated for lacking modern services. The firm should put in place guidelines for giving appreciation to older clients like the use of bonus and giving loyal customers redeemable points. Through a continuous and consistent effort, the bank will be able to develop and establish a strong customer allegiance5.
To avoid the loss of customers, the bank has to consider an immediate solution of offering customers their requests as a special case only to distinguished clientele. Nonetheless, the company should carry out pertinent research activity on the possibility of providing similar services through other means that are less costly.
These services may be used instead of the cheques for example embracing of mobile phone and internet banking; here, the bank amalgamates with mobile phone service providers corporations to provide customers with banking services through their handsets.
In order to build a competitive advantage the firm may consider using the direct opinion of the clients themselves. An establishment of a consistent and proactive research group may be able to ensure that the firm has consistent and up to date market needs.
Understanding the perspective of the client on his choices and the reasons for the choices may be an avenue for the development of new products. This can help in keeping the customer from seeking the services of the other service providers. It also improves customer devotion through consistent appropriate and honest communication with agents of the company.
Through consistent audits and evaluations done on the system of the company, the level of efficiency may be determined as well as the ability of the bank to achieve set goals. Other departments of the company are scrutinized to establish their proficiency in goals achievement. Excellent strategies facilitate smooth operations beside the competent service delivery to the client; all these benefits aid in client contentment and loyalty.
Bibliography
DiJulius, John. Secret Service: Hidden Systems That Deliver Unforgettable Customer Service. California: New Harbinger Publications, 2003.
Faulkner, William. Satisfying your Customers. New York: Vintage Books, 2002.
Gitomer, Jeffrey. Customer Satisfaction is Worthless, Customer Loyalty is Priceless. Chicago: William & Sons publishers, 2005.
Heyken, Shep. The Cult of the Customer: Create an Amazing Customer Experience That Turns Satisfied Customers Into Customer Evangelists. New York: Waveland press Inc, 2009.
The concept of Too Big to Fail (TBTF) is used to describe financial institutions that are very large and are interconnected with other institutions and contribute a big part of the economy such that, when they fail, they have serious effects on the local economy. TBTF are normally an economic disaster and the government must support them when they face difficulties to avert the problem.
The main cause of the TBTF problem results from the interconnectedness that exists between large financial institutions and other business firms. Large banks generate big undesirable financial externalities that destabilize the stability of other firms. Most large banks provide credit facilities to households and businesses and disruptions would definitely affect the operations of this business.
The impact or loss experienced is dependent on the interconnectedness that exists between the financial institution and other business that exist in the network supported by the failing financial institutions. The great negative externalities create a problem for the policymakers/ government since the danger of these failing institutions can cause a wider problem to other businesses. The government has no option but to step in and save the financial institution in question.
Most government are likely to support the TBTF institutions as compared to other less complex organizations and hence most of these TBTF have a tendency to exercise less control in their operations and are less disciplined since they have the prospects of being rescued by the policy makers. The American government passed the FDIC act in 1991 proposes that the government should use the least costly method to rescue an insolvent bank (Dudley 6).
The impact of the TBTF problem was experienced in the late 2007 when most nations helped struggling financial sectors recover from losses. During this period, banks were offered liquidity support, capital injections and others were nationalized.
The concept of TBTF came into practice in 1984 when FDIC took over the continental Illinois national bank and trust company which was one of the largest banks in the US. FDIC compensated creditors while the shareholders lost their money. This was seen as the government action to bailout the financial institution where the creditors were bailed out but not the equity holders (Meltzer 1).
Causes of TBtF Issue
One of the main causes of the TBTF problem is the excessive growth of financial institutions both locally and internationally. As banks continue to grow, they become increasingly complex and bigger attaining a big market share both locally and internationally. This increased growth has results to complexities in administration and this finally results to failure.
Another cause of TBTF problem is the excessive credit growth which contributes significantly to the banking crises around the world. Various researchers have also indicated that weak economic growth, high inflation rates and the real interest rates are important in predicting economic crises in the banking sector and hence, it is necessary to check them as they are likely to cause crises.
Another imperative cause of banking failure is poor management practices. Properly managed banks have a tendency to survive harsh economic conditions due to proper planning and use of advanced risk management practices. The probability of a bank survival in the USA is determined by the ratios such as capital: assets ratio, the non-performing ratio, and loan: assets ratio and certificate: deposit ratio.
For banks in Europe, the main determinants of a bank in crises are loan-loss provisions, capital: assets, non performing loan: assests and the bank earnings. All these ratios are likely indicators of a looming TBTF problem. Good management practices and proper risk mitigation strategies have a great impact on the ability to save a bank from failure.
The other cause of the too big to fail problem is the existing policy and financial institutions regulations. Different countries have varying laws that control the operations of banks. These rules and regulation affect and regulate the different banks. The government failure to regulate large banks is also a cause of TBTF problem.
Problems of the TBtF issue
There are many problems that are direct results from the TBFT. The failure of the big bank is likely to have far reaching effects to both the business and the households. Small businesses depend upon banks for credit facilities and when these banks fail, they lack of money to perform their operations. The same case applies to individuals who rely on banks for loans and other financial support (Dudley 6).
Another great impact of the TBTF is the use of taxpayers money to bail out these banks. Most of the large banks have a wide scale of operations and the money required to bail them out is quite substantial as compared to the taxpayers money generated by a given country. The use of taxpayers money will have financial implications on the countrys financial and economic progress.
Another great issue arises from the need to control the operation of large banks. Some of the TBTF have branches in the major areas of the world and financial problems affecting other areas such as inflation and regional financial instabilities may affect the bank. In this case, the intervening government may be forced to bear a burden not caused by the prevailing market conditions in that country.
Another problem associated with the TBTF banks is their indiscipline because of the assurance and expectations that the government will rescue them. Such corporations tend to lack proper managerial and risk mitigation strategies and this escalates the problem of TBTF.
Solutions to the Too Big to Fail Issue
Cut down on size
One of the solutions of the TBTF banks is the size of these banks. Most of the large banks have numerous branches both locally and internationally. On the other hand, these branches have wide interconnectedness to the local and foreign businesses. It therefore becomes hard to control the whole bank as one entity. This necessitates that the bank size be reduced. (Meltzer 1) states that, if a bank is too large to fail , then it is too big.
He suggests that such banks should be cut down in size so as to reduce their complexities and externalities. In order to reduce the size of megabanks, both radical and incremental measures should be undertaken. One act involves limiting the combinations of commercial banking and investments banking as well as offering insurance underwriting. This was defined by the Glass-Steagall act which separate commercial and investment banking.
These restrictions have however been abolished but reinstating them could serve as a better method of solving the current problem. This separation however may not work well for the systemically important firms. Taxation has also been cited in the articles as another method to cut down on the size of the large banks. The proponents of this idea argue that, if a bank is too big to fail, then it should pay a high tax so as to significantly contribute to the taxpayers money in case of its failure.
Increased taxation is also likely to prevent banks from becoming excessively big. Of the failure of large institutions impose a negative externality, then, it should be pay additional capital charges to remedy the negative externality in terms of pigovian tax. Taxations would thus serve as a disincentive to the growth of large banks. However, imposing a huge capital charge on large organizations may act as a deadweight loss as it would directly result to reduced lending and other economic activities in the country.
Another regulatory measure is the Dodd-Frank act which combines a set of restrictions and laws to regulate the TBTF institutions. The law provides regulations for capital requirements, risk assessment method on deposit insurance, the liquidation process as required by FDIC, the Volckers rules, tests on financial stress and methods of protecting investors.
One of the regulations imposed by the Dodd frank act is the abolishment of the financial support that can be given to the large banks. This will definitely result to an end to the TBTF phenomena. This act limits the government intervention should the TBTF banks fail. However, this mechanism prevents only the use of taxpayers money but does not prevent the impact the failure of TBTF has on the society in general. This is because the main consequence of the TBTF is the impact it has on the small business.
The Volcker rule is another measure among the Dodd-Frank rule that has been used to prevent the negative impacts of the TBTF. The law enables the creditors to understand that in case of failure, they are eminently going to suffer loses.
The reduction in creditors of the large institutions due to their caution they take due to Dodd-frank would result to limited source of funding and this would enable small banking investment to take advantage. This means that banks that rely on borrowed deposits would have to pay premiums so as to reduce risks imposed on the creditors.
Another law is the stringent measures that have been imposed on the systemically important financial institutions. The Dodd Frank rule identified these financial institutions and imposes new rules and regulations. These regulations are likely to impose restrictions on the big banks and enable them operate in a more controlled manner.
The Volckers rule is the cornerstone of the Dodd-frank rules and was formed as a modern version of the Glass-Steagall rule of 1993 that separated investment banking. The Volckers rule bans proprietary trading. This occurs when a bank invests its own funds so as to make profits.
This rule bans banks from one of the most profitable business and most banks argue that this rule cannot prevent financial crisis. Most of the financial institutions indicate that the financial crises resulted from bad management of mortgages and not from insurance banking (Mishkin 4). There is no evidence showing that the financial crises of 2007 were caused by the lack of separation of the banking activities.
The Basel III regulations are also set to reduce the impact of the TBTF banks. The Basel III is a global regulation standard for banks capital. The rules under these regulations seek to improve the quantity and quality of the capital from banks. The proposed rules are that tier I capital will be increased from 4% to 6% , the tier 1 common equity requirement increased from 2% to 4.5 % and a leverage ratio of 3%.
All these measures among others will improve the capital quality and quantity and limit the effects of TBTF (Mishkin 4). In line with these rules are other international rules such as the United Kingdom which is set to adopt ring fencing. Ring fencing as outlined by Sir John Vickers independent commission seeks to separate banking activities from other activities.
The rule indicates that high street banking business should be separated from the investment banking which is more risky. Ring fencing stipulates that there is need to separate the high end banking operations from other banking services. Furthermore, these banks will be required to hold a capital of 10% and 20% when the debt instruments are included.
CONCLUSION
In culmination, the too big to fail problem results from the interconnectedness that emerge from big financial institutions and other businesses. When big financial institutions fail, they have far reaching economic impact and as a result, government has to bail these institutions. All the articles indicate that it is necessary for appropriate measures to be taken to avert the fail scenario as well as reducing the size of these banks. The articles however criticize the measures taken are ineffective in controlling the impacts of TBTF and other specific measurers need to be undertaken.
Works Cited
Dudley, William. Solving the Too Big to Fail Problem . Macro prospective on the capital markets, economy, technology & digital media. 15 Nov 2012:1. Web.
Meltzer, Allan. End Too-Big-To-Fail. The Magazine of International Economic Policy. Winter, 2009.
Mishkin, Frederic. How Big a Problem is Too Big to Fail? A Review of Gary Stern and Ron Feldmans Too Big to Fail: The Hazards of Bank Bail outs . Journal of Economic Literature 19.1(2006): 9881004.
Merging, as defined by many scholars, means combining two independent firms to form one company while acquisition refers to a situation where one firm buys another one that is perceived to be financially stable. It is apparent that both vertical and horizontal merging is associated with disadvantages and advantages. In recent times, there have been so many cases of merging between banks over and above other financial institutions.
For instance, the recent mergers formed between JP Morgan and Washington Mutual, Wells Fargo and Wachovia among other mergers are some examples. However, it is scaring that current and future merging would increasingly pose more problems that would see many banks suffer from financial constraints as well as technical problems.
Due to increasing levels of technology, diverse banks are embracing different technologies that would make it difficult for the two merged firms to match their diverse technologies. In addition, management system practiced by different banks would as well create a problem considering that todays management system is tending to vary across financial institutions due to increased levels of competition.
It is also noted that large banks are merging creating a monopoly problem in the market that subsequently leads to low levels of competition in the market. Loss of employment and uneven distribution of stocks is as well becoming a central issue that may stop merging practices in future (Rosenbaum, & Pearl, 2009).
Merging of financial institutions including banks is likely to face diverse problems within the area of regulation. In recent times, most mergers tend to be kept a secret from the public, including employees. This has made it quite difficult for regulators and the government to determine the number of mergers that occur within a specified period.
Any merging of two or more independent companies should be reported and registered legally by various market regulators.
Furthermore, it is alleged that merging of two dominant firms in the market would create a monopolistic situation, which may hinder competition leading to exploitation of consumers through diverse practices such as provision of low quality products at high prices.
Since merging requires more funds, it would prove difficult for mergers to obtain funds from reputable lenders (Fleuriet, 2008).
The acquiring firm sometimes may face a range of problems while acquiring a given firm. The problems mainly relate to lack of standardization in addition to inadequate knowledge relating to acquired firm. Lack of standardization denotes failure of two merging banks to have similar systems that would exactly match with each other.
The variations arise because of using dissimilar technologies or sometimes having a completely different management system. The acquiring firm might also lack full information regarding the acquired firm management system as well as its financial position.
Sometimes, the acquired firm might hide its true financial position, which later leads to more complications when the firm is already acquired. Knowledge pertaining to the firms culture and systems is essential in determining whether structures of the acquired firm would match that of the acquiring firm (DePamphilis, 2008).
There have been continued issues relating to staff reduction while practicing merging and acquisitions among diverse organizations. The mergers always require additional funds to employ new technologies in their systems in order to remain competitive in the market. Initially, the two firms experience increased overhead costs, which can partly be explained by efforts incurred by mergers to restructure new systems.
The merging firms believe that they would be able to pull their funds together and acquire new technology in the industry enabling them to remain effectual in their operations.
The merging firms endeavor to reduce overhead costs by combining different departments, which leads to subsequent reduction of employees. It is notable that two CEOs of the merging two companies would hardly be given the top position of the ensuing merger (Rosenbaum, & Pearl, 2009).
In the contemporary world market, it is imperative for various organizations to acquire funds that would enable them to carry out their operations effectively. There are various sources of funds, including internal and external sources. The internal sources constitute retained earnings as well as reinvested dividends by the existing stockholders whilst the external sources mostly comprises of equities and debts.
However, it becomes essential to determine whether it is more beneficial to raise funds through equity or debts. Each source has its advantages and disadvantages. Although debt has become an expensive way of raising capital, it is evident that debt is the best option of raising capital for further expansion and other investments given that it does not dilute the share capital of existing shareholders (Fleuriet, 2008).
Raising funds through equity to many may seem as the cheapest way of raising capital for any organization seeking to expand its operations. Indeed, if a keen examination were to be done on sources of capital, it would come to ones sense that equity is perhaps the most expensive way of raising capital.
Generally, the cheapest way of raising capital is through internal sources such as retained profits, even though a firm does not raise sufficient capital for various investment activities. This forces a firm to seek other means such as issue of debts and equities. Although debt is expensive in terms of interests and principal payment, it is obvious that equities of existing shareholders are not diluted to any extend.
On the other hand, issuing equities end up diluting stock of a firm meaning that investors end up sharing dividends with new stockholders. Consequently, investors keep working hard only to take a small portion of net profit after tax as dividends goes mostly to individuals and institutional investors (Peterson, 1999).
In the contemporary economy, it is easier for a firm to raise capital through equity as compared to debt. A number of advantages associated with equities make it possible for investors to prefer equity to debt. Frequently, ordinary stock shares allow all firms stockholders to share both profits and losses, thereby distributing equal risks among equity holders.
Conversely, debt calls for the organization to pay interest to debt holder at the end of agreed period irrespective of whether the firm made a profit or a loss. Most firms in a range of markets are normally uncertain of their performance in the industry making them fear commitments linked to debts interests and principal payment. It is as well renowned that debt has become expensive due to their regular high interest rates.
A corporate bond, which is offered at a coupon rate of 15%, becomes quite expensive for a firm since most profits go to payment of interests. Finally but not least, equity allows a firm to incorporate diverse experts in running of the firm, which enables the company to make fine and crucial decisions pertaining to operation.
Debt does not allow the company to access new management systems, which would help the firm maneuver through turbulent market environment (Peterson, 1999).
References
DePamphilis, D. (2008). Mergers, Acquisitions, and Other Restructuring Activities. New York, NY: Elsevier Academic Press.
Fleuriet, M. (2008). Investment Banking explained: An insiders guide to the industry. New York, NY: McGraw Hill.
Peterson, P. (1999). Analysis of Financial Statements. New York, NY: Wiley.
Rosenbaum, J., & Pearl, J. (2009). Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions. Hoboken, NJ: John Wiley & Sons.
Non-bank firms acquire and use real assets in a way that makes the value of future benefits received greater than the cost of obtaining them. Banks, on the other hand, acquire and use assets so that the value of their benefits exceeds their costs. A majority of banks hold financial assets while non-bank firms hold real assets. Banks use deposits of their customers (creditors) and owners to acquire financial claims against others.
They may extend loans or may invest in other financial instruments. The returns the banks expect to receive will thus depend on the performance of these investments. Non-bank firms will use funds provided by the owners and borrow loans from financial firms or get credits to purchase real assets.
The returns they receive are from selling the assets at a higher price or use them (assets) to produce other products which they sell at a margin.
Financial intermediaries, by their existence, contribute greatly to economic performance through bringing both borrowers and investors together. Financial intermediaries reduce transaction costs through brokerage and create their own financial instruments. Financial intermediaries also help in reducing agency costs, which come up because of information asymmetry between the market and investors.
Why Is It Important to Have Stricter Regulations on Banks?
There has been a lot of debate on whether strict regulation on banks are necessary. The reasons below show that it is necessary to have strict regulations on banks and other financial institutions:
The main reason why banks need regulation is to ensure that there is financial stability in the economy. This is to ensure that prices of financial instruments are relatively stable and adequate for an economic growth.
Regulation of banks and financial institutions is critical to prevent market failure (financial collapse) caused by externalities from the financial system.
Regulation is necessary to ensure enhancement of consumer welfare including protection from fraud and monetary (macro-economic) policy considerations.
Regulation is necessary to ensure that banks and other financial institutions are solvent enough by stipulating capital levels required.
Lastly, regulation is critical to ensure that these institutions are liquid at all times to be able to meet their financial obligations and when they fall due.
Maturity Matching
The term maturity refers to the date or to how long it would take for any financial instrument, such as a loan, to be repayable. It also refers to when the interest would be due. Though there is no clear definition, finance scholars have described the circumstances that show maturity matching.
In Working Capital Management, maturity matching is a financial plan, whereby one matches the expected life of an asset with the life of the source of funds. Others have tried to define it in Asset Management as the situation where an organization controls its cash inflows and cash outflows. An organization does this by matching the expected life of its income-generating assets with the expected life of its interest-bearing liabilities.
In maturity matching, when used, a firm would finance its fixed assets and permanent current assets with long-term sources of funds, while current assets would be financed using short-term sources of funds. When a firm matches the variations of its assets and liabilities of the maturity, it hedges itself against any unexpected changes in interest rates.
Maturity Matching Instead of Borrowing From Financial Markets
If financial institutions used maturity matching rather than borrowing from financial markets, this action would have an enormous effect in the overall economic growth. This is because when firms match the variations in assets and liabilities, it hedge against the uncertainty in changes the short-term interest rates bring.
It is easier for a financial firm to manage its risks caused by changes in interest rates than borrow money from the financial markets. This improves financial markets liquidity, which leads to stability in the financial system. Additionally, it helps the firms to maintain high credit ratings since they will rely less on borrowed funds. Therefore, there is less exposure to credit risk.
Maturity matching would help the financial institutions to reduce their liquidity risk and improve their profitability. This is because they pay less interest compared with borrowing from financial markets. Consequently, it increases growth in the economy as a whole.
Therefore, in conclusion, the usage of maturity matching is more advantageous than borrowing from financial markets. This is because it will lead to increased profitability of the firms and reduction of liquidity risk. At the end, it leads to stability in the financial sector and to increased economic growth.
What is Speculation/Hedging/Arbitrage?
Arbitrage
It is a trading strategy, whereby an investor would gain a profit from a transaction without injecting more capital or exposing himself/herself to more risk. For example, purchasing a financial instrument from one market and selling the same instrument in another market with different prices. In this case, the investor takes advantage of the market inefficiencies.
Another definition given by economics is that it is an opportunity to buy a financial asset from one market at a low price and sell it to another market at another higher price thus making profit.
Therefore, arbitrage is the simultaneous purchase and sale of a financial instrument at a low price and selling it at a higher price to make a profit without commitment of more capital by the investor. The investor makes profits by taking advantage of the differences in prices caused by market inefficiencies in the two markets. This ensures that prices do not deviate from the fair value significantly.
Speculation
Investors invest in risky assets with an aim of making profit when the prices change through the process. It is not a form of betting because investors make decisions after evaluating the financial assets performance before purchasing the asset. It is not a traditional investment since the risk acquired is greater than the average one.
Another definition of speculation is the commitment to any transaction containing significant risk but with higher chances of huge profits, especially in financial instruments. Speculation is also the considerate assumption of a risk, which is higher than the average short-term risk with an expectation of receiving huge profits from anticipated changes in prices.
Hedging
Hedge is an investment situation position taken by an investor to counterweigh potential losses, which is likely to cause another investment. A number of financial instruments such as swaps, options, futures contracts, forward contracts, insurance, and stocks can construct it.
It is the process of decreasing risks using derivatives. It is also the process of dealing with the risk of price changes in assets by offsetting such risks in the financial markets using financial instruments. It can vary in complexity depending on the number and the type financial instruments used.
Develops an Efficient Market
In an efficient market, the prices reflect all the relevant information about the underlying asset. Thus, no one can take advantage of the market and make above-normal profits. Arbitrage will help in creation or development of efficient market since all investors will act rationally. Hence, they will sell overpriced assets and buy the undervalued assets. Eventually, the market will correct itself and the asset prices will be correct.
Speculation will lead to efficient market through investing in risky assets and expecting their prices to rise. Thus, prices end up in moving towards their intrinsic value. Hedging helps investors to manage risks. Therefore, it allows investments without worrying about unexpected risks. Therefore, financial asset prices will move towards their intrinsic values.
Effect of Short Selling in European Markets
This refers to selling shares of a company with intention to part ownership. It was quite common in the United States before the fall of Lehman Brothers. This triggered a temporary ban on this trade in Hedge Funds.
The aim was to control the use of this derivatives trade to inject poor practice in the stock market. There is also an argument that the risk involved is almost zero. This makes the real owners of the stock to suffer in case of a financial meltdown.
However, it is important to note that this ban has a long-term bad effect on an economy. The shares of a company are adversely exposed. This is because the wholesale trading which swings investors confidence. Managements of the various listed companies may sometimes make poor decisions. This may lead to possibility of failure in business models. Short selling mitigates the risk associated with this failure.
Risk Assets
This is because the number of investors available is big. This is unlike a situation where there are limited investors who can easily make radical decisions. This includes selling their shareholding, which may cripple a company.
Investors invest in risky assets with an aim of making profit when the prices change through the process. It is not a form of betting because investors make decisions after evaluating the financial assets performance before purchasing the asset.
Speculation
It is not a traditional investment since the risk acquired is greater than average. Another definition of speculation is the commitment to any transaction containing significant risk but with higher chances of huge profits, especially in financial instruments.
Speculation is also the considerate assumption of a risk, which is higher than average short-term risk with an expectation of receiving huge profits from anticipated changes in prices.
Outcome
In this light, it is not a good idea that European Countries ban short selling. This is especially true if it is a long-term ban. The long-term effects outweigh the short-term benefits by far. This is because nobody will have confidence in investing in a company where the threshold for investing is excessively high.
However, if the ban is short-term, like in the United States case, it is possible that the ban will meet the target intended. This is because it will reduce the number of people who want to invest without actually taking a risk.
Debate between policy makers and economists has been witnessed over the century. The relative issue being debated appertains to the ensuing pros of market-based as opposed to the bank based financial systems.
By the end of nineteenth century, most German economists persistently asserted that their financial system which was entirely bank-centered evidently assisted in propelling Germany past the industrial power (UK) market centered system (Goldsmith, 1969, p.41).
In the twentieth century, the debated issue stretched to incorporate Japan which is perceived as a key bank-centered economy alongside the US which is widely regarded as a classic market centered system. In fact, in not more than a decade, various economic observers alleged that the bank centered financial system of Japan could propel its economy beyond the US which was deemed the chief global economic power.
Embedded in the debate that engrosses market centered vs. bank-centered pecuniary systems is the tradeoff acuity.
Most economists have incessantly affirmed that the embraced bank based systems apparently helps in the mobilization of savings, viable investment identification and the exertion of corporate control especially in the initial economic development phases as well in the weak organizational environments (Goldsmith, 1969, p.56).
Nevertheless, other economists lay much emphasis on the market merits namely capital allocation, the provision of risk managing instruments alongside the mitigation of problems related to extremely influential banks. Despite the unending debate, economists have utilized various theories to highlight the financial systems comparative advantages.
Theoretical framework
Most researchers works have ideally produced informative insights pertaining to the operation of these two financial systems. It is however very intricate to draw any meaningful conclusions with respect to the long-standing and escalating effects of the market-centered and bank-centered financial systems merely on the basis of these four nations.
This follows the eminent facts that the quoted countries tend to have somewhat comparable long run development rates.
Even though the named countries in total comprise of nearly fifty percent of the global output and occasionally experienced substantial divergence in growth rates over the past decades, a broad analysis materialize to offer greater essential information on the debate that involve bank-centered versus the market-centered financial systems (Levine, 1997, p.689).
To better analyze and compare these financial systems, scores of secondary datasets might offer an investigative correlation that exists amid economic growth as well as the extent at which nations tend to either be market-centered or bank-centered.
The competing theories which tender empirical evidence mainly anchor on the financial structure. As regards bank-centered highlighted views, it appears that banks play a positive task in capital mobilization, risk management, supervision of managers and viable projects identification (Levine, 1997, p.691).
Bank-centered view similarly underlines the ensuing comparative weaknesses associated with the market-centered systems. It is noted that properly developed markets swiftly disclose market information to the public and this in turn reduces individual savvy investors motives to obtain such vital information (Stiglitz, 1985, p.134).
Therefore, massive market developments might encumber the inducement to identify pioneering projects which could spearhead growth. Such problems are effectively mitigated by the banks due to the formulated enduring correlations with firms and they do not immediately disclose decisive information within the public markets.
According to Bhide (1993, p.36), bank centered proponents lay much emphasis on the fact that liquid markets construct narrow-minded investors climate. Investors within the liquid markets may economically trade their shares in order to have inducements that would enhance the exertion of painstaking corporate control. As such, an immensely developed market might thwart economic growth as well as corporate control.
In the developing economies, banks seem to efficiently finance the industrial growth as opposed to the stock markets. Rajan and Zinagales (1999, p.87) noted that influential banks that have intimate correlations with firms stand better chances of efficiently obtaining information on firms and consequently encourage to settle up their debts when compared to atomistic markets.
Based on this observation, bank-centered systems which are unimpeded by the accruing dogmatic restrictions appertaining to their insurance market and securities actions may take advantage of the economically processed information, boost industrial growth and develop enduring associations with firms.
Market-centered do not merely underline the positive responsibility played by markets as regards to corporate control, the enhancement of risk management, allocation of capital and the dissemination of information but similarly evaluates the banks problems (Levine & Zervos, 1998, p.56).
This implies that there are possibilities that influential banks can protect established firms and extract information rents to baffle advancement when competitions emanate. Advocates of market-centered views emphasize that markets might reduce any inbuilt ineptitudes that are related to banks so as to boost economic growth (Weinstein & Yasef, 1998, p.637).
Econometric description
The suitability of bank-based system and the market-based systems can be analyzed based on the units of typical growth equations.
The growth representations and their econometric equivalents are representative of the actual per capita Gross Domestic Product, p, a function dependent on variables, Y. These standard growth equations can be modified as below in order to establish the rivalry between the two systems (Bhide, 1993, p.36).
Take into consideration these regression equations:
P = kY + mS + U(1)
P = nY + qF + U(2)
P = rY + tS + wF + U(3)
P stands for the actual per capita Gross Domestic Product while Y stands for the typical growth factors. S evaluates the financial organization in which the huge values of S denote a market based system while the negligible values denote the bank-based system (De-Haan et al., 2009, p.67).
The positive changes in the fiscal segment such as the securities are represented by F. the more significant the values of F, the more the fiscal services. U denotes the error term in the equation while the other letters are merely coefficients.
Both bank based and market based systems are especially good in initiation and propagation of growth. However, their entire contribution to financial advancement is dependent on the banks for bank -based and markets for market-based (Rajan & Zinagales, 1999, p.89).
Therefore, bank based assessment predicts the coefficients q and w are above the zero mark while m and t are negative while the market-based assessment predicts the all coefficients will be above zero mark. The law and finance perception, argues that the eventual financial advance is vital more than whether the cause is market-based or bank-based. It thus does not single out which is the better of the two.
The hybrid view on the other hand, puts up the argument of banks being more vital in the growth of financial services under certain conditions while the market-based systems are more important under substitute conditions (Stiglitz, 1985, p.136).
Banks are seen to be crucial when the economic growth is low. This changes as the peoples incomes increase causing the countries to reap more benefits from the market-based systems. The regression equation can thus be specified as below.
(iv) P = kX + mS + dS*Y + U (4). These view supposes that m>0 ang d>0.
A reason advanced to explain this occurrence is that banks possess a comparative advantage in the economies exhibiting less powerful legal frameworks. Powerful banks can retrieve information forcefully from weak organizations or even go to the extent of compelling them into paying their debts (Kidwell et al., 2008, p.52).
Gains to economies from market-based systems can only be realized with then strengthening of the legal frameworks. Figuratively, the regression equation suggested is as follows (v) P = kX + mS + dS*L + U (5) which predicts b<0 and k>0.
Data
For any comparisons to be made on the financial structure of the two systems, the real definition of financial structure must be well comprehended. The definitions of bank-based system and that of market-based financial system are on the financial structure are varied. Therefore proper understanding can only be got from analysis of varied forty-eight countries for a period of 15 years.
The advantage of this broad cross-country method is that it allows a similar evaluation of fiscal systems across different nations thus improving the reliability of the resultant international comparisons (Fiordelisi et al., 2010, p.35). The financial structure can be analyzed on various arrays of substitute measures.
Activities in Structure
These compute the ratio of the performance of the stock markets in relation to that of the banks. The measurement of the stock market performance is by application of total value traded ratio while that of the bank is the bank credit ratio. When the ratio is obtained, a more market-based system is denoted by a large of the structure activity and the opposite implied
Structure size
This aims to measure the quantity of the sock markets in relation to that of the bank. The magnitude of the domestic stock-market is acquired via the utilization of the marketplace capitalization ratio as well as credit ratio for the banks. Eventual structure is equivalent to the logarithm of the market capitalization ratio by that of the bank (Stiglitz, 1985, p.135).
Structure efficiency
This appraises the efficacy of the stock market with regard to that of the financial institutions. The effectiveness is measured by use of the value-traded ration or other advanced method while the bank uses the overhead costs. When the logarithm of the total value added is computed and the result multiplied by the overhead costs we obtain the structure efficiency (Wurgler, 2000, p.189).
Structure regulatory
This measure the regulatory restrictions imposed on commercial banks. These restriction will limit what the bank can do and in the process lower its effect in the development of the financial services.
Therefore, depending on the values of the above data the bank-based system can be preferred to the market-based system (Kettell, 1999, p.21). At certain units, the value could be favorable for the banks while in other it would be market-based system.
Financial Structure
The financial structure, especially the structure activity indicator shows appealing classifications of both bank-centered and market-centered financial system. In fact, the total value of traded ratios serves as the basic index of classification. Low values indicate a bank-based system while a high ratio indicates a market-based system.
The size measure using structure- size index shows the anomalies between the market-based and bank-based systems. Many theories use market liquidity but this notion seems prone to problems (Wurgler, 2000, p.190). The structure-efficiency index uses the inefficiency stock market to describe bank-based financial systems for example, Kenya, Egypt and Ghana.
Structure-regulatory variable places few restrictions on banks turning the financial system to be bank-based as opposed to market-based systems that tightly regulate the activities of banks as is the case with the United States. The activity, size and efficiency financial structure measures can be used to determine whether an economy is bank-centered or market-centered.
Stiglitz (1985, p.134) argues that states with strong shareholder rights in relation to creditor rights, firm accounting systems and no deposit insurance lean on market-centered financial systems.
Thus, neither bank-centered nor market-centered grouping is critical in identifying growth enhancing financial systems. Indicators on financial services surrogate the extent to which state financial systems provide financial services via evaluating companies and screening managers, alleviating threat management and mobilizing resources.
Financial-activity is an assessment of stock markets and intermediaries which uses total value traded ratio. Bank-based systems have high private credit ratio (Howells, & Bain, 2007). Basically the financial activity index is the measure of the total financial sector activity. Finance-size could be regarded as the assessment of stock markets along with intermediaries that tend to utilize market capitalization quotient.
The private credit ratio is used to determine the size of intermediaries (Mishkin, 2009, p.121). Conversely, finance competence may be regarded as the evaluation of financial sector competence with respect to the use of total cost traded ratio. In bank-based sectors, overhead costs are used (Valdez, & Molyneux 2010).
Financial structure does not show any significant relationship to economic growth. Results from growth aggressions tabulations, show that there is inconsistency with both bank-centered and market-centered financial systems (Grabbe, 1995, p.71).
While the bank-centered analysis envisage negative correlation amid growth versus and the financial structure dealings, the market-centered systems confirm a positive correlation amid the two. This notion predicts that use of financial structure is not a sufficient way of distinguishing between financial systems.
It is notable that optimal degree level of financial structure changes with income per capita. Rajan and Zingales (1999, p.27) argues that nations with feeble investor fortification codes and inadequately obligatory property rights and bank-centered systems will better promote growth. Nevertheless, economies benefit from more market centered systems as the legal systems improved.
Though they posted this assertion, the outcome does not suggest that differentiating between bank-centered and market-centered is an important way of differentiating financial systems even after using systematic evolution of financial structure. Use of estimated equations also points out that financial structure changes with income per capita (Boyd and Smith, 1996, p.375).
Use of regression table also shows that neither the structure nor the interactive variables enter clicks to the required dimension. Inclusion of structure and investor rights as well as interaction with financial structure does not show any conclusive changes. This provides evidence that financial structure is not a useful way to distinguish financial systems.
Analysis on samples based on the level of economic development, indicate that financial structure does not enter any regressions. Though the theories do not refute the work of Boyd and Smith (1996, p.378), the outcome suggest the lack of link between growth and the level of bank-centered system and market-centered systems is not due to selection of optimal level of financial structure.
References
Bhide, A. 1993. The hidden costs of stock market liquidty . Journal of financial intermediation, 34(1), pp.1-51.
Boyd, J. H. & Smith, B. D. 1996. The Co-Evolution of the Real and financial Sectors in the growth process . World bank economic review, 10(2), pp.371-396.
De-Haan, J., Oosterloo, S., & Schoenmaker, D. 2009. European Financial Markets and Institutions. Cambridge, UK: Cambridge University Press.
Fiordelisi, F., Molyneux, P., & Previati, D. 2010. New Issues in Financial Institutions Management . Basingstoke, London: Palgrave Macmillan.
Goldsmith, R. W. 1969. Financial structure and development . New Haven, CT: Yale University Press.
Grabbe, J. O. 1995. International Financial Markets . Upper Saddle River, NJ: Prentice Hall.
Howells, P. & Bain, K. 2007. Financial Markets and Institutions . Upper Saddle River, NJ: FT Prentice Hall.
Kettell, B. 1999. What Drives Financial Markets. Upper Saddle River, NJ: FT Prentice Hall.
Kidwell, D. S., Blackwell, D. W., Whidbee, D. A., & Peterson, R. L. 2008. Financial Institutions, Markets and Money. Hoboken, NJ: John Wiley & Sons.
Levine, R. & Zervos, S. 1998. Stock markets, banks, and economic growth . American economic review.
Levine, R. 1997. Financial development and economic growth: Views and Agenda . Journal of economic literature, 35(82), pp.688-726.
Mishkin, F. S. 2009. The Economics of Money, Banking and Financial Markets. Upper Saddle River, NJ: Prentice Hall.
Rajan, R. & Zingale, L. 1999. Which Capitalism? Lessons from the East Asian Crisis . Journal of Applied Corporate Finance.
Stiglitz, J. E. 1985. Credit Markets and the Control of Capital . Journal of Money, Credit and Banking, 17(2), pp.133-52.
Valdez, S., & Molyneux, P. 2010. An Introduction to Global Financial Markets. Basingstoke, London: Palgrave Macmillan.
Weinstein, D. E., & Yasef, Y. 1998. On the Costs of a Bank-Centered Financial System: Evidence from the Changing Main Bank Relations in japan . Journal of Finance, 53(2), pp.635-672.
Wurgler, J. 2000. Financial Markets and the Allocation of Capital . Journal of Financial Economics, 58(1-2), pp.187-214.
The implementation steps for the CRM bank, and microcredit program should be started by finding the professional team that will be engaged in assessing the market and implementing the necessary steps for micro-crediting development.
The next step is the arrangement of the proper banking financial structure as well as the assessment of the marketing situation. The impoverished people are often too skeptical on the matters of crediting, hence, the promo campaign should be arranged. People should realize that they have an opportunity to take microcredit, start business activity, and then return the credit. The next step is risk assessment. The effectiveness of micro crediting in poor regions is 20% (The Microcredit Summit Campaign, 2008). This means that in average 1/5 of the clients are able to overcome the poverty line, while up to 15% of credits are not returned because of various reasons (decease, catastrophe, murder, imprisonment etc.)
Definition of development strategy is the following key step in micro crediting development. This involves the selection of software and hardware basis of the financial activity and the outlining of the analytical tools that will be used for adequate assessing of the progress.
Development Plan
Short-term
This presupposes the creation of the consumers base and arrangement of the initial steps for providing micro-crediting to the population. The steps and actions required for creating this plan are as follows:
Risk assessment (including demographic study)
Creation of the technical basis, and communication system arrangement
Launch of the promo
Mid-term
Assessment of the incomes and losses
Application of the analysis tools
Extension of the personnel (creation of the proper delegation structure and motivation system)
Improvement of the IT base
Long-term
Improvement of the crediting obligations and decrease of the interest rate. Creation of lax crediting system
Providing of credit insurance system
Cooperation with social structures for defining the risks of non-returning (Migration services, Public Health, etc. )
Marketing Strategy
The marketing strategy of the company involves numerous social, marketing and financial aspects of crediting development.
Product
Micro-credits ranging from $ 25 to $ 1000 (7 levels of loans) for starting a business. These are not consumers credits, hence the interest rate is higher. The interest rate involves the consideration of inflation rate as well as risk assessment (rural with a 30% fixed interest rate and urban with a 20%). Loans starting from $ 150 will be available only after 2 years of positive credit history achievement. (Maes, Foose, 2009)
Place
Rural and urban departments of CRM bank in Mexico and Mexico City. The place is selected for the great opportunities of micro-crediting development and the great amount of the target audience. (Rhyne, 2004)
Promotion
The service is mainly aimed at women, as in accordance with statistics (Rutherford, 2002) up to 90% of micro-credit borrowers in underdeveloped countries are women.
Pricing
This involves the interest rate for loan amortization 20-30%
Measurement
Analysis and measurement of success may be performed by using a system of ratios: Liquidity, Asset turnover, Financial Leverage, and Profitability. These indicators will help to assess the financial success of the organization as well as provide the necessary analysis associated with risks, social environment, and program effectiveness. (Microfinance Information Exchange, 2010)
The effectiveness of the team performance may be measured by the rate of loans provided / loans returned, the number of clients and returned clients. The technical team should be assessed by the rate of technical failures of the equipment, as well as the average speed of operations. If the speed grows, this means that the technical team is working effectively, and vice versa. (Rutherford, 2002)
Soft- and Hardware
The technical performance of the company is closely associated with the matters of financial effectiveness of the company. Hence, the hardware needs to correspond office needs: file storage (up to 150 Gb), quick search (2.0 MHz processor and higher), and sight-safe displays (flat LCD), ergonomic input devices (mouse and keyboard), printers and scanners for processing clients data. Communication hardware such as phones, network cards, modems. UPSs for being insured against voltage leaps.
The software of the system needs to correspond with the tasks and aims of the organization in general. File management and editing, OCR systems, and data protection software are the key aspects of loaning activity. Database software should provide all the necessary aspects of data protection and data search. Communication software is required for contacting partners, clients, other departments and services listed in long-term development points.
Relevant Fields
Micro-credit loaning may be used for private business development and helping people to create additional working places. Hence, family workshop traditions may be used as the source of stable income if these traditions have the required manufacturing basis. (Dias, Morales and Sandoval, 2009) Considering the fact that the service is mainly aimed at the rural population, the loans will be used for developing farms, auto service stations, and small shops. The approximate structure of application is as follows:
Reference List
Dias, Y., Morales, J., Sandoval, R. (2009) Opportunity in diversity: Insights from McKinseys Latin American Payments Map. McKinsey Report
Maes, J., Foose, L. (2006) Microfinance Services for Very Poor People: Promising Approaches from the Field. Poverty Outreach Working Group SEEP Network
Microfinance Information Exchange (2010) Mexico 2009. Microfinance Analysis and Benchmarking Report. A report from Microfinance Information Exchange
Rhyne, E. (2004) Mainstreaming Microfinance: How Lending to the Poor Began, Grew. Kumarian Press.
Rutherford, S. (2002) ASA: The Biography of an NGO, Empowerment and Credit in Rural Regions. ASA, Dhaka.
Maturity gap of the bank (MGAP) = Maturity of assets (MA) Maturity of liabilities (ML). Maturity of assets (MA) = [0*15+ (6/12)*120 + 3*100+ 5*220 +5*400 + 5*150 + 10*260 +10*530+ 15*200+ 20*150+ 20*320]/ (2405- 20) = 24,510/2385 =10.28 years
When the planning period is one year, the repricing gap = RSA RSL= 6 month T-bills (4.25%) + 5 year personal loan (11.5%, repriced @ yearly) + 10 year commercial loan (12.25% repriced @ 6 months) + 15-year commercial loan at fixed 10% interest (repriced monthly) -3 months CDs (3.8%) 6 months CDs (3.85%) 1 year term deposit (4.0%)- overnight repo (3.4%) = $120+ 400 +530 +200 (215+180+460+200) = $195 million.
When the planning period is two years, the repricing gap = RSA RSL= 6 month T-bills (4.25%) + 5 year personal loan (11.5%, repriced @ yearly) + 10 year commercial loan (12.25% repriced @ 6 months) + 15-year commercial loan at fixed 10% interest (repriced monthly) -3 months CDs (3.8%) 6 months CDs (3.85%) 1 year term deposit (4.0%)- 2 year term deposits (4.3%)+ overnight repo (3.4%) = $120+ 400 +530 +200 (215+180+460+150+200) = $45 million.
The banks duration gap when the current market yield was flat at 6.5%
Weighted average bank assets duration (DA)
Whereby Wi is the market value of asset I divided by all bank assets market value (Grier 2007, p.70).
Da = Macaulays asset I duration
n= is the different bank assets number
Therefore, the weighted market values of the following assets are computed as follows:
6 months T-bills (6.5%) duration = (Asset value/Total market value of assets) X duration of the T-bills. Duration = (120/2385) X 0.5 =0.025 years
3 year T-notes (6.5%) duration = (Asset value/Total market value of assets) X duration of the T-notes. Duration = (100/2385) X 3 =0.126 years
5 year T-notes (6.5%) duration = (Asset value/Total market value of assets) X duration of the T-notes. Duration = (220/2385) X 5 =0.461 years
5-year personal loan (6.5%) duration = (Asset value/Total market value of assets) X duration of the personal loan. Duration = (400/2385) X 5 =0.839 years
5-year Kangaroo bond (6.5%) duration = (Asset value/Total market value of assets) X duration of the Kangaroo bond. Duration = (150/2385) X 5 =0.315 years
10 year car loans (6.5%) duration = (Asset value/Total market value of assets) X duration of the 10 year car loan. Duration = (260/2385) X 10 =1.090 years
10-year commercial loan (6.5%) duration = (Asset value/Total market value of assets) X duration of the 10-year commercial loan. Duration = (530/2385) X 10 =2.222 years
15-year commercial loan (6.5%) duration = (Asset value/Total market value of assets) X duration of the 15-year commercial loan. Duration = (200/2385) X 15 =1.258 years
20-year Kangaroo sovereign bonds (6.5%) duration = (Asset value/Total market value of assets) X duration of the 20-year Kangaroo sovereign bonds. Duration = (150/2385) X 20 =1.258 years.
A 20-year mortgage at 6.5% interest, balloon payment, duration = (Asset value/Total market value of assets) X duration of the 20-year mortgage at 6.5% interest, balloon payment. Duration = (320/2385) X 20 =2.683 years.
Conversely, the weighted Average Bank Liabilities Duration (DL) =
Whereby:
zj = Market value of liability j divided by all bank liabilities market value
DLj= Macaulays liability j duration
k = different bank liabilities number.
The weighted market values of the following liabilities are computed as follows:
3 months CDs (6.5%), duration = (Liability market value/Total market value of liabilities) X duration of the 3 months CDs. Duration = (215/2042) X 0.25 =0.026 years
6 months CDs (6.5%), duration = (Liability market value/Total market value of liabilities) X duration of the 6 months CDs. Duration = (180/2042) X 0.5 =0.044 years.
1-year term deposit (6.5%), duration = (Liability market value/Total market value of liabilities) X duration of the 1-year term deposit. Duration = (460/2042) X 1 =0.225 years.
2-year term deposit (6.5%), duration = (Liability market value/Total market value of liabilities) X duration of the 2-year term deposit. Duration = (150/2042) X 2 =0.147 years
5 year CDs at 6.5% interest balloon payment, duration = (Liability market value/Total market value of liabilities) X duration of the 5 year CDs at 6.5% interest balloon payment. Duration = (250/2042) X 5 =0.612 years
20-year debentures at 6.5% interest, balloon payment, duration = (Liability market value/Total market value of liabilities) X duration of the 20-year debentures at 6.5% interest, balloon payment. Duration = (200/2042) X 20 =1.959 years
Overnight repo at 6.5% interest, duration = (Liability market value/Total market value of liabilities) X duration of the Overnight repo. Duration = (200/2042) X 0.002 =0.0003years
The weighted average bank assets duration (DA) =
= 0.026+ 0.044+ 0.225+ 0.147+ 0.612+ 1.959+ 0.0003 =3.0133 years.
The duration gap of the bank assuming the current market yield is flat at 6.5% is given by DGA = Da WDL.
DGAP is the duration gap
Da represents the average duration of assets
DL is the average duration of liabilities
W is the ratio of total liabilities to total assets.
The impact on net interest income over the next six months when current market interest is 5.65%
If the current interest rate of the market is 5.65%, then a decrease in bank sensitive assets by 50 basis points causes a change in the asset sensitive interest rate to decrease from 5.65% by 0.5% to 5.60%. On the other hand, a decrease in the rate-sensitive liabilities by 25 basis points causes the interest rate of these liabilities to decrease by 0.25% to 5.40%. Therefore, in the next six months, the banks funding gap will be:
Repricing gap (RP) = Rate sensitive assets (RSA) Rate sensitive liabilities (RSL) (Choudhry, 2011). Re-pricing or funding gap using six months planning period will incorporate 6 month T-bills. (4.25%) + 10 year commercial loan (12.25% repriced @ 6 months) + 15-year commercial loan at fixed 10% interest (repriced monthly) -3 months CDs (3.8%) 6 months CDs (3.85%) overnight repo (3.4%) = $120+ 530 +200 (215+180+ 200) = $255 million.
From the six months funding gap, a decrease of 0.5% in asset sensitive rate, and a 0.25% decrease in liabilities sensitive rate causes the net interest income to decline by $2.76 million. NII = FG(R) = [$120+ 530 +200] x0.005 (215+180+ 200) x0.0025 = $2.76 million.
The impacts of the anticipated short-term deposits on the overall asset-liability of the bank
Short-term deposits pay low interests to the bank as compared to long-term deposits. This means that short-term deposits are associated with high-interest expense especially on short-term liabilities such as CDs. Hence if the bank relies heavily on CDs it has to pay higher rates since these short-term non-core liabilities are riskier. Moreover, the maturity gap for asset-liability of the bank will widen as clients resort to short-term deposits.
The reason being the bank will increase its long-term lending capacity while borrowing for the short-term (Choudhry & Masek 2011). The effect is that in the short-term interest rates will rise thus increasing the borrowing cost of the bank. Furthermore, excessive short-term deposits have short re-pricing periods that omit exposure of assets-liability to the risk associated with interest rates. Therefore, short-term deposits will understate the balance sheets rate sensitivity.
The impact on equity when interest rate increases by 50 basis points across the yield curve
When the bank anticipates that the interest rate will increase across the yield curve by 50 basis points, such an increase will cause the equity value to decrease. The value of the equity will be lowered because when the interest rate increases by 0.5%, it reduces both the liabilities and assets market values. However, the banks assets market value tends to decline more than the liabilities market value given that the duration of the asset is longer than the banks liabilities duration (Choudhry, 2003).
Strategies to reduce the equity value volatility
Several approaches can be used to reduce volatilities on valued assets. One of the approaches is based on asset allocation. This is where the assets are tactically allocated to generally reduce the portfolio volatility. The equity is allocated at the right time depending on the rewards or risks that are expected for a range of asset classes. Though timing the market might be a challenge it should be given greater consideration to enhance its achievements (Ghosh, 2012).
The other approach is the use of derivatives. The bank may use Derivatives to purchase the portfolio insurance as a cushion against the pending losses. In other words, this strategy is inclined to reduce volatility by holding another class of assets whose value is likely to increase while the value of other equities is falling. However serious considerations should be taken on the cots that are involved resulting in the reduction of long-term returns.
The other strategy is diversification in various emerging equity markets. Diversification improves the overall portfolio efficiency while at the same time reduces the risk. However, the assets are still exposed to the overall equity risk premium (Choudhry, 2003). Also, geographic diversification will safeguard the banks portfolio against some eminent unrelenting losses which will probably ensue within a particular equity market range. Other strategies such as value or income and low volatility equity may also be applied to reduce volatility in assets.
The banks liquid capital sufficiency to meet the Basle II requirement
Generally, Basle II requires that banks and other financial institutions hold a greater amount of capital that can be used to militate against the risks that these institutions may be exposed to. According to the requirement, this bank holds enough capital in form of portfolios and equity that can be used to safeguard against the risks that the bank may be exposed to (Choudhry & Masek, 2011). The amount of equity and assets more so the liquid assets that the bank hold is enough to settle any eventuality that may arise as a result of operational and lending practices.
The development of credit risk management
Introduction
Credit risk management has dramatically evolved over the last twenty years as a result of secular forces that have increased the importance of its measurements. These forces that have driven the development of credit risk management includes the structural rise in the number of worldwide bankruptcies, the widening disinter-mediation trend by the largest and highest quality borrowers, increased competition on loan margins, the real asset declining value in various markets, and increased growth in instruments of the statement of affairs having intrinsic risk exposure default (Altman & Saunders 1998, p.171).
Banking professionals responded to these challenges through the development of new and sophisticated models that comprise credit-scoring and early warning systems. Moreover, the banking industry moved away from individual loans and securities risk analysis to the adoption of the fixed income securities measurement of portfolio risk where the credit risk assessment plays a vital role (Altman & Saunders 1998, p.171). Models such as the risk-adjusted-return on capital (RAROC) were developed (Altman & Saunders 1998, p.171). Such sophisticated models were developed to better measure the credit risks of off-balance sheet instruments.
Traditional credit measurement methods
One of the early credit measurement methods that most financial institutions virtually relied upon to assess loans was the subject analysis or expert system. In this system bankers relied upon the information on the borrowers characteristics such as its reputations, collateral, leverage as well as the volatility of its earnings to arrive at their credit decisions (Altman & Saunders 1998, p.172). Such decisions were largely subjective or expert. However, this system of credit measurement have largely been outperformed by other more objective methods of credit measurement such as the multivariate credit-scoring system
In the multivariate scoring system or the accounting-based credit-scoring system, the financial institutions make decisions by making comparisons of potential borrowers various key accounting ratios with that of the group or industry (Altman & Saunders 1998, p.172). In the model, vital accounting variables are added and weighted to give either the credit-risk score or the probability of risk default measures. In case the value attained by the credit- risk score or probability is above the required benchmark, then the credit applicant is either subjected to further scrutiny or rejected.
Newly proposed models
The resultant weaknesses in the traditional methods led to the development of new models to replace the traditional bankruptcy prediction and credit-scoring models. The most recent models include the KVM. In this model, crucial inputs into the probability of default have to be estimated. The model is based on the concepts of option pricing model whereby the asset value of the firm is evaluated as the firms equity value call option (Altman & Saunders 1998, p.174). Secondly, the model is founded on the theoretical linkage amid the firms equity value observable volatility and its asset value unobservable volatility.
The second newer approach backed with stronger theoretical underpinnings is those models that accredit the disguised likelihood of the term structure default of yield spreads amid risky corporate and default-free securities. The models draw from the disguised forward rates on risky bonds and risk-free as well as the utilization of these rates to pull out the default market expectations at prospective variant periods (Gordy 2000, p.124).
The models operate under various assumptions such as that the expectations of interest rates theory holds, that there is reduced transaction cost, that there is the absence of call sinking fund together with other optional features, and that there is the existence of discount-bond yield-curves and such curve can be extracted from coupon-bearing yield-curves (Gordy 2000, p.126).
The third newer model is the capital market-based. These models are based on the mortality rate model and the aging approach. This approach is currently being applied in the structured financial instruments analysis and can be extended to the analysis of default loans (Altman 1984, p.177). The fourth new model applies the neural network analysis on the problems of credit risk classifications. In particular, the neural network credit risk model examines potentially hidden relationships between the predictive variables which are then utilized as additional explanatory variables in the non-linear bankruptcy prediction function.
In conclusion, these credit risk measures have various disadvantages that render them inapplicable in some situations. That is, each model cannot be exclusively applied in the credit risk analysis. The first traditional subjective analysis was found to be inadequate as the number of credit risk in LDCs increases hence, outperformed by multivariate credit scoring systems. Besides, the multivariate credit scoring models have been criticized for being overly based on the book value accounting data which is measured at discrete intervals. The effect of this is that the model fails to pick the more subtle and fast-moving changes in borrower conditions.
Secondly, its linearity assumption is flawed and the model is further based on the tenuously underlying theoretical models. Other newer models such as the KVM have been criticized over the inaccuracy of using the stock prices to derive the implied or expected variability in the values of assets. This makes the assumptions used in these models to be questionable.
References
Altman, E & Saunders, A 1998, Credit risk measurement: Developments over the last 20 years , Journal of Banking and Finance, vol.21 no.11-12, pp. 1721-1742.
Altman, E 1984, The success of business failure prediction models: An international survey , Journal of Banking and Finance, vol.8 no.2, pp. 171-198.
Choudhry, M & Masek, O 2011, An introduction to banking: liquidity risk and asset-liability management, John Wiley & Sons, Hoboken.
Choudhry, M 2003, Bond and money markets: Strategy, trading, analysis, Butterworth-Heinemann, Oxford, UK.
Choudhry, M 2011, Bank asset and liability management: strategy, trading, analysis, John Wiley & Sons, Hoboken.
Ghosh, A 2012, Managing Risks in Commercial and Retail Banking, John Wiley & Sons, Hoboken, New Jersey.
Gordy, M 2000, A comparative anatomy of credit risk models , Journal of Banking and Finance, vol.24 no.1-2, pp. 119-149.
Grier, WA 2007, Credit analysis of financial institutions, Euromoney Books, New York.
