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Banking Sector 1

BANKING SECTOR

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Banking Sector 2

Banking Sector

Introduction

To get a better understanding of the banking sector, it is essential to understand what it

entails as well as the institutions involved. Leith defines a bank as a financial institution that can

accept deposits of all nature both (cheques and cash) and channels various amounts of money

into lending undertakings (2013, pp. 1501). The banking sector, especially in the modern society,

plays multiple roles, which are not limited to intermediary or unifying functions between the

fund suppliers and the deposit demanding sides of the community. The banking sector helps in

accomplishing investment and help people in saving activities for future use or a given factor.

Therefore, the banking sector has various expectations that they need to meet and which are

governed by multiple codes of ethics. Some of those expectations are to protect the interests as

well as the rights of the depositors, engaging in economic development that will be appreciated

by the members of the society and conduct their banking operations putting integrity,

transparency, impartially as well as reliability in the first place (Carse, 1999, p.10). The banking

sector is also expected to establish a genuine financial market that is too stable, and that is free

from money laundering. The various tasks that will be therefore discussed will be impactful in

understanding how the banking sector operates and the different financial institution. The

financial institutions that will be discussed include banks of all sorts that range from credit

agencies to pension funds.

Task 1

Primary functions and objectives of Central Banking

Central banks are the pillar of any country when it comes to the banking system and

sector. The Central bank is, therefore, public financial institutions that are mandated with the

duty of managing the states currency, interest rates as well as the money supply. Apart from that,

the central banking also ensures that the commercial banking sectors of their respective countries

are overseen. The primary business or banks also possess the monopoly especially when it comes

to ensuring that the nation’s monetary base is increased. The central bank is even mandated with

the job of printing the national currency, which in most occasions serves as the nation’s legal

tender. However, the universal primary functions of all central banks are to ensure that their

Banking Sector 3

respective states or countries monetary supply is managed through active duties, for example,

setting the reserve obligation, interest rate management, and finally acting as a last resort for

commercial banks or any other financial institution undergoing financial crisis and even

insolvency. The banks are also mandated with supervisory powers with a deep intend of ensuring

that all the other financial institutions do not conduct any fraudulent activities as well as reckless

behaviors. The various functions and objectives of the central banks are clarified below.

According to Ahuja (2012, pp.112), the primary function of the central bank is to issue

note. The central bank is solemnly mandated with the monopoly of issuing notes in almost every

country. These printed currency notes, therefore, become unlimited legal tender that can be used

throughout the respective countries, however in countries such as India, the central bank issues

one rupee while the other notes are issued by the Reserve Bank of India. In a country such as

Zambia, the Bank of Zambia carries out this mandate.

Another primary function carried out by the central banks are those of agent, bankers, and

advisors to the government. As a banker to their respective governments, the central banks

perform the same functions as those any commercial bank would to their customers. Therefore,

the central bank maintains the states or countries accounts for the government; it receives

deposits from either the state or country government as well as make temporary advances to the

government. As a banker, it also collects draft and cheques deposited in the account that belongs

to the state and provides the foreign exchange resources. The resources are there to help the state

pay external debt and purchasing foreign goods. As an agent, the central bank collects payments

as well as taxes on behalf of the state. The bank also raises loans from the public and therefore

manages the public debt. It acts as the representative of the state of the various international

financial conferences and institution. On the other hand, as a financial adviser, the central

advises the government on the monetary, financial, economic and fiscal matter such as

devaluation, deficit financing, trade policy, and foreign exchange policy. In conclusion, for the

central banking to meet its functions, it requires an object that makes it focus more on its various

services, therefore the aim of the central bank is to ensure that all its functions especially the

main ones meet the states or countries economic interest which is consistency with the

government’s economic policies.

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Monetary Policies Used by the Central Banks of US and UK

The financial crisis of 2007-08 had an extensive effect on the real economies around the

globe and acted, as a reminder that price steadiness is not sufficient for financial stability. The

central banks of the US and the UK, therefore, came up with policies after the financial crisis

that aimed at decreasing the likelihood of such crises without relying on how to deal with the

repercussion that accompanies such an emergency (Claessens et al., 2010, pp. 280). One of the

policies put in place by both banks involves the latter which ensures that likelihood of a financial

crisis occurring is decreased in all the available aspects. The policymakers believed that laying

down a plan to deal with would be beneficial in that it could make the burden on cyclical

policies, which include monetary policies that support the financial stability, would be lighter.

The other policies set by these countries is that the government would support the

banking sector since it was a necessity. By promoting the banking sector, the government would

be safeguarding the banking sector and therefore create a stable financial system. Some of the

support guaranteed by both governments involved interbank lending, increase in the coverage of

retail deposit insurance and recapitalization of a financial institution in difficulty and asset relief

scheme. In addition to this, the government added the optional use of a fiscal policy that the

government used to counter the undesirable influence of the financial turmoil on the real

economy. The purpose of this policy was to help mitigate the effects of the global economic

downturn. These three strategies are the central policies that both governments came up with the

bid to prevent future financial crisis and to avoid the 2007-08 financial crisis that almost brought

the two economies to their feet.

Task 2

Role of Banking in Business

Most businesses have various needs for a line of financing or credit with a bank. These

requirements may especially increase when the businesses are slow or struggle in some ways and

most cases, the banks have been the last resorts in ensuring that these particular businesses find

their feet again and operate at their optimum level. As mentioned in the introductory part of this

report, banks are there to act as an intermediary as well as a unifying factor that brings together

both the depositors and those seeking to lend. The banks, therefore, offer loans to starting as well

Banking Sector 5

as struggling business for them to operate at a maximum level and realize growth in their profits.

The loans offered are used by the firms to expand and with time return the loan with interest. The

same banks provide all the businesses with accounts that help them save returns which they use

later to develop into bigger organizations. The accounts offered have desirable rates that do not

undermine these companies, and the bank acts as a financial advisor to the same companies.

How the banking trend especially in regards to business or trade flow the global banks will need

to leverage the expertise of active regional partners. When we look at the worldwide trend, most

banks globally will be known for their quality service standards and which will be preceded by a

long-standing client relationship.

Investment Banking and Commercial Banking

The investment bank has been known to be the financial institution that assists

corporations, governments, and individuals in raising capital by acting or underwriting the

customer’s agent in the issuance of securities and this can sometimes involve both. The purpose

or the functions of the commercial banks, when compared to the investment bank, is to cater to

the general public in providing services such as cash or cheques deposit, providing the needed

loans as well as any other necessary investment merchandises. The public has undermined the

functions of the banks as just places to have their salaries deposited and withdraw of the same

but this has been perceived different since banks are broad categories depending on their overall

functions (Ritter, 2003, pp. 257). Unlike commercial banks, investment banks do not accept

deposits and instead assists various corporations, individuals and the government in raising

financial capital. The banks also offer services such as aiding acquisitions as well as mergers and

helps in ensuring equity security. The banks also help in the making of the market and lastly

launches’ or offers IPO services. Investment banks are further divided into two sides that is the

sell side dealing with trading securities for cash and the buy side, which provide various

institutions with advice concerning the buying of investment services.

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Task 3

Reserves = 850

Debentures = 1050

Cost of debt debentures = 4.7 percent

Risk-free rate of return = 4 percent

Equity risk premium = 6 percent

WACC = (E/V)*Re + (D/V)*Rd*(1-Tc)

Where:

Re = cost of equity

Rd = cost of debt

E = market value of the firm’s equity.

D = market value of the firm’s debt

V = E + D

E/V = percentage of financing that is equity

D/V = Percentage pf financing that debt

Tc = corporate tax rate.

WACC = (850/ (850 + 1050))*0.06 + (1050/ (850+1050)*0.047*(1-0.04) =

0.0267 + 0.051 = 7.77 percent.

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The factors to be considered by Tulip plc in choosing to raise funds via a rights issue are

the state of the stock market since a falling market will make it challenging to build finances

using a right issue and the financial health of the institution as with the available investments

shareholders can assess the company. The last factors to consider are the purpose of the rights

issue so as not to deviate from the intended goal and the attractiveness of the right issue itself

since the best rights are those that give back returns.

Modigliani and Miller's analysis of the capital structure theory developed a capital

structure proposition, which essentially hypothesized that in any given perfect market, the capital

structure does not matter. The capital structure that any individual company would use for its

financial operation is irrelevant and entirely does not matter and therefore whether an individual

company has an optimal capital structure is just a matter of opinions (Modigliani and Miller,

1958, pp. 261). All the theories presented on the questions, therefore, agree with one prevailing

assumption that the market value of any given firm is determined by the earnings and the risks

they have underlain. The approaches also ascertain that the market value is too independent on

the various ways the companies or business decide to finance their invests as well as distribute

their dividends. The assumptions made however include no taxes, no bankruptcy costs, and no

transactional costs. Other assumptions given include no effect of debt and symmetrical market

information

Task4

Wealth maximization is superior to the profit maximization financial objective because

profits only involve estimates in addition to the cash flows. Profit maximization also ignores the

value of money time and disregards financial risks associated with the financial management.

Profit maximization takes into account the costs and includes the sales amounts. Apart from that,

profit maximization involves the capability of the firm in having maximum output as its product

from a limited input on the other hand; wealth maximization consists of the ability of a company

to have an increase in its market value especially of its common stock over time. The market

value of wealth maximization is their based on various factors such as sales, goodwill, quality

Banking Sector 8

product, and services. Therefore, wealth maximization is superior to profit maximization as a

financial object.

The following two indicators or methods of financial evaluation will be taken of

stakeholder wealth in practice: Net present value indicator and internal rate of return method.

The net present value indicator indicates the ranking of various proposals, which is equal to the

current value of all the future cash flow a well as the discounted at the marginal cost of wealth.

The internal rate of return, on the other hand, indicates the method of ranking investment

proposals using the rate of return. This is computed by finding the rate of discount, which is then

equated to the present value of future cash influx to the project cost.

Task 5

Air France-KLM Group shares have more than doubled in the last year despite it

recovering from the 2016’s strikes as well as the terrorists’ attacks. The increase should how a

well-managed company can achieve a lot in a financial year. The group has realized a growth in

market value that totals to almost $4 billion in just one year. Their financial stability practically

crumbled in 2016 when the group had one of its worst times in the industry. Its shares are

currently among the best performers among its members, and this can be attributed to the

financial management policies that have been set aside to ensure that in times of economic crisis

the group can sprout back up. Such procedures may include putting in place measures that will

decrease the chances of the financial crisis and how to deal with the repercussions that may be

realized after such a state. The intervention of other companies and banking sectors also helped

the group overcome its downturn and achieve success in the end. The market value of the team is

currently impressive.

Conclusion

Finance plays a significant role in any given institution, be it a company or government

institution. It is also important to note that banks play substantial roles when it comes to unifying

the members of the society’s especially the loan seekers and the depositors and therefore capital

is essential for each person as well as the different business.

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References

Ahuja, B.R., and Ahuja, N.L., 2012. Intellectual capital approach to performance evaluation: A

case study of the banking sector in India. International Research Journal of Finance and

Economics, 93(1), pp.110-122.

Carse, D., 1999, September. The Importance of Ethics in Banking. In Speech in Banking

Conference on Business Ethics, Hong Kong.

Claessens, S., Dell’Ariccia, G., Igan, D. and Laeven, L., 2010. Cross-country experiences and

policy implications from the global financial crisis. Economic Policy, 25(62), pp.267-

293.

Leith, C. and Wren‐Lewis, S., 2013. Fiscal sustainability in a New Keynesian model. Journal of

Money, Credit and Banking, 45(8), pp.1477-1516.

Modigliani, F. and Miller, M.H., 1958. The cost of capital, corporation finance and the theory of

investment. The American economic review, 48(3), pp.261-297.

Ritter, J.R., 2003. Investment banking and securities issuance. Handbook of the Economics of

Finance, 1, pp.255-306.

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