Graham Mavar
Mgmt. 415 Sec 6
Industry Analysis: Banking
The banking industry has come under increasing pessimism of late because of rising short and long-term interest rates. The banking industry’s market capitalization made a substantial decline. Most investors are concerned with whether the industry can sustain continued profitability as a result of these factors.
Banks have responded in recent years to these problems by diversifying away from interest sensitive products and services. But interest rates are the fundamental aspect of any financial services. Therefore, I believe the financial services industry will be deeply affected by rising interest rates. Banks have experienced good business factors over the past two years. Interest rates were low, credit quality was good, and inflation was low. These factors are usually predictive of the types of earnings banks should report. But good times can’t continue because interest rate hikes cause reduced lending activity, damaged credit quality, and reduced values of bond portfolios.
Porter’s Five Forces Analysis:
1. Rivalry among competing sellers:
The banking industry is continuing to restructure and position itself for our changing economy as a result, many mega-mergers have occurred in recent years. Citicorp and Travelers Insurance agreed to merge in April 1998 at a value of $70 billion. Bank of America and Nation’s Bank also agreed to merge shortly afterwards which became the largest bank in the United States. Bank mergers are usually consummated as a cost-cutting measure but also to compete with non-bank providers of financial services. Bank rivalries are very strong, and as we’ve seen many of the largest banks are merging to increase their power. In fact, Charlotte, NC is practically owned by Bank of America and First Union.
2. Potential entry of new competitors:
There is virtually no chance of a new entrant significantly affecting the major banks’ market share. The only place that new entrants may have a chance in the industry is through Internet banking, because of its low cost.
3. Firms offering substitute products:
This is not really an issue within the banking industry, because there aren’t really any legal alternatives, except buying a safe and borrowing from a loan shark
4. Competitive pressures stemming from supplier and buyer bargaining power:
I grouped these two categories together because in the banking industry the buyers are the suppliers and vice versa, so I might as well just discuss the situation as a whole. Interest rates are the single most important aspect of bank profitability they are the bargaining power. Most bank profits are derived from net interest income. This is interest income received on loans minus interest expense for borrowed funds. Interest rates determine the amount of money a bank can earn. Another measure is a banks’ net interest margin which is a bank’s net interest income divided by its average earning assets. This is a common measure of a bank’s ability to squeeze profits from its loans.
When interest rates fall, they have a positive effect on a bank. First, net interest margin can expand. Second, the value of a bank’s fixed rate of investment portfolio is enhanced by declining rates, since a bond with a higher stated interest rate becomes more valuable as prevailing rates drop. Third, falling rates lower the cost of credit, which stimulates loan demand and reduces delinquency rates.
Opportunities:
1. Because of the increasing amount of technology Internet banking will begin to replace traditional banking, thus cutting personnel costs.
2. Incorporating investment banking into the banking industry, as some major companies are doing, lets the bank increase profits and promote economic growth while improving company image.
Threats:
1. An increase in interest rates causing a decline in bank activity.
2. A collapse of the Fed leading to bank failures, a repeat of the crash of 1929.
3. A decline in the US economy leading to a fall in the value of the dollar, thus causing an instable economy. From there the US banking system would be less secure in terms of dollar values that many people would move their money overseas into a more stable economic situation. Similar to the situation in many South American countries. (a little far-fetched, but possible)
Key Success Factors:
? Capability to use the internet for banking, investing, and general e-commerce
? Size of company, name recognition, innovative local marketing
? Best rates (loans, checking, savings, etc.)
? The capability to have the fastest and simplest banking through design, innovation, and location
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