Money, banking and finance (APC 312) january 2015

Banking Academy, Vietnam
ASSIGNMENT COVER SHEET
UNIVERSITY OF SUNDERLAND
BA (HONS) BANKING AND FINANCE

Student ID: 149080615/1
Student Name: Tran Quyet Thang
Module Code: APC 312
Module Name / Title: Money, Banking and Finance
Centre / College: Banking Academy of Viet Nam
Due Date: 16 Jan 2015

Hand in Date: 16 Jan 2015

Assignment Title: Individual assignment

Students Signature: (you must sign this declaring that it is all your own work and all sources
of information have been referenced)

Money, Banking and Finance (APC 312) – January 2015


Banking Academy, Vietnam

Title page

Money, Banking and Finance
APC 312

Banking Academy, Vietnam
Submitted on January 16, 2015

Prepared by: Quyet Thang Tran
Student ID: 149080615/1

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Banking Academy, Vietnam

Table of Contents
Part A: Discuss why banks need to be more regulated in terms of risks they face
compared to other financial firms. ................................................................................. 1
Risks that banks and other financial firms have to face. ..................................... 1
Impact of banks’ failure .......................................................................................... 3
Impact of regulations ............................................................................................... 4
Part B: Critically analyze the competitive conditions in the banking industry.............. 4
Competitive approaches .......................................................................................... 5
Degree of competition in the banking industry ..................................................... 6
Impact of regulations to competition in the banking industry ............................ 7
References ...................................................................................................................... 9

Tables
Table 1: Net interest margins of five biggest banks in UK in 2011-2012 ..................... 5

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Part A: Discuss why banks need to be more regulated in terms of
risks they face compared to other financial firms.

There are several common differences between banks and other financial firms
especially in terms of risks. With the different features, functions and the impacts to the
whole economy, banks have to take higher levels of risks such as credit risk, liquidity
risk…This is the reason why banks are more regulated than non-bank firms. The
analysis below will shows some main types and levels of risks which banks and nonbank enterprises meet while operating. Besides, customers’ protection is also the reason
for banks to be more regulated. Moreover, several regulations also are mentioned to
reduce the negative impacts of bank failures and stable the financial system.
Risks that banks and other financial firms have to face.
Firstly, banks have the right to take the deposits. The banks collect huge numbers of
the short-term to medium-term deposits in order to provide the loans for customers for
the long term. Furthermore, by having ability to create money, the deposit liability of
banks usually form the bulk of a country supply, so the quantity and growth of these
deposits are often of considerable policy interest to the government and central banks
(Howells & Bain, 2007). While non-banks without deposits taking are not under the
pressures of these policies. While performing the function of transforming assets, the
financial intermediaries actually share risks with savers, change the maturity and
quantity of funds by gathering short to medium term funds with small amount of money
and then convert them into huge funds for long term. The risks are arising through this
process. In a commercial bank, some of 74% of bank assets are in the form of loans,
and they generally produced more than half of bank revenue (Mishkin & Eakins, 2011).
Therefore, credit risk - the risk, that borrowers might default on their loans (Hubbard
& O’Brien, 2012) in banks, is very high. It means that the ability of borrowers in paying
money back is an important factor. In order to make a loan, banks have to follow the
requirements and processes carefully in order to prevent non-performing loans. For
example, in Vietnam, the ratio of non-performance loans is still very high about 15%
based on the estimation of Moody's (Vietnamnet, 2014). Because of this problem, banks
do not willing to make loans and lead Vietnam economic growth to slow down. The
main cause is the asymmetric information between banks and borrowers. Banks may

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not know all information about the financial health and the purposes for taking loans of
their customers. As the result, this will increase the level of credit risk in banks.
Furthermore, banks usually take short-term deposits and make long-term loans. This
means that the maturity of deposits and loans are mismatched. And because these loans
can only transfer to cash when becoming mature so it can cause banks to lack money
for cash demand. It means that banks can meet the liquidity risk - the possibility that a
bank may not be able to meet its cash needs by selling assets or raising funds at a
reasonable cost (Hubbard & O’Brien, 2012). Additionally, because the depositors can
freely be withdrawal, if many depositors want to withdraw their money in the banks at
the same time, banks will have the obligation to return the funds back immediately.
This could lead banks to run out of cash and become insolvent like in the case of
Northern Rock in September in 2007. It ran into short-term difficulties as a result of
temporary market conditions - the troubled US sub-prime market and London Interbank
Offered Rate (Libor) - rises to its highest level in almost nine years because Northern
Rock grew rapidly by using securitization of mortgages (BBC, 2008). According to
Bloomberg Businessweek, by early Sept. 15, Northern Rock was reported to have paid
out about $2 billion because customers worried about losing their savings (2007).
Therefore, Bank of England acted as lender of the last resort to bail out this bank and
reduce its impacts to the whole economy. However, non-bank firms like pension funds
or investment trusts offer the different financial products such as pension funds, various
types of insurance… in terms of contracts. It means that the customers have to follow
the terms of contracts and wait for the due date. For example, the saver of pension fund
cannot withdraw the pension whenever it suits (Howells, 2010).
Thirdly, banks also have another problem with the difference between the maturity of
the deposits and loans. Since the long-term interest rates at which banks lend and the

short-term interest rates, at which they borrow, can fluctuate, banks run the risk of
losing money if unexpected differences between the two arise (Bednar & Elamin,
2014). According to Basel Committee on Banking Supervision, 2004, excessive interest
rate risk can pose a significant threat to a bank's earnings and capital base. For example,
if the market rate increases and the bank interest rate is unchanged, banks will the
opportunity costs for investing in other projects.
Next, banks could meet the foreign exchange rate risk because of the fluctuation of
values of different currencies. Foreign exchange rate risk is measured by the standard
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deviation of domestic-currency values of assets or liabilities attribute to unanticipated
changes in exchange rates (Levi, 2007). Banks can be influenced directly by holding
assets or liabilities in a foreign currency. For example, Vietnam commercial banks can
take deposits in USD and make loans in VND, so any changes in exchange rate between
USD and VND could bring impacts immediately to banks’ assets. However, banks still
are affected by foreign exchange rate risk although banks do not hold foreign assets or
liabilities. For example, a Vietnam commercial bank holds a loan to a Vietnam exporter.
Let say, this exporter exports a good worth $1,000 and receive payment three months
later. If VND/USD three months later decreases, the actual payment that this exporter
receiving in VND will be lower than estimated amount with current exchange rate.
Therefore, the profitability of exporter will be diminished and this impacts to loan
repayment to banks.
Impact of banks’ failure
Most of the bank liabilities are non-transaction deposits and checkable deposits. Both
types of deposits are money that savers put in the banks, so the failure of banks can
cause losses for people, at least temporarily, access to the means of payment (Howells

& Bain, 2007). This means that banks play an important role as a payment system for
the economy to circulate cash flows. The payment system is an operational network governed by laws, rules and standards - that links bank accounts and provides the
functionality for monetary exchange using bank deposits (Summers, 2012). For
example, a crucial payments system of Bank of England which processes payments
worth an average £277bn a day had failed for nearly 10 hours and it causes that
homebuyers and sellers around the country would be left unable to complete purchases
on time and that big businesses, which also use the system, would fail to make payments
(Jill, et al., 2014). This problem interrupts the activities of trading home in UK.
Next, systemic risk - risk to the entire financial system rather than to individual firms
or investors (Hubbard & O’Brien, 2012) bring huge negative impacts to the whole
economy system. If there is any bank failed, this can make all depositors withdraw all
their money not only in banks that are failure but also in other banks. This process is
called contagion. Depositors react like that because of their fear about losing their funds
in the accounts in banks. In order to prevent systemic risk, too-big-to-fail policy – a
policy under which the federal government does not allow large financial firms to fail
for fear of damaging the financial system – means that largest commercial banks will
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be bailed out. In this case, FED or central banks will have a role as lender of last resort.
However, this will lead moral hazard to increase. It means that the banks will take more
risky activities because they know that if they fail, they will be saved by the
governments.
Impact of regulations
Furthermore, because of asymmetric information, depositors have less information
about what banks do with their money. Therefore, regulations are carried out to reform
banks’ activities to protect consumers. For example, on 29 January 2014, the European

Commission adopted a proposal on banking structural reform for a regulation to stop
the biggest banks from engaging in the risky activity of proprietary trading (European
Commission, 2014). Besides, there are many other areas of banks that need to be
regulated such as liquidity, capital requirements…like Basel III required.
On the other hand, regulations also bring out some costs for banks. For example, the
“too big to fail” policy, to bail out the big banks, leads these banks take risky activities
– this is called moral hazard. In addition, there are some major regulation initiatives
causing significant impacts on US banks such as higher capital requirements, higher
liquidity requirement, tightening of derivatives regulation and enhanced consumer
protection regulation (Elliott, et al., 2012). For example, the higher capital requirement
is implemented by Basel III and leads banks to take higher funding costs for operation.
Therefore, the profitability of banks will be affected. Additionally, this also creates a
barrier for new entrants to join in the banking industry.
In conclusion, with higher levels of different risks compare to other firms, banks need
to be more regulated. The failure of one banks can lead whole economy to slow down
and face the financial crisis. Nevertheless, besides create a safe environment in the
banking industry, regulations also cost banks in some areas such as operations,
profitability…

Part B: Critically analyze the competitive conditions in the
banking industry.
Like other industries, the competition among banks also exist. In order to analyze the
competitive conditions in banking industry, some approaches are used to measure such
as interest rate, market concentration, etc. Furthermore, the levels of competition

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between the big banks and small banks, domestic banks and foreign banks. Lastly, the
impacts of regulations to competitive condition in the banking industry are mentioned.
Competitive approaches
Firstly, the operational efficiency – the provision of a good quality service at the lowest
possible price (Howells, 2010) in banking industry can be evaluated through net interest
margin because the products and services, that banks offer, are financial instruments.
Net interest margin (NIM) is the difference between the interest a bank receives on its
securities and loans and the interest it pays on deposits and debt, divided by the total
value of its earning assets (Hubbard & O’Brien, 2012). In other words, NIMs show the
future profitability that banks can make based on their assets. The table below will show
NIMs of some big banks in UK as follows:
Barclays

RBS

Lloyds

HSBC

Std. Chtrd.

2011 2012 2011 2012 2011 2012 2011 2012 2011 2012
Net interest
margin
203

185

192

193

207

193

251

232

230

230

(basis
points)
Table 1: Net interest margins of five biggest banks in UK in 2011-2012

Source: KPMG LLP (UK) 2013
It can be seen clearly that NIMs of five big banks in UK are a little bit difference
compare to each other. Furthermore, the changes in NIM figures in two years 2011 and
2012 of these banks are small. The interest rate in banks can be considered as the price
for banking services and products. In this case, the interest rate of five UK big banks is
set similarly. This means that banks have to highly compete to each other by offering
reasonable price for attracting customers.
Another way, to measure the competition of the banking industry, is contestability. The
behavior of banks in contestable markets is determined by threat of entry and exit (The
World Bank, 2012). The increase in contestability in the banking industry can be
explained through some entry conditions. For example, in EU, the “single passport”

system allows financial services operators legally established in one Member State to
establish/provide their services in the other Member States without further
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authorization requirements (European Commission, 2014). It means that a bank can
easily expand its market to all EU countries with only a license to operate in one EU
country.
Another factor, that could influence the competition, is changes in technology
especially the digital banking. The development of the Internet and smart phones has
brought many advantages for users. Now customers of banking services can easily
check their balance through digital apps on their phone or assess to the websites of
banks. Furthermore, there are many other transactions like transferring money, making
payment that customers can conduct without going to a bank branch. In the term of
competition, taking a good location can be considered as a competitive advantage and
a barrier for new entrants because they need to find the places such as in urban areas,
big streets…that make customers easy to come. However, this changes; for instance in
UK banking industry, some new entrants (Shawbrook, Aldermore and Atom Bank for
example) are actively choosing different means of service delivery, eschewing branches
altogether, while others such as Metro and Handelsbanken are currently building branch
networks in the low hundreds rather than the low thousands currently operated by the
major banks because of 39% of small and medium enterprises use online banking at
least once a day, with a further 30% using it at least once a week and only 7% never
use it (Barty & Ricketts, 2014). This is not only the way for the new entrants entering
market, but also the chances for all banks to improve their services to compete.
Degree of competition in the banking industry
Market concentration can be used to measure competition in the banking industry

through the size of banks. For example, according to Labour leader Ed Miliband,
Britain has one of the most concentrated banking systems in the world with just four
banks - Barclays, HSBC, Lloyds Banking Group, and the Royal Bank of Scotland
Group controlling 85% of small business lending (Chalabi, 2014). Therefore, these
small banks in this local market might conduct M&A to be able to have more
competitive to the four biggest banks. With dominating the market, these big banks are
very powerful to bring significant impacts to the market.
Additionally, the high competition also happens between the foreign banks and
domestic banks because of globalization. Firstly, foreign banks can take a lot of
advantages by providing services to many customers not only in one country compared

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to domestic banks. This can help the operations of foreign banks become more efficient.
Secondly, the products and services of foreign banks also are more diversified rather
than domestic banks. This allows foreign banks to spread their risk. Moreover, the
funding bases of foreign banks are larger than domestic banks and the abilities to access
the funds from their parent banks. It means that foreign banks can take funds for low
costs so they will have good competitive position. Lastly, foreign banks might take
other numerous advantages from their economies of scale such as high skill labors.
On the other hand, foreign banks also meet some barriers and find difficulty in operating
compared to domestic banks. The local banks might be able to collect more information
about customers because they understand clearly about cultures and behaviors of
customers in using banking services and products. In addition, domestic banks know
the policies and procedures better rather than foreign banks. Moreover, they can be
supported by governments in order to compete to foreign banks.

Impact of regulations to competition in the banking industry
Moreover, the regulations also impact to the competition in the banking industry. For
instance, in October 2009 the European Commission required the UK banks that had
received state aid in the crisis to sell off some of their activities in order to encourage
more competition in future (Howells, 2010). By increasing the competition, there are
several benefits such as cost reduction, making banks operate more efficiently. If the
banks are highly competitive, they will have to consider the net interest margin
carefully to ensure both attractions to customers and profitability. In addition, to
compete with others, banks will try to provide services with high quality, give aid to
customers whenever problems happen…Another reason for encouraging the
competition in the bank industry is the concept of “too big to fail”. With controlling
85% of small business lending, if there is any problem in these banks, it can bring huge
damages for the economy. Likewise, a high competitive banking industry could reduce
the issues of moral hazard. Additionally, making the system more competitive requires
that the branches and other assets that are sold off are bought by non-bank firms, or
alternatively by banks that do not currently operate in the UK (Howells, 2010). It means
that the assets of banks in UK cannot increase by purchasing these activities.
Furthermore, in September 2013, the Payments Council launched a new free-to-use
account switching service - the Current Account Switch Service to help consumers
make switching current accounts from one bank to another, simpler, reliable and hassleMoney, Banking and Finance (APC 312) – January 2015

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free (Bank of England, 2014). It means that customers will be supported to change their
accounts to other banks. This provides the opportunity for small banks and new entrants
to attract more customers from other banks.
In conclusion, big banks are higher competitive compared to small banks because of
their scale. While the competition among foreign banks and domestic banks depends

much on how they operate and take the advantages. However, the banking industry
have become more competitive with the reform of regulations to reduce the impacts of
big banks and help the small banks have position in the market to compete.

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References
Bank of England, 2014. A review of requirements for firms entering into or expanding
in the banking sector: one year on, s.l.: Bank of England.
Barty, J. & Ricketts, T., 2014. Promoting competition in the UK banking industry,
London: BBA, Pinners Hall.
Basel Committee on Banking Supervision, 2004. Principles for the Management and
Supervision of Interest Rate Risk, Basel: Bank for International Settlements Press &
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[Online]

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M.,

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banks:

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are

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Howells, P. & Bain, K., 2007. Financial markets and institutions. 5th ed. London:
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