Savings is an important determinant of the financial condition of households and economies because this relates to investments in real estate, shares, bonds, as well as other financial instruments together with the existence of finances deposited in banks in support of the investment activities of the bank to generate income. Savings refers to the positive value left when consumption is taken out of income. On the larger scale national savings pertains to personal savings and business savings added to public savings. Business savings equates to the value of undistributed corporate profits while public savings refer to revenues less expenditure for public projects. Savings is closely linked to investment since the money left after making consumer purchases may be allocated for fixed capital such as machineries resulting to greater production that contributes to economic growth. However, savings does not result to increase in investment if the amount is stashed in the house and not deposited in financial intermediaries such as banks to be recycled into investments by businesses. (Sloman & Sutcliffe 2001) Banks play the important role of channelling and transforming deposited savings into resources for investment by lending deposits to individuals and business firms for use in business ventures with interest or by the banking institution engaging in its own investments. Money deposited does not become idle because this is used to support investments leading to earnings and eventually to economic growth. (Siklos 2006)
Dynamics of British Banks
According to the British Banker’s Association (2006a), banks can be classified into independent British banks, British banking brand owned by British companies, British banking brands owned by foreign companies, and foreign banks operating the United Kingdom. The number of independent British banks is small because of the consolidation of various banks since the 20th century. In the United Kingdom, there are only a number of independent local banks [See Table 1 in Appendix] unlike in other economies. There are also only a number of independent specialist banks. There are also a significant number of British banking brands controlled by British companies together with an almost equal number of banking brands controlled by foreign banking institutions. There are only limited foreign banks in the United Kingdom carrying brands such as Citibank, ING Direct and Bank of Cyprus. However, on the aggregate, there are currently 223 members of the British Banker’s Association, indicating vibrancy in the banking and finance industry in the United Kingdom. Although there are only a limited number of independent banking institutions in the United Kingdom, this does not mean that the industry is weak since the consolidation of banks to form the present independent banking institutions mean that the operation of these banks have become large scale. Their scale of operation has compensated for the decrease in the number of independent banks. The independent banks also comprise the major players in the banking and finance industry.
Current Performance of British Banks
Based on the September reports of the British Banker’s Association (2006b), mortgage lending continues to increase while consumer credit weakens. In August 2006, the value of gross mortgage lending reached a record high of £20.9 billion, comprising an amount of 9 percent higher compared to July as well as 24 percent higher than the value in August 2005. This means that loans for purposes of real estate or property purchases experienced an increasing trend in the previous months. In terms of net mortgage lending or gross lending less repayments and redemptions, the amount increased to £6.2 billion in August when compared to £5.8 billion in July. The average amount for the previous months has been £5.4 billion while the value for the same months in the previous year was £4.6 billion. This indicates that the banking industry is experiencing increasing earnings from the mortgage loans.
The component of the earnings accruing to the bank also experienced change. Previously, there were more mortgage approvals but resulting to lesser earnings while current activities consist of lesser mortgage approvals with corresponding higher value. In August 2006, there were a total of 184,557 approved mortgages for different purposes with a corresponding £19.1 billion aggregate value. The number of approvals was lesser by 5 percent but the aggregate value increased by 4 percent when compared to August 2005. On the average, the loan approved for the purchase of home amounted to £141,500 comprising an amount 8 percent higher than the same month in the previous year. (British Banker’s Association 2006b)
In relation to loans and overdrafts, net lending increased by £0.2 billion in August 2006. However, this is a lesser amount when compared to £0.4 billion in the previous month of this year and the average increase in the previous months of £0.3 billion. With regards to underlying net lending through credit cards, the value decreased by £0.4 billion in August 2006 when compared to a decrease of £0.1 billion in July of the same year. This is also a higher decrease when compared to the £0.1 billion contraction in the previous months of this year. (British Banker’s Association 2006)
Figures indicate that the values of gross and net mortgage lending primarily for housing and for mixed loans favoured banking institutions. This means that the improvement in the earnings of banking institutions was attributed to changes in the price of housing that encouraged individuals and business firms to obtain loans to finance housing acquisitions rather than increased volumes. Values for the month of August reflects stable and robust demand for mortgage loans directed towards housing purchases. Although there is a decrease in mortgage approvals when compared to the previous months or the past year, earnings from mortgage loans for housing increased relative to the previous months or the past year. The condition of the housing and real estate market for August was favourable to banking institutions and the increased value of approved mortgage loans worked well for banking institutions relative to increased volume of mortgage approvals. This means that the banking industry is affected by changes in the other industries or endeavours requiring financing such as real estate or housing. The industry should base its operations and strategies on relevant changes in other industries and the market.
Bank Operations & Strategy
A comparison of the operations of banking institutions in Europe shows a variance in their strategy resulting to differences in performance. According to Llewellyn (2005), substantial variance in the profitability of banks across Europe exists [See Table 2 in Appendix]. In considering the dynamics between competition and profitability, in European banking institutions, British banks are considered as sources of best practices because of their greater profitability relative to other banks in neighbouring countries. British banks have been experiencing excess earnings in the previous decade relative to their counterparts in other European countries indicating the relative profitability of British banking institutions.
The different in profitability of British and other European banks can be explained by considering the extent of utilization of these banks of the stakeholder value (STV) and shareholder value (SHV) paradigms, which correspond to differing business objectives and performance results. On one hand, other European banks try to balance the application and integration of stakeholder and shareholder value while on the other hand, British banks uniquely apply an almost exclusively shareholder value strategy. The success of British banks is forcing other banking institutions in different European countries to consider the British strategy in order to experience the same level of profitability as the banks in the United Kingdom, when the change implies radical change in their business operations and strategy. (Llewellyn 2005)
Shareholder & Stakeholder Value Strategies
These value strategies comprise the bottom-line objectives of banks as business firms. Although the difference between shareholder and stakeholder value is complex, shareholder value works for banks through the maximization of shareholder value in order to have a corresponding increase in the rate of return on equity. This business perspective means that the shareholders are the de facto owners of the banking institution so that they in effect embody risks. Stakeholder value covers a banking operation where there are many stakeholders in the bank with only one group of shareholders. (Llewellyn 2005)
In the case of the stakeholder value paradigm, profitability is a bank objective but this is not necessarily the primary or exclusive objective since this approach focuses more on balancing the differing interests of stakeholders in the bank. In effect, this means that stakeholder-based banks would not pursue profitability in the same intensity as shareholder-based banking institutions. (Crockett 2004) The implication of the utilisation of stakeholder value as a business strategy means that the bank does not focus on profitability. Since the banking institutions in other European countries apply stakeholder value policies relative to the shareholder value utilization in British banks, the latter inevitably experience greater profitability relative to their counterparts in other countries in the region.
Stakeholder value is implemented by the German Landesbanks and Savings Banks, since its equity holdings can be traded in the market. In other European countries, banking institutions are state-owned, semi state-owned or cooperative banks where there is no overt ownership of shares for trading in the market. Due to the lack of shares trading, these banks would not become subject to pressures from the capital market in the same level as shareholder banks that would drive activities towards profitability. In the case of the United Kingdom, all banks are shareholder institutions since there are no state-owned banks and there are only a limited number of mutual bank-like firms such as building societies. In any case, mutual bank-like firms have limited market share and regulation works to limit their range of business operations. While there are also a number of stakeholder institutions in the UK, these compete in fairly small banking markets, primarily for savings and mortgages. (Llewellyn 2006)
Shareholder Strategy of British Banks
British banks have become profitable primarily because of the choice or from capital market pressure to become profitable. Apart from this, UK structural conditions; such as flexible labour market legislations, limited number of stakeholder banks, and a minimal mutual sector competing with banks have also supported the adaptation of shareholder strategy. The stable business cycle continuing from the 1990s has supported the goal of banks to achieve high levels of profitability. (Bikker & Bos 2005)
Among British banks, application of shareholder value strategy is done in various ways or a combination of several modes such as: 1) substantial reduction in costs and employment in order to maximize the value obtained when costs are deducted from revenue; 2) branch closure based on population serviced; 3) sale of unprofitable business ventures; 4) exits from unprofitable areas of business; 5) large scale securitisation of assets; 6) withdrawal from investment banking depending upon the profitability assessments; and 7) divestment from unprofitable foreign operations (Quignon 2000). These moves constitute the rationalization of the banking industry (Quignon 2005).
Future Prospects for British Banks
Despite the benefits of having a nearly shareholder value practising industry, this could also result to certain problems within the industry if some probable disadvantages of shareholder value will not be guarded against. If the British banking industry wants to maintain its increasing aggregate earnings, it should consider as its future prospects the maintenance of effective shareholder value activities but guard against the possible pitfalls of the strategy.
Possible problems that could arise is the development of short-term prospects by banks because of excessive focus on earning high rates of return in the short run; subjection to the impulsive nature of the stock market so that shareholders would cease to be the exclusive stakeholders in the bank, with the effect of changing its banking strategy; excessive cost cutting to the extent of compromising service quality; and the exploitation of power in markets with limited competitors or high entry barriers. (Llewellyn 2006)
Apart from these issues, social exclusion (Quignon 2005) has also emerged as a potential problem in the banking industry market. The drive of banking firms to gain profit may cause them to apply exclusionary policies that discriminate against customers not deemed as profitable by the bank based on geographic location or economic status. If demand for banking service from the sector not deemed as profitable or would increase to a certain level, this may increase the number of mutual bank-like firms and stakeholder financing institutions. If this happens, then the dynamics of banking institutions in the United Kingdom could change resulting to lower prospects for profitability.
Moreover, the effect and ramifications of the continued implementation of an uncompromising shareholder value strategy creates indeterminateness in the industry (Llewellyn 2005). This is because if banking institutions are given free reign to determine the type of business that it would undertake, this brings out the issue of the level that the targeted rate of return is to be determined. The liberality in the industry would allow banks to determine increases in the rate of return on equity by pulling out of business areas offering rates of return at a lower level that the target set by the company.
These issues indicate the possibility of the profitability-responsibility paradox (Llewellyn 2006) arising in the industry when the potential situations previously mentioned are not guarded against. The paradox would cause banking institutions to consider non-financial values in their services requiring certain levels of compromise of the profitability focused shareholder value strategy primarily applied in the industry.
Thus, despite the proven effectiveness of the shareholder value strategy, its application by banking institutions should involve certain levels of compromise (Quignon 2005) with market demands or the interests of potential and actual customers. Without compromise, shareholder value as a banking strategy is expected to fail in the long run.
Banking institutions play an important role in economies by acting as channels for investment to catalyze economic growth. This means that banks have to apply effective operations strategies in order to realize their firm goals of obtaining earnings from transforming deposited savings into resources for investment, by lending deposits to individuals and investors for use in business ventures with interest or by the banking institution engaging in its own investments.
British banks have been experiencing constant increases in earnings from mortgage lending continues to increase while that from consumer credit weakens. The positive performance of British banks in the previous months is attributed to the improvements in market conditions and proliferation of finance-based activities in allied industries such as real estate or housing. Overall, the success of British banks is credited to the unique implementation of the shareholder value strategy relative to the stakeholder value paradigm applied by most of the UK banking industry’s counterparts in other European countries. The implementation of shareholder value strategy has created an environment conducive to bank profitability.
However, this strategy involves potential problems, which, if the industry will not guard against could result to the demise of the existing banking system. Future prospects for British banks then involve the possible consideration of the profitability-responsibility paradox requiring certain levels of compromise in the application of the shareholder value strategy such as the lowering of rate of return standards for customers in the lower income levels and the consideration of employee satisfaction as a prerequisite to customer satisfaction.
Bikker, JA & Bos, JWB 2005, Trends in Competition and Profitability in the Banking Industry: A Basic Framework, SUERF Studies, 2005/2, Vienna, SUERF.
British Banker’s Association 2006a, BBA Member Banks, viewed 9 October 2006, http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=103&a=1562.
British Banker’s Association 2006b, Continued Strong Mortgage Lending and Weak Consumer Credit, viewed 9 October 2006, http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=145&a=7683.
Crockett, A 2004, Interview reported in SUERF Newsletter, SUERF, Vienna, December 2004.
Llewellyn, DT 2005, ‘Competition and Profitability in European Banking: Why are British Banks so Profitable?’ Economic Notes, vol. 34, no. 3, pp. 279-311.
Llewellyn, DT 2006, European Financial Integration: Convergence or Diversity in Banking, Joint SUERF/NIESR Workshop, London, 24th March, 2006.
Quignon, L 2000, ‘Are British Banks too Profitable?’ BNP Paribas, Conjoncture, July 2000.
Quignon, L 2005, ‘British Banks at the Peak of Profitability’, BNP Paribas, Conjoncture, March 2005.
Siklos, PL 2006, Money, Banking & Financial Institutions, McGraw-Hill, New York.
Sloman, J & Sutcliffe, M 2001, Economics for Business, FT Prentice Hall, London.