The role of banks in infrastructure development
The developmental activities of a country are dependent on its economic growth which is attained over a certain period. The economic growth considers the investment and the production to the extent which illustrates that the investment and production is to the extent of GDP in a country. This leads to improvement in the overall standard of living and economic development. The two key contributions of the banks in terms of the financial system are stated below as follows:
- Brokerage Services – Banking assists in investing in listed securities in the capital market. These services are discerned to be provided in accordance with registered financial advisors who are able to provide a high level of professional assistanceto their clients. In the recent times, banking service is able to determine the long-term and short-term financial goals along with risk tolerance limit. It is also able to examine the most suitable alternative investments which might help in reaching the desired goal and execute trades (Webb and Martin 2017). OCBC securities is considered as one of the first brokerage service in Singapore to introduce “OCBC OneTouch on their iOCBC TradeMobile” app for both Android and iPhone which enabled the users to evaluate their stock portfolio. The bank took noteworthy initiative to launch app named Apple Watch. This service was able to provide important “account information via wrist devices”. The bank is able to make significant contribution to the financial system with continuous engagement with prospective customers to initiate cross selling of the brokerage services. In addition to this, OCBC launched “StockReports+ in September 2016”, which aggregates independent research done by the brokers and provide quantitative analysis for the stocks in “Singapore, Hong Kong, United States and Malaysia markets”. OCBC expanded the contribution of brokerage services to the financial system by enabling trading on the “Shenzhen ‘A’ market after the launch of the Shenzhen-Hong Kong Stock Connect in November 2016”. This allowed the existing customers to trade over 15 global exchange online (Ocbc.com. 2018). Some of the other brokerage services are identified in form of providing opportunity to earn income on unvested cash in the brokerage account with bank deposit program thereby assisting in dividend reinvestment plan, periodic reinvestment plan and providing margin borrowing and option trading (Unionbank.com. 2018).
- Asset Transformation – The process of asset transformation deals with creating new asset from liabilities with different characteristics and conversion of small denomination, “immediately available and relatively risk-free bank deposit into loans”. Asset transformation in banks is used with deposits to produce revenue for pooling deposits to fund loans. Henceforth, in a simple way the process of asset transformation involves converting bank liabilities or deposits into bank assets or loans. The primary activities of bank include withdrawal of deposits by the customers at the stipulated time and the contract is made at the time of deposit agreement (Entrop et al.2015). Bank loans are considered as assets as the present money is the bank lends and expects to receive along with interest payments. Very often, bank decides to undertake asset transformation via lending long and borrowing short rate of interests with transformation of revenues. The bank performs asset transformation by offering varieties of financial products in form of “deposits, loan products and investment options” (Majd Bakir 2015). The asset conversion cycle of OCBC shows that as there was an increase in the customer deposit by 6% in 2016 (“amounting to S$ 261 billion”), this comprised of 80% compensation for funding of the group. This shows that 80% of the Banks’s liabilities (deposits) were transformed into assets (loan). The sound assets transformation policies adopted by the bank was further evident with a stable funding and liquidity position in 2016. In addition to this, there was an increase in the “loans-to deposits ratio stood at 82.9%, as compared with 84.5% a year ago”. However, bank is in a good position to cover any unforeseen fund requirements due to the high asset transformation rate (Ocbc.com. 2018).
A study conducted by the IMF has implied that an increase in one percentage point of the GDP is able to increase the output by 0.4% in the same year and after four years by 1.5%. In general, the financial institutions are also able to bring economic development in the infrastructure facilities in a country with asset conversion. The financial services are discerned to play an important role in terms of providing growth to the infrastructural facilities. The private sector finds it difficult for raising the capital needed for setting up of the infrastructure industries. The development banks and the merchant banks are able to contribute for raising capital in these industries. Banks have the opportunity to work with multilateral developing organizations for setting up financial and investment funds and other industrial platforms (Bhattacharya, Oppenheim and Stern 2015). The multinational banks have been able to gather substantial amount of information pertaining to “management, client, government and market-related information” with the help of daily operations. They have been able to resolve several types of the finding issues associated to infrastructural development. There is significant scope of commercial financial institutions which may work with the multilateral development organizations and financing funds. The global infrastructure is able to embrace new opportunities. This is done by strengthening cooperation and resolving investment issues faced in several countries, there is significant opportunity for development of economy, infrastructure quality along with promotion of regional connectivity (IMF 2014).
There are number of problem associated to the financial deficit and financial surplus units. For instance, the problem with financing to providing debt finance to financial surplus unit was depicted with “maturity mismatch, size mismatch, return and risk” for OCBC in 2015. In several instance OCBC struggled to meet the short maturity debts. As per the financial revealing, OCBC has majority forms of Credit Exposure arising out of residual contract maturity amounting to S$119152 in 2016. As per the depiction of annual report published on 31st December 2016, the “absolute non-performing asset grew by $ 2.89 billion in compared to $ 2.04 billion”. This shows significant issues with the debt financing by bank to both financial deficit and financial surplus units. The financial surplus units such as oil and gas support services witnessed higher NPA because of the high “NPL ratio from 0.9% a year ago to 1.3% in 2016”. However, the group had been able to maintain a strong funding position and capitalisation options (Paligorova and Santos 2017).
Debt financing for financial deficit and surplus units
The problem associated to debt financing for financial deficit units are seen with OCBC issuing of unsecured debt. This is evident with “subordinate debt, Commercial papers and Structured notes” increasing in 2016. Over time the bank is seen to issue more debt within “1 week, 1-week to1 month, 1 to 3 months and 3 to 12 months”. The increasing debt obligations over the months, shows that the securities comprise of the equity securities, trading and investment portfolio of government, debt and equity securities (Eichengreen and Panizza 2016).
Some of the other risks identified with debt financing for the financial deficit units are identified with lending to the consumer, corporate or institutional customers. Some of the most noted trading and investment banking activities are discerned with banking activities pertaining to “trading of derivatives, debt securities, foreign exchange, commodities, securities underwriting and the settlement of transactions” (Porter 2016). This has exposed the group to the counterparty and issuer credit risk. OCBC credit risk exposure is quantified in terms of the transaction’s present positive “mark-to-market value plus an appropriate add-on factor for potential future exposure”. For example, a bondholder may sell the bond at any time, in order to receive this privilege, the bond holder will be able to make a lump sum payment at the time of purchasing the bond. The rate of interest on bonds are generally lower than the bank loans but the accessing time of the bank loans are faster (Christensen et al. 2016).
Basel III is identified as the global voluntary regulatory framework for bank which assesses “market liquidity risk, stress testing and capital adequacy”. This is considered as the third instalment of the Basel Accords after Basel I and Basel II, in reply to shortages of financial guideline for the financial crisis of 2007 to 2008. The four-important consideration under Basel III is acknowledged with capital adequacy ratio under capital requirements, leverage ratio under leverage requirements and LCR and NSFR under “liquidity requirements”. As per the prescription of the regulatory requirements under Basel III, OCBC needed to maintain “Common Equity Tier 1” (“CET1”) “capital adequacy ratio” (“CAR”) of 4.5%”, Tier 1 CAR of 6% and Total CAR of 8%. OCBC has adhered to the changes prescribed by Basel III and maintained prescribed captain adequacy requirements. This is evident with, “common equity tier 1 of 14.7 in 2016 and 14.18 2015”. It has further able to maintain the minimum total capital requirements, which is evident with total CAR of “15.90 in 2014, 16.8 in 2015 and 17.1 in 2016” (Ocbc.com. 2018).
Impact of Basel III on risk management and capital adequacy
The increasing nature of “capital adequacy ratio” is considered to be safe for the bank as OCBC is in a better position to cover its financial obligations. (Ocbc.com. 2018).
The Basel III norms also strengthened the liquidity requirements by putting an augmented effort to determine capital requirements for counterparty in case of credit default. The main changes in the Basel III norms that are brought by strengthening the liquidity requirements in form of LCR and NSFR. The introduction of NSFR was done to encourage the banks to utilize stable sources while financing the operational activities. The LCR was introduced to ensure there was sufficient stock for imaginative “high-value liquid asset” consisting of “cash or cash equivalent units” for meeting liquidity obligations. Liquidity policies introduced under Basel III (LCR) depicted that, the banks needed to consider “high-quality liquid asset” for covering “net cash outflows” for more than 30 days. As per the NSFR requirement, the accessible sum for stable funding is required to exceed the required amount of stable funding for more than one year under extended stress. The objective of liquidity risk management of the bank was to confirm that there are funds available to meet the contractual and regulatory obligations of finance and OCBC is able to undertake new transactions. As per the fourth quarter result of 2016, the average Singapore dollar (“SGD”) and “all-currency liquidity coverage ratios” (“LCR”)” for the group thereby not considering OCBC Wing Hang which will be included in due course”) was depicted with “284% and 145%” respectively. Balance sheet of the bank’s is able to demonstrate that OCBC is recognized to prudently manage its risks and attain a healthy liquidity and funding position. Based on the performance review the bank had to go through difficult operating environment in 2016 (Chen, Dasgupta and Yu 2014). The availability of the sales national assets is considered for infinite time and this may be held for selling the needs of liquidity or any change in exchange policy, market prices or interest rate. The different types of expected liquidity of the company are managed with combination of “treasury and asset liability practice management”. However, OCBC is still working on its regulatory framework for applying the regulatory reporting of Group-wide NSFR and “liquidity coverage ratio (LCR)” (Ocbc.com. 2018).
In several cases banks need robust risk-based ratio for capital as this helps in excessive leverage build up. Basel III required the banks to maintain a minimum leverage ratio of 3%. This is considered with leverage ratio as per risk and calculated by dividing Tier 1 capital by the bank’s average total consolidated assets”. In addition to this, The Basel Committee tested “a minimum Tier 1 leverage ratio of 3% during the parallel run period from January 1, 2013 to January 1, 2017”. The main changes brought in the leverage requirements had done to protect the bank from systemwide build-up of leverage due to financial stress during destabilization or unwinding of a certain process. The leverage ratio of OCBC was 8.2%, which was above than a least requirement of 3% as suggested by the “Basel III committee”. OCBC was also decided to introduce more transparent measures for capital requirement by maintaining a high “discretionary counter-cyclical buffer” (Ocbc.com. 2018).
The process and complexities of asset securitization
The process of asset securitization is identified as practice for financial pooling different types of contractual debts. These are identified with such as “auto loans, credit cards, commercial mortgages and residential mortgages and sending the associated cash flows to the “third-party investors” in form of securities”. These securities may be defined as “bonds, pass-through securities, or collateralized debt obligations (CDOs)”. The associated investors are recompensed from the “interest cash flows and principal” “collected from the underlying debt” and redistributing the same with capital structure of new financing. The securities supported by mortgage receivables are termed as “mortgage-backed securities” while securities backed by “other receivables are termed as asset backed securities”. The procedure of asset “securitization” is identified as a complex one which includes several actors. The diagram depicted below is taken from IMF website which shows the rudimentary mechanism of creating securities and transferring of asset. The entity which originally holds the asset, initiates the process by legal entity which is known as SPV, specially created to limit the risk of the final investor in relation to the issuer of the assets”. Based on the situation, SPV is either responsible for issuing the direct securities or reselling the pool of assets to a trust (Agarwal et al. 2016).
SPV is a legal framework rather than the element which is responsible to play an active role in the transaction process. The most noted character played by SPV is seen to be of that of an arranger, which is typically a bank responsible for setting up the contract and evaluating the “pool of assets”. It also determines the way in which this would be fed and characterized by securities on like structure of fund. The main purpose of structuring is observed with the postmodern “characteristics of securities”, in a way that they agree to the needs of final investor. The arranger plays a significant role in distribution of the securities made for final “investors”. This also enables refinancing of short-term debts with long-term bonds (Fimarkets.com. 2018).
OCBC may wish to adopt asset securitization with the purpose of asset “transformation intention, balance sheet consistency motive, fee income motive and funding motive”. Due to the increasing percentage of loans, OCBC may wish to securitize some of its loans for changing the balance sheet position. This may include opting for diversification strategies for the bank. The bank is seen to be having significant amount of mortgage and as per the interpretations of balance sheet and there is a high chance of being overexposed by these mortgages. Henceforth, if OCBC decides to securitize some of its deemed excess, then the bank may acquire an asset more favourably in areas pertaining to student loan. In this situation, the bank may lack the “capital requirement” for purchasing these assets and may be reluctant to expand its balance sheet for incorporating more student loans. Secondly, by the decision to securitize its assets, bank’s mmay not have its funding, asset holding and risk-taking capabilities into different processes (Abdelsalam et al. 2017). Due to this, securities would be able to link parties which possesses more comparative advantage and share mutual benefit. The bank is discerned to be having a comparative advantage in terms of initializing the loans. Henceforth, OCBC may be able to outsource its relatively weaker SPV’s to the eventual investors and specialize in terms of funding and holding loans. Moreover, in case the “SPV is not a subsidiary of the bank” then it needs to pay a fee to the bank for purchasing of the assets and this can create additional source of income thereby potentially leading to increased “rate of return on equity”. The shifting of this “credit risk” enhances the capacity of the bank for lending activities. Furthermore, this increased capacity enhances the bank reputation this customer and able to build an approachable bond by providing loans to those otherwise struggle to obtain (Ocbc.com. 2018).
OCBC may also want to encourage its funding activities which benefited asset securitization of bank loans. By exercising securitization options, the bank would be able to widen its fund sources and the investors who had previously sceptical will no longer have to invest their funds in a bank which they don’t prefer (Le, Narayanan and Van Vo 2016).
“Global Financial Crisis (GFC)” was well-thought-out as the one of the worst downturn in global economy followed by Great Depression in 1930. The implication of this crisis originated from Lehman Brothers bankruptcy filed On September 15, 2008. This was one of the largest bankruptcy in the history with “$639 billion in assets and $619 billion in debt”, thereby surpassing previous bankrupt giants such as “Enron and WorldCom”. The demise of “fourth-largest U.S. investment bank” -entities such as “financial crisis” which swept through GFC in 2008. This collapse was identified as a seminal event which greatly intensified financial erosion off close to “10 trillion in market capitalization from global equity markets in October 2008” (Ball 2016).
The impact of GFC during 2008-2009 did not had any severe implication on the performance of the bank. OCBC was able to maintain a sturdy “balance sheet and capital position”. These implications were attributed to the basic blueprint for banking with its emphasis on the SME and retail banking unlike the strong proprietary trading gains recorded in some “global financial institutions”. The core net profit after tax for OCBC (“excluding the onetime gains”) increased by “32% in 2009 to attain a new record of S$1,962 million. This was discerned to be exceeded to the previous high of S$1,878 million in 2007”. The increase in the earnings in 2009 was recorded with higher amount of “non-interest income”, decrease in the allowances and lower expenses. The allowed margin for adjustments and net interest income depicted a healthy trend at the time of financial crisis. By the adaptation of a robust risk management framework, active monitoring and prudent loan growth policy of the portfolios, OCBC was able to achieve the best quality in terms of the asset and “credit loss” experience among the three banks based in Singapore. In June 2009 the company’s Non-performing loan ratio peaked at “2.1%, compared to 1.7% in December 2007 and 1.5% in December 2008”. This value was depicted with an increase of 1.7% in December 2009. The total amount of the assets and specific allowances for loan over the average loan were discerned to be below 30 BPS in 2008 and 2009. The coverage ratio for the allowances remained at a healthy level with “125% in December 2008 and 102% in December 2009”. During the situation of crisis, OCBC continued to maintain a strong capital cushion with a “Tier 1 ratio of 14.9% in 2008 and 15.9%”. This is seen to be even higher than the non-financial crisis situation in 2007 when the ratio was only 11.5%. OCBC is considered as the only bank in Singapore which did not reduce its DPS for the period (Bis.org 2018).
As Singapore is identified as a small and open economy with strong linkages with the other countries, it severely got affected in terms of falling Global trade. The “Monetary Policy” responses were graduated deliberately, which was underpinned with the objective of promoting “price stability” in medium term. Singapore government intentionally did not respond to every single development in the “economy or the financial markets” as this would have brought in needless volatility and ambiguity. In response to the significant decline the external demand in the late 2008, MAS was seen to support the domestic economy in the early 2010 thereby consideration for strong recovery path of the rising economy. In the early 2010, the government took a strong recovery route for addressing the rising “domestic cost pressures amidst high rates of resource utilisation”. To address this concern, MAS was seen to shift its gradual and modest appreciation towards “S$NEER policy band”. Subsequently a more stricter policy for MAS tightening is seen from improving on the policy band slope (Bis.org. 2018).
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