NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY

FACULTY OF COMMERCE

DEPARTMENT OF BANKING

MASTER OF SCIENCE IN BANKING AND FINANCIAL ECONOMICS

NAME: MOREBLESSING BANDA

STUDENT NUMBER: N02018951Y

INDIVIDUAL ASSIGNMENT
1a). Assess how bank business models, bank intermediation, value creation and
performance are linked and how these should be re-examined, especially in light of the
role of bank intangibles. (20).

Link between Business models, bank intermediation, value creation and performance.

Business model, performance and value creation

 The business model is an increasingly relevant unit of analysis to assess value

creation, and to an extent organizational effectiveness, as it spans boundaries of firms,
industries and even sectors (Bashir and Verma, 2017). Amit and Zott (2001)
conducted early empirical research that supported this shift in business model
adoption in exploratory and explanatory studies that redefined value creation
assumptions. Many academics believe that value creation is the core objective or
"common thread" of the business model concept, and that it is what makes it
important.
 A bank's business model explains how it generates and appropriates value. Business
models are divided into two categories: operational and dynamic. A business model's
operational dimension defines how a company creates value for customers by
completing activities and how it appropriates a portion of that value (Andreassen et
al., 2018). The operational dimension represents decisions concerning target
consumers, product/service offers, and the resources and activities that go with them.
The difference between customers' willingness to pay for products and services and
the opportunity cost of resources is the value created. The negotiation between the
actors in a wider activity system results in value appropriated.

Business model and performance

 Bank business models change throughout time as the economy and financial
environment evolves, as well as new rules and regulations (International Federation of
Accountants, 2020). The data's panel structure allows us to spot trends in the
evolution. We discover that the trading model is the most insular during our sample
period, with few banks transitioning in or out of it. With the global financial crisis, the
transition patterns of other company models alter dramatically. The majority of post-
crisis shifts are away from wholesale-funded commercial banking and toward retail-
funded commercial banking. On the back of regulatory constraints that raise the
relative cost of wholesale funding, this constitutes a reversal of a pre-crisis trend. We
 also look at variations in relative performance around the time a bank changes
business models. We compare a switching bank's performance to that of a peer group
of non-switchers who maintain their original business strategy. Surprisingly, there is
little evidence that underachievers are more likely to switch models. Banks that
transition to a retail-funded model, on the other hand, increase their relative
performance.
 The dynamic dimension depicts how banks alter their operations throughout time.
According to Miles and Snow (1978), banks solve the entrepreneurial problem of
product/market positioning, the technical problem of activities and resource setup, and
the administrative problem of balancing exploration and exploitation through a
"adaptive cycle." The development of the operational business model entails solving
the entrepreneurial and engineering difficulties. Prospectors, defenders, and analysers
were the three purposive adaptation models identified by Miles and Snow.

Financial intermediation and value creation

 In the saving-and-investing process, financial intermediaries play a critical role.

Financial intermediaries play an important role in satisfying the portfolio preferences
of both depositors and borrowers at the same time (Wensveen, 2003).
 They invest the pooled funds by issuing securities such as bonds, mortgages, bills, and
other financial instruments. Rather than buying stocks directly, savers deposit money
with financial intermediaries, who then lend it to final borrowers.
 Non-bank financial intermediaries provide borrowers with debt instruments regardless
of the asset kind, and lenders with financial assets regardless of the debt instrument
type. Financial intermediaries connect depositors and borrowers while also converting
primary securities into secondary securities for ultimate lenders' portfolios.

1b). The authors observe that “…the importance of the conventional functions of taking
deposits and making loans for banks have been reduced…” Allen and Santomero
(1997) point to the need for different theories of financial intermediation. Interrogate
these views, indicating the new directions, if at all, that banking theory should pursue
and why? (20).

Transaction costs and asymmetric information are central to traditional intermediation

theories (Guo, Holland and Kreander, 2014). They are intended to keep track of institutions
that accept deposits, issue insurance policies, and channel funds to businesses. However,
there have been substantial developments in recent decades. Intermediation has increased
despite lower transaction costs and asymmetric information. New financial futures and
options markets are mostly for intermediaries, rather than individuals or businesses.
Traditional theories have a hard time explaining these changes.

New directions in markets and intermediaries

It is commonly agreed that recent years have seen unparalleled levels of financial innovation
(Arnaboldi, 2010). Financial innovation, on the other hand, has been happening for ages,
albeit at a slower pace. Allen and Gale (1994) provide a comprehensive history of financial
innovation. They point out that a variety of instruments have been invented over time, but
just a few have survived. By the 1930s, what are known as classic financial instruments had
been invented and proven to be reliable.

Government securities have been the most important sort of instrument traded in financial
markets in almost all countries. Banks and insurance companies played a crucial role in
converting family savings into company investments in real assets in the nineteenth and early
twentieth centuries. Insurance companies would issue policies and lend the proceeds to
corporations or invest in security markets, while banks would receive deposits from people
and offer loans to businesses. Markets for securities issued by corporations were large in
terms of assets outstanding in the United States and the United Kingdom, but not in most
other nations until the post-war era. Individuals rather than intermediaries dominated the
financial markets in the United States and the United Kingdom, particularly the equity and
bond markets (Reads, 2011).

1. Financial futures and options

Foreign currency futures were first introduced at the International Monetary Market (IMM)
(part of the Chicago Mercantile Exchange) in 1972, establishing standardized marketplaces
for financial futures and options. In the years that followed, new forms of futures contracts
were launched. The IMM's ninety-one-day T-bill contract and the Chicago Board of Trade's
(CBOT) Treasury bond contract, both launched in 1976 and 1977, were both successful.
Financial futures markets were first established in other nations in the 1980s, with the
London International Financial Futures Exchange (LIFFE) in 1982 and the Tokyo Futures
Exchange (TFE) in 1985.
The Chicago Board Options Exchange introduced the first standardized options in 1973.
(CBOE). The CBOE was an early success, and by 1984, it had surpassed the New York Stock
Exchange as the world's second largest securities exchange. As a result of this success,
several US and international exchanges have begun to provide options exchanges. The New
York Stock Exchange, the New York Stock Exchange, the American Stock Exchange, the
Philadelphia Stock Exchange, the European Options Exchange in Amsterdam, and the
London Stock Exchange were among them (Press and Street, 2018).

2. A development of exchange traded derivatives (particularly swaps)

In addition to the expansion of exchange traded derivatives, the amount of OTC derivatives,
notably swaps, has increased dramatically. Currency swaps were the first swaps, which took
place in the 1960s as a way for UK enterprises to avoid exchange regulations (Ajide, 2016).
They entailed exchanging one currency's stream of payments for another currency's stream of
payments. The core procedures developed for currency swaps were later applied to other
situations, most notably in the exchanging of fixed-rate loans for adjustable-rate loans.

3. Securitised Loans

This market began, as generally known, with changes in the mortgage sector. The mortgage-
backed securities market in the United States extends back to at least the 1950s, although it
was not until the 1970s that it became significant in terms of outstanding volume. The launch
of "pass-through" securities by the Government National Mortgage Association in 1970 was
a watershed moment. These allowed for the unrestricted trading of shares in a pool of
mortgages rather than the previously required transfer of ownership to individual mortgages.
For performing these responsibilities, the bank that services the loan, i.e., collects payments
and handles other administrative matters, receives a fee. Commercial mortgages, bank loans,
vehicle loans, and credit card receivables were among the first types of securitized loans to
emerge (Ajide, 2016). The fact that securitization has grown in popularity in recent years
shows that asymmetric information cannot be that essential for securitized loans. If this were
the true, an adverse selection or "lemons" problem would arise, with bad risks wanting to
securitize more than favourable risks. This does not appear to be the case empirically.

4. Securities directly issued by firms

When compared to derivatives or securitized loans, the majority of these have been relatively
insignificant in terms of volume issued. However, given our prior remarks on the changing
nature of the information set available to market participants, the trend is significant. The
evidence presented here suggests that the traditional distinction between financial markets,
where firms issue securities that are directly owned by individuals, and intermediaries, where
depositors and policyholders provide funds to banks and insurance companies that lend them
out, has broken down. These same intermediaries, as well as participants representing the
traditional institutions, such as commercial and investment banks and insurance firms, have
dominated the amount of transactions in these markets and those dealing more intricate
financial claims. Indeed, many significant banks and insurance companies' businesses have
changed dramatically during this time, with trading activity taking up the majority of their
efforts.

This trend has been compounded by the rising use of loan securitization, which has changed
the lending functions done by banks. Many asset origination activities are now just the initial
step toward asset sales or sophisticated stripping and repackaging. Such assets are, at the very
least, considered for sale. However, arguably the most notable trend revealed by the statistics
is the rising concentration of asset trading and risk shifting by banks, insurance firms, and
other financial organizations. The large number of outstanding derivatives and the volume of
transactions suggest that this has become a substantial, if not the most important, activity for
the sector (Ajide, 2016).

Reasons why banks should pursue new directions (financial innovation)

 Financial innovation could also assist to smooth out business cycle swings. Credit
cards and home equity loans are examples of innovations that allow households to
maintain their consumption even while their wages are fluctuating. Businesses can
smooth their spending over short periods when revenues do not match costs because
to the greater availability of credit (Athavale and Edmister, 2011).
 Financial innovation has promoted savings and channelled these resources to the most
productive uses by increasing the variety of products offered and facilitating
intermediation. It has also aided in increasing credit availability, assisting in the
refinancing of debts, and allowing for better risk distribution by matching the supply
of risk instruments to the demand of willing investors.
 When the demands for information technology develop new technological ideas and
stimulate their funding, as in the case of venture capital, innovation is at the forefront
of stimulating technological growth.
  Financial innovation decreases the cost of capital, increases efficiency, and smooths
consumption and investment decisions, resulting in significant benefits for both
people and businesses. Innovation helps economic development because new products
contribute to the deepening of financial markets.

c). Critically evaluate any two of the aforementioned theories, marshalling evidence
from empirical studies known to you. (20).

The efficient structure hypothesis

Under the pressure of market competition, the efficient structure hypothesis (hereinafter the
ES hypothesis) predicts that efficient companies will win and develop, becoming larger,
gaining greater market share, and earning higher profits. The market becomes increasingly
consolidated as a result. According to this theory, as a market grows more concentrated, it
becomes more efficient, and anti-concentration policies produce unneeded economic
distortion (Ongena, Schindele and Vonnák, 2021).

In contrast to the structure-conduct-performance theory, the ES hypothesis has the following

implication (hereafter the SCP hypothesis). According to the SCP hypothesis, a concentrated
market results in little competition, which leads to market inefficiencies, such as monopolistic
pricing and excess (monopoly) profits. The SCP hypothesis predicts a positive relationship
between concentration and profits, but through a different mechanism than the ES theory.
Anti-concentration measures are required under this idea. The ES hypothesis has been
“tested” in previous empirical research in the context of a test of the SCP hypothesis, in part
because of these opposing predictions. These studies regress a market performance variable
(e.g., market price or company profitability) on a market structure variable, as is the typical
test of the SCP hypothesis (e.g., a measure of market concentration).

They do, however, include market share as an additional independent variable, and if market
share has a positive effect, they consider this to be evidence in favour of the EP hypothesis
(see e.g., Weiss 1974 and Smirlock 1985). This strategy has a number of flaws. First, it is
commonly acknowledged that such analyses cannot be used to establish causal links (Tirole
1988). Second, market share isn't a strong indicator of a company's efficiency. Third, the ES
and SCP theories are examined as alternatives in these publications, but they may be
compatible in theory, at least in the short run.
Berger (1995) recommends regressing firm profitability on a direct measure of firm
efficiency to address these flaws in the research. Berger (1995) recommends running
additional regressions in which a market concentration measure and market shares are
modelled as functions of the efficiency measure to supplement this regression study.
Although this test's key addition is a direct focus on efficiency, we argue that it still has flaws
because the ES hypothesis makes no unambiguous predictions about the relationship between
market performance and company efficiency.

Intuitive quiet life hypothesis

According to the 'quiet life hypothesis (QLH),' banks benefit from market dominance in
terms of foregone revenues or cost savings (Ongena, Schindele and Vonnák, 2021). To test
this notion, we propose a unified technique that measures both competition and efficiency at
the same time. In the case of German savings banks, we develop bank-specific Lerner indices
as competition metrics and evaluate whether cost and profit efficiency are negatively
connected to market dominance. Between 1996 and 2006, both market power and average
revenues decreased among these banks. While there is strong evidence for the QLH, the
estimated consequences of the QLH are minor from an economic standpoint.

Neoclassical theory predicts that if some market actors have the ability to influence (output)
prices, these agents, such as banks, will set prices above marginal cost in order to maximize
profits. The extraction of producer rents then results in social welfare losses for consumers.
Hicks (1935) proposed that producers might renounce such fees in exchange for inefficiency.
Because agents may want to utilize their market power to behave systematically inefficiently,
this has been dubbed the "Quiet Life Hypothesis" (QLH).

According to Rhoades and Rutz (1982), the QLH should be applied to banks in particular
since they frequently avoid exhibiting high anomalous returns due to their fiduciary duties
and regulated position. They are the first to show that banks with market power reduce risk
rather than maximize profits in the US banking industry. Since the late 1980s, financial
industry rivalry has risen steadily as a result of economic integration and deregulation in both
the United States and Europe.

Only two recent studies, Berger and Hannan (1998) for US banks and Maudos and Fernández
de Guevara (2007) for European banks, take into account the QLH. The former finds support
for the QLH and demonstrates that welfare losses due to cost inefficiencies are significantly
bigger than welfare costs due to monopoly pricing. They do, however, use a concentration
measure as a proxy for market power, which has been shown in several empirical
investigations to be a poor proxy for competitive behaviour. Lerner indices, which evaluate a
bank's ability to raise prices above marginal cost, are used by Maudos and Fernández de
Guevara (2007) to estimate competitive behaviour more directly. They reject the QLH and
report very moderate welfare losses due to inefficiency compared to those attributable to
market power, in contrast to Berger and Hannan (1998).

Maudos and Fernández de Guevara (2007) make an important addition by emphasizing that
assessing the QLH necessitates concurrently obtaining both competitiveness and efficiency
measurements from a single model. 3 They do stress, however, that a pooled assessment of
competition and efficiency in Europe requires caution because it compares significantly
diverse intermediaries. Bos et al. (2008) show that failing to account for heterogeneity
adequately distorts performance metrics, validating Maudos and Fernández de Guevara
(2007)'s advice to test the QLH for more homogeneous banking samples.

d). Critically assess the differential implications, if any, of the two perspectives, drawing
from their conceptual foundations and their applications. (20).

Differential implications between RBV and DC

 The resource-based perspective of the firm stresses long-term competitive advantage;

on the other hand, the dynamic capabilities approach emphasizes competitive survival
in the face of quickly changing modern business conditions. In one of the few
empirical studies on the topic, strategy researchers Gregory Ludwig and Jon
Pemberton urged for elucidation of the specific processes of dynamic capability
building in certain industries to make the notion more helpful to senior managers who
decide the course for their companies (Masocha, Chiliya and Zindiye, 2011).
 The optimization of the role of resources is the focus of a resource-based vision
strategy, whereas capabilities views serve as the primary foundation for a long-term
competitive advantage (SCA).
 The resource-based view (RBV) emphasizes that competitive advantage is founded on
valuable, rare, inimitable resources and organization (VRIO) (Barney, 1997). Internal
processes or routines are the focus of dynamic capabilities (DC), which represent the
firm's behavioural orientation toward constant integration, reconfiguration, renewal,
and recreation of its resources and capabilities, as well as continuous upgrading and
 reconstruction of its core capabilities in response to the changing environment and to
remain competitive.
 The RBV makes no mention of how a competitive advantage is gained (Priem and
Butler, 2001a). The DC perspective examines how a company's resources and
capabilities change over time, allowing for a clearer understanding of how
competitive advantage is gained and sustained (Ambrosini and Bowman, 2009).
Because the DC literature is very young, it is primarily conceptual and gives limited
actual information on how to address the RBV's weaknesses.
 According to RBV, enterprises need VRIO resources to gain a competitive advantage.
The resource is the unit of analysis. On the other hand, from a DC perspective,
capabilities at the source of competitive advantage must be VRI (the capability itself
being "O").
 When a resource allows a company to conceive and implement methods to improve
its efficiency and effectiveness, it adds value. An attribute provides value and
becomes a resource if it permits the exploitation of opportunities and/or the
neutralization of threats, as opposed to the traditional strengths, weaknesses,
opportunities, and threats (SWOT) analysis (Barney, 1991). Resources, according to
Penrose (1959), are collections of potential services. She also described services as
the consequence of a company's resource utilization; they are useless unless they are
utilized effectively.
 Companies, according to Amit and Schoemaker (1993), must have access to suitable
competencies in order to maximize their resources. That is, while certain resources
may have the potential to produce valuable services, the value of these services will
be hidden until the company has the capacity to deploy them (Newbert, 2008).

Fig 1 showing RBV and DC path competitive advantage

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