“Иқтисодиёт ва инновацион технологиялар” илмий электрон журнали. № 5, сентябрь-октябрь, 2017 йил
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DEVELOPMENT OF CAPITAL RAISING TECHNIQUES THROUGH
FINANCIAL SECURITIES IN COMMERCIAL BANKS
Gavkhar Bekmurodova,
1st category specialist at National Bank of Uzbekistan
E-mail:
Аннотация:
В этой статье открыта тема несколько видов увеличения
капитала в коммерческих банках и показано в текущем примере
международных коммерческих банков и банков Узбекистана.
Аннотация:
Ушбу мақола тижорат банкларининг капиталини бир неча
хил йўллар орқали кўпайтириш усуллари ва уларнинг амалдаги холатини
халқаро ва Ўзбекистон тижорат банклари мисолида кўрсатилган.
Abstract:
The multiple ways of increasing capital of commercial banks and
their experience in both international and Uzbekistans’ commercial banks have been
discussed in the article.
Introduction
Today, mainly commercial banks sustain the financial stability of the
government by both providing various services to clients and collecting money
through the services offered to people.However, banks must generate income on its
own without the supply from central banks that is government. So, how do they make
money? Actually, banks are profit organization; id est. the single service can make
huge revenue for them. Although it is not enough in today’s economy where high
demand and low supply exist.
Literature review
Problems related to financial securities were clearly identified and solved in the
foreign economists’ scientific novels like Bagehot, Walter. (1873).
Lombard Street: A
Description of the Money Market
. Henry S. King, Third Edition, Calomiris, Charles
W., and Andrew Powell. (2001). “Can Emerging Market Bank Regulators Establish
Credible Discipline? The Case of Argentina, 1992-99” in Frederic S. Mishkin, (ed.),
Prudential Supervision: What Works and What Doesn’t
. University of Chicago Press,
Chou, Yuan K., and Martin S. Chin. (2004). Financial Innovations and Technological
Innovations as Twin Engines of Economic Growth.
Mimeo
, University of Melbourne,
January, Flannery, Mark. (2005). “No Pain, No Gain? Effecting Market Discipline
via Reverse Convertible Debentures” in Hal S. Scott (ed.),
Capital Adequacy beyond
Basel: Banking, Securities and Insurance
, Chapter 5, Oxford University Press,
Frederic S. Mishkin and Stanley G. Eakins. (2009).
Financial Markets and
Institutions
, Pearson, Sixth Edition, Greenspan, Alan. (2009). The Fed Didn’t Cause
the Housing Bubble.
Wall Street Journal
, March 11, Miller, Merton H. (1991).
Financial Innovation and Market Volatility.
Blackwell Publishing, Rajan, Raghuram.
(2009). “Too Systemic to Fail: Consequences and Potential Remedies,” presented at
the
Proceedings of a Conference on Bank Structure and Competition
, Federal
Reserve Bank of Chicago, May and many others.
“Иқтисодиёт ва инновацион технологиялар” илмий электрон журнали. № 5, сентябрь-октябрь, 2017 йил
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By investigating a number of researches done by above-mentioned works, the
article uses appropriate models and techniques where they are needed.
What are the financial securities?
Financial securities are the type of financial instruments and called simply as
securities. The key features of securities are negotiability and financial worth. Most
importantly, securities form high income above face value and both issuer and holder
of security can gain maximum profit. They have different forms such as debt
securities that include banknotes, bonds, debentures or equity securities that form
stocks and etc.
Financial securities may be issued by various financial organizations as a mean
to raise capital or finance any other projects. Commercial institutions like
international banks can also issue one type of financial security. Usually, companies
issue different securities to attract new investors and receive considerable
investments from them. However, securities such stocks entail some risks which need
to be eliminated.
The need for recalling financial securities is the encouragement for commercial
banks to raise capital significantly. Nevertheless, it is important to identify how
actually depository institutions like commercial banks generate income.
The way commercial banks make money in general.
The initial service or purpose of banks are lending and saving money securely.
Through opening up bank accounts one can transfer the sum of money from one
place to another so easily. But these services are not free of charge indeed managers
charge some amount to fulfill the service.
There are various forms of loans that banks offer and each loan has different
interest charge by banks according to their risk involved. The riskier the loan is the
higher the interest rate is. This is the main profit oriented service for the banks.
Besides above mentioned duties banks offer other feeble option like providing
cheques, ATM access, and checking. Credit cards sustain banks with high income
since it follows more risk and requires being more risk tolerant. Such cards may give
a rise to credit risk because customer may not fulfill its obligation at the maturity
date.
Securities and investment projects in commercial banks.
Banks play a considerable role in issuing securities or investment. They as an
agent have a right to underwrite on behalf of customers. Actually, Investment banks
are designed to maintain individuals, corporations and government via underwriting
issue of shares, stock, bonds or other securities. However, commercial banks can also
have department that promotes underwriting services for clients or government. This
encouragement creates better reputation between bank customers and also entails a
huge amount of profit.
Along with financial securities like stocks, bonds, shares; other types of
securities exist for commercial banks to be used as a profitable tool for the institution.
This tool, so called derivative instruments, that is form of off-balance sheet
transactions that can be used by banks to gain maximum profit.
“Иқтисодиёт ва инновацион технологиялар” илмий электрон журнали. № 5, сентябрь-октябрь, 2017 йил
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Derivative instruments.
As the term explains, derivative instruments derive its value from underlying
asset or index. However, the way it obtains value differs from nonderivative
instruments, because they are highly dependent on current stock market prices. The
prediction made today should match future condition. In that way, derivatives make a
huge profit by encouraging the economy as a whole as well. If the future condition
occurs reversely to the expectation, a considerable loss influences not only a trader
itself but the economy too. Nevertheless, in every contract traded there is a winner
and loser. So the economy may offset its losses with another gain.
The financial profitability of derivatives.
There are various approaches, which facilitate financial institutions with
profitability in trading derivatives. Let’s take banks as an example. Banks as dealers
can raise capital through 5 distinctive ways in OTC markets.
1. Volume.
The larger is the capital involved in the contract the higher is the
opportunity to gain the profit if it is professionally worked out contract. It means that
by betting large sums of money one can make huge money but, surely, with
experienced skills.
2. Economies of scale.
The gradual flow in operations, systems, or counterparty
credit management illustrates that there is an economies of scale in order for traders
or dealers to take advantage. As the industry is in process and market share increases,
dealers realize the opportunity to make considerable money.
3. Proprietary trading.
While trying to speculate on various risks existing in
OTC markets, dealers notice the flow in profitable markets as well as creating market
itself. However, it is impossible to separate this action from market making.
4. Complexity.
Derivatives business prefers complexity. In turn, it establishes
sophisticated risk profiles to meet client needs. Moreover, this process requires high
margin trades and the trade is structured and negotiated in nature. More complexity
allows buyers to become beware.
5. Cheating.
Often dealers suggest clients to go for trades that they do not
know how to price fairly. This is called either direct lying or misleading the buyer. It
means that dealers sell clients contracts that ultimately make buyers be in a risky
position. Additionally, this action is not illegal but it is considered as being unethical.
To evaluate the profitability of each above-mentioned approach in percentage,
I would asses them 30%, 20%, 25%, 20%, 5% respectively. However, this is my
critical view and it is hard to find banks or other financial institutions operating profit
like this.
The flow of securities in Uzbekistan.
There are 28 commercial banks in Uzbekistan. Each bank has its own well
worked out goal to achieve and every year they implement different projects that are
goal-oriented. Although, special banks so called Investments Banks do not exist in
Uzbekistan, however, commercial banks deal with operations with financial securities
besides their main services.
Unfortunately, not all banks are experienced in this field and therefore, these
financial institutions still lack in achieving international standards with securities.
“Иқтисодиёт ва инновацион технологиялар” илмий электрон журнали. № 5, сентябрь-октябрь, 2017 йил
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It is important to mention that Asaka Bank is getting priority over other
commercial banks in securities market in Uzbekistan. It issues the shares which are
purchased by large investors like The Ministry of Finance, “O’zavtosanoat” Co., and
The Fund for Establishment and Development of the Republic of Uzbekistan. Since
1996, Asaka Bank has been sustaining its capital through diversified services
including operations with securities.
Nevertheless, not all commercial banks develop such strategies within internal
and external system. For example, Agro Bank, maintaining clients in agriculture
industry, fails to promote different techniques for raising capital efficiently enough.
To maintain customers it must sufficient amount. Financial securities whether
purchased or sold can lead to that amount if the operation is done thoroughly and
accurately. For example, underwriting issue of shares, issue bonds, stocks,
commercial paper can be engaged in either in international or local financial
securities market so that issued financial tools entail huge amount of profit.
Recommendations
OFF BALANCE SHEET activities have being used by most of the banks to
enhance the profitability and liquidity. These are the financial products that do not
appear on the typical bank balance sheet but introduce income high enough and by
this feature OBS are preferred in the majority of critical situations of banks. Off
balance sheet products include credit cards, letters of credit, acceptances, operations
of deposit box facilities and many others. Moreover, derivatives, as it has been
mentioned above, and securitization have being used often for more than 20 years.
Securitization
Issuing bonds, commercial paper and the sale of asset backed securities are the
type of securitization. By using the means of securitization banks play an indirect role
unless the core banking activity that is intermediation is required.
Large financial institutions purchase loans from banks and finance companies,
and then gather together pools of loans with similar characteristics, such as mortgage
loans to people with certain credit scores. These securitizers then issue securities that
entitle the owner to a share of the payments on the pool of loans. The securities are
bought by financial institutions such as commercial banks, investment banks, pension
funds, and mutual funds, and then often trade in secondary markets.
Banks want to sell loans and securitization provides a way for them to do so.
The benefit for banks when they sell mortgage loans is they eliminate the default risk
that such loans entail. Banks still perform the basic function of reducing asymmetric
information because in initially lending the money, they screen borrowers and design
loan covenants. Due to this work, banks can sell the loan for more than the amount
originally given to the borrower. Thus, banks earn profits on the sale and avoid the
default risk associated with holding loans. Many banks sell mortgage loans and
purchase mortgage-backed securities, effectively swapping relatively few loans for
small parts of many loans. This provides diversification to banks, reducing their risk,
and it also increases liquidity since mortgage-backed securities are easier to sell than
individual mortgages. Demand for mortgage-backed securities from Fannie Mae and
Freddie Mac comes from many financial institutions. These include mutual funds and
pension funds, along with banks. Fannie’s and Freddie’s securities are an attractive
“Иқтисодиёт ва инновацион технологиялар” илмий электрон журнали. № 5, сентябрь-октябрь, 2017 йил
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alternative to bonds because they are very liquid and are considered very safe, as a
result of being backed only by prime mortgages and having an implicit government
guarantee. And they pay a bit more interest than other safe assets like Treasury
bonds. Securities backed by subprime mortgages are very different and were
purchased by institutions such as investment banks and hedge funds prior to the
financial crisis.
Commercial paper
, as the Goldman Sachs case study shows, dates back to the
1800s. Corporations issue a promissory note, which agrees to repay the bearer at
some specified date in the future. The USA has outstanding commercial paper issues
of more than $1 trillion, but they have only been issued in European countries since
the 1980s, and the size of the market is much smaller, amounting to about $17 billion
in the UK.
Asset backed securities
The issue of asset backed securities is the process whereby traditional bank
assets (for example, mortgages) are sold by a bank to a trust or corporation, which in
turn sells the assets as securities. The bank could issue a bond with the pooled assets
acting as collateral, but the credit rating of the bank is assigned to the new security,
the proceeds of the bond are subject to reserve requirements, and the assets are
included in any computation of the bank’s capital ratio.
The bank can avoid these constraints if a separate entity is established (special
purpose vehicle, SPV, or trust). The bank sells the asset pool to the SPV, which pays
for the assets from the proceeds of the sale of securities. Effectively, while the
process commences in an informal market (the bank locates borrowers and makes the
loans), asset backed securitization means a large number of homogeneous loans (in
terms of income streams, maturity, credit and interest rate risks) are bundled together
and sold as securities on a formal market.
Collateralized bond obligations
Collateralised bond obligations
(CBOs), consisting of collateralized bonds and
collateralised loan obligations (CLOs), which involve collateralised pools of
corporate loans or other credit facilities. After being pooled and turned into a
security, they are split into different investment classes or security tranches. The bank
loans used as collateral for CLOs are typically at investment grade level, whereas the
CBOs are usually a mix of investment grade and sub-investment grade, but
collateralised by higher yielding securities. CLOs originated in the 1990s and consist
of a pool of investment grade revolving/term loans, standby letters of credit and even
derivatives. Unlike the original ABS/MBS, the components of the pool can be quite
diversified, and the originator remains the owner of the underlying portfolio.
For the bank arranging them, CDOs offer a number of benefits:
•
release of core capital and thus increased efficiency of the capital allocation;
•
illiquid loans become liquid, tradable securities;
•
investors are attracted to the bank because they can have a choice of
different tranches
to meet their risk/return needs.
Commercial banks in Uzbekistan like international banks can use or introduce
new financial securities to the system so that the profitability of banks could grow
“Иқтисодиёт ва инновацион технологиялар” илмий электрон журнали. № 5, сентябрь-октябрь, 2017 йил
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significantly than expected. Certificates of deposits or repurchase agreements can on
the best examples for such financial institutions to get recording results in their
financial statements.
It is true that some commercial banks in
Uzbekistan are using CDs and
repos but the result does not catch the pick the hill. Hedging in exchange markets and
underwriting issues, attracting more preferred shareholders than common
shareholders (Asaka bank) also contribute to the capital growth.
Moreover, there is a term used comparative advantage which means the basic
principle behind the international trade of goods and services. If a good/service is
produced in one country
relatively
more efficiently than elsewhere in the world, then
free trade would imply that, in the absence of trade barriers, the home country exports
the good/service and the COUNTRY gains from trade. Firms engage in international
trade because of
competitive advantage
. They exploit arbitrage opportunities. If a
firm is the most efficient world producer of a good or service, and there are no
barriers to trade, transport costs, etc., this firm will export the good from one country
and sell it in another, to profit from arbitrage. The FIRM is said to have a competitive
advantage in the production of that good or service. If certain commercial banks of
Uzbekistan trade in international banking services, it is best explained by appealing to
the principle of competitive advantage. Banks are exploiting opportunities for
competitive advantage if they offer their customers a global portfolio diversification
service and/or global credit risk assessment. The same can be said for the provision of
international money transmission facilities, such as global currency/debit/credit
facilities. Global systems/markets that facilitate trade in international banking
services are discussed below.
Conclusion
By engaging in asset transformation, the bank hopes to profit by charging a
higher interest rate on its assets than it must pay on its liabilities.
Thus, a bank manager must be concerned with both asset management
(acquiring assets with the highest return and the lowest risk) and liability
management (acquiring funds at the lowest cost).
But a bank manager has to additional concerns as well:
Liquidity management = making sure that the bank has enough cash to cover
deposit outflows (hold some excess reserves, even though they do not pay interest).
Capital adequacy management = maintaining sufficient capital as a cushion
against a decline in the value of the bank’s assets, while still providing a decent
return to the bank’s shareholders.
Referance
1.
Bagehot, Walter. (1873).
Lombard Street: A Description of the Money
Market
. Henry S. King, Third Edition.
2.
Calomiris, Charles W., and Andrew Powell. (2001). “Can Emerging Market
Bank Regulators Establish Credible
3.
Discipline? The Case of Argentina, 1992-99” in Frederic S. Mishkin, (ed.),
Prudential Supervision: What Works and What Doesn’t
. University of Chicago Press.
“Иқтисодиёт ва инновацион технологиялар” илмий электрон журнали. № 5, сентябрь-октябрь, 2017 йил
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4.
Chou, Yuan K., and Martin S. Chin. (2004). Financial Innovations and
Technological Innovations as Twin
5.
Engines of Economic Growth.
Mimeo
, University of Melbourne, January.
6.
Flannery, Mark. (2005). “No Pain, No Gain? Effecting Market Discipline
via Reverse Convertible Debentures” in Hal S. Scott (ed.),
Capital Adequacy beyond
Basel: Banking, Securities and Insurance
, Chapter 5, Oxford University Press.
7.
Frederic S. Mishkin and Stanley G. Eakins. (2009).
Financial Markets and
Institutions
, Pearson, Sixth Edition.
8.
Greenspan, Alan. (2009). The Fed Didn’t Cause the Housing Bubble.
Wall
Street Journal
, March 11.
9.
Miller, Merton H. (1991).
Financial Innovation and Market Volatility.
Blackwell Publishing.
10.
Rajan, Raghuram. (2009). “Too Systemic to Fail: Consequences and
Potential Remedies,” presented at the
Proceedings of a Conference on Bank Structure
and Competition
, Federal Reserve Bank of Chicago, May.
11.
Ross, Levine. (2005). “Finance and Growth: Theory and Evidence” in
Philippe Aghion and Steven N. Durlauf, (eds.),
Handbook of Economic Growth
, Vol
1A, Chapter 12, Elsevier North-Holland.
12.
Taylor, John B. (2009).
Getting off Track.
Hoover Institution Press.
13.
Tufano, Peter. (2009). “Financial Innovation” in George Constantinides,
Milton Harris and Rene Stulz, (eds.),
Handbook of the Economics of Finance
Vol 1A,
Chapter 6, Elsevier North-Holland.
