The Strategy Seminar: Applied Strategy: Too Big To Fail? Size and Risk in Banking

TOO RISK TO FAIL? SIZE AND RISK IN BANKING

Mitchell Stan, The Open University

Michael L. McIntyre, Carleton University

In general, people usually feel safer when they invest or keep their money in the larger bank than in the smaller one. The reason is that the bank system which is controlled by majority of a chain of large banks plays a crucial role in economic development in each country. Once a big bank is collapsed, it will lead to serious consequences for an economy. In order to prevent it happening, the government is ready for a bailout plan to rescue these banks. Therefore, they think that it would be hard for these large banks collapse. Many scholars are deeply concerned about the relationship between size of a bank and risk. Some studies affirmed that the smaller the bank is, the riskier it is. This concept applies to both private as well as publicly-traded companies. In contrast, other studies tried to prove that the larger bank is riskier than the smaller one in different aspects.  Separately, this study emphasizes the risk index to examine a risk in diversity sizes of banks. In the past, there were some research about the risk index; however, they were still incomplete when the collected data in different periods resulted in variety conclusions (Ennis & Malek 2005). Some studies used the risk index to analyze the relationship between risk and involvement in non-bank activities (Boyd & Graham 1996), or a positive relationship between bank risk-taking and the spreads over the default free rate (Hannan &Hanweck 1988).

This study measures the risk by using the risk index and its subcomponents which are returns on assets, variances of those returns and capital levels for various sizes of banks. The higher the risk index is, the lower the risk is. The author used the accounting data and total assets to measure the returns. Accounting data is a reliable source since it is required to report firmly in standard. Total assets are utilized instead of equity because it is more independent on the leverage. The formula of the risk index is:

Risk index=(¶/A  +K/A  )/((σ¶)/A)

With ¶: net income, A: total assets and K: total regulatory capital held by the bank. “The risk index incorporates profitability, return volatility and leverage into one measure.” (Mitchell and Michael, 2012) Although the risk index has some backwards, it is still an effective tool for measuring between groups of the risky banks. It is used popularly as a proxy for risk in the financial and non-financial literature since Roy (1952). Basing on four hypotheses (H1-H4), the authors conducted the examination the connection between the risk and size of the banks, from the largest banks to the smallest banks, which are both of publicly-traded and privately-owned institutions.

H1: total risk, measured by the risk index, is higher for the larger banks than for the smaller ones

H2: returns measured relative to total assets are higher for the larger banks than for the smaller ones.

H3: Volatility risk, measured by the standard deviation of return on assets, is higher for the larger banks than for the smaller ones.

H4: The capital-asset ratio is lower for the larger banks than for the smaller.

                                                (Mitchell and Michael, 2012)

These four hypotheses are analyzed thanks to the data in the FDIC database, which has 7,369 banks from JPMorgan Chase Bank, the largest bank, to Oakwood State Bank, the smallest one, at a point of time when this study happened. After analyzing them, the authors strongly affirmed that larger banks are riskier than the smaller ones due to the lower levels of capital relative to assets factor during the period 2001 to 2008.

The finding in this study is obviously different to Boyd & Gertler (1994) who pointed out that during the period 1984-1991 larger banks had lower returns on assets than the smaller ones. Whereas it is agreeable with Ennis & Malek (2005) during the period 1992-2003 returns on assets had a correlation to the size of the banks.

The regulators and bank supervisors may find this outcome useful for their works. It will help the supervisors make a decision in allocating the supervisory resources as well as set up the policies clearly and exactly. For the regulators, this study helps them manage risks to banks more effectively and efficiently since now they deeply understand in the relationship between risks and return characteristics of banks.

(Source: Academy of Banking Studies Journal, Volume 11, Number 2, 2012)

The Strategy Seminar: Applied strategy- The impact of the corporate identity mix on corporate reputation

Authors: Kevin Money, Susan Rose, and Carola Hillenbrand

The authors interpreted corporate reputation (CR) as trust and positive emotions hold by stakeholders toward companies. In addition, the authors believed that an organization does not automatically own the trust and positive emotions that stakeholders hold toward it but can influence them via daily business operation (BO) gradually and gain its reputation ultimately. The authors also recognized CR as a key success factor of organizations. The purposes of this article are to verify whether corporate identity mix (CIM) is an antecedent of CR and to test the correlation between a strong CR and stakeholder behavior.

The theories and studies the authors acknowledged and applied when conducting the research are as follows: the relationship between CIM and CR (Pitt and Papania, 2007), the two-level study of the corporate brand and CR (Brown et al, 2006), the organizational level study of corporate brands (Aaker, 2004), the individual level study of organizations (Fombrun and van Riel, 2004; Walsh et al, 2009; Money et al, 2010), and the operationalization of CIM on CR at the individual level (Walsh et al, 2009). Based upon these theories and studies, the authors further developed a five-construct research model with four hypotheses.

The four hypotheses are (Money et al, 2010):

1.          Positive experiences of CIM contribute to positive corporate brand benefits (CBB).

2.          Positive CBB contributes to positive perceptions of CR.

3.          Positive experiences of BO contribute to positive perceptions of CR.

4.          Positive perceptions of CR contribute to positive consequences of CR.

The results of the research support the four hypotheses and validate the model. Furthermore, there are four findings of the research: (1) it is possible to measure the impact of CIM and BO on CR; (2) the research suggests the relative importance of CIM, CBB, BO, and CR; (3) the research makes the CIM framework (Melewar and Jenkins, 2002) measurable; and (4) the study confirms and theorizes the individual-level concepts (Brown et al, 2006).

The implication of this research is that CR is manageable and measurable. First, managers/executives may develop a CR watching system. Since every industry has its own characteristics, managers may weight differently on elements constructing CR. By scrutinizing the whole system, managers may then know which element should be improved first or least. Also, through the CR watching system, managers can also easily acknowledge the exact responsibility of every related department and improve the personnel promotion system.

Source: BrandManagement; 5^th June 2010, Vol. 18, 3, 197-211

The Strategy Seminar: Applied Strategy- Process Integration and Information Sharing in Supply Chains

This is an article studying whether hold-ups, or the potential for hold-ups, within a supply chain affect process integration and information sharing between firms.  The article defines process integration as an investment with the goal being to enhance process integration and/or information sharing between firms.   Manufacturers are concerned valuable, proprietary information given to the distributors will be leaked; while distributors concerns center on manufacturers using internal sales teams to do distributors jobs once a sales area is developed.  The US is a transaction cost economy, an economy which once dependence is established between firms the value from these dependences can be shared between partners.  The relevance of this study with the current global financial crisis, firms are seeking an advantage to stay competitive, to remain solvent, and, if feasible, increase profitability. 

This study tested six different hypotheses.  The study uses performance scorecards and financial performance data (i.e. Sales Growth, Sales Productivity, Profitability, Contract Renewal) collected from major petroleum manufacturers and their relationships with independent petroleum distributors.  The first hypothesis is “as asymmetry (or unevenness) of interdependence increase, the extent of process integration and information sharing in manufacturer-distributor partnerships decreases” (Schloetzer 1011).  The second hypothesis is “as the magnitude of interdependence increases, the extent of process integration and information sharing in manufacturer-distributor partnerships increases” (Schloetzer 1011).  The third hypothesis is “the extent of process integration in manufacturer-distributor partnerships enhances partnership financial performance” (Schloetzer 1011).  The fourth hypothesis is “the extent of information sharing in manufacturer-distributor partnerships enhances partnership financial performance” (Schloetzer 1012).  The last two hypotheses are “the extent of process integration and information sharing in manufacturer-distributor partnerships are directly (5^th) or indirectly (6^th) related to distributor contract renewal via financial performance” (Schloetzer 1012).  

The results for the first two hypotheses support the main idea; when there is a larger interdependence, both partners then depend on each other more and when there is larger unevenness between firms the reverse is true.  Results for hypotheses three and four, show, in practice, larger supply chain integration allows firms to grow larger together rather than seeing a larger benefit going to one partner in the relationship.  Hypotheses five and six both predict positive relationships between supply chain integration and contract renewal.  The results of the study also show that as process integration and information sharing grow between firms so does sales growth & productivity and profitability. 

The implication of this article is with the current global financial difficulties and with firms increasingly looking for better financial performance.  A way to do this is to increase process integration and information sharing between supply chain partners.  Rather than increasingly benefiting only one firm in the relationship, this mixing process will increase financial performance of both firms through sales growth & productivity and overall profitability.

Schloetzer, Jason D. “Process Integration and Information Sharing in Supply Chains”, The Accounting Review (2012): Vol. 87, 1005-1032. Web. 16 Sep. 2012.

Trieu Tran Introduction

Hello all,

My name is Trieu Tran. I come from Viet Nam. I have lived in the United States more than for three years to pursuit Master of Accounting degree. Unfortunately, my background is not relating to business since I graduated from the university of Technology in my hometown with Environmental engineer major. However, I’ll try my best to step in business area. Like most of you, this is my first time to write a blog about business. I hope you can enjoy my article as well as this is a my great chance to experience the interesting news which you bring to our blog. Thank you,

Chih-Wei Hsu Introduction Post

I am now in the MS-Accounting program and look forward to graduating in this December. I earned my bachelor degree of BA-Risk Management and Insurance from Chengchi University, Taiwan. Before coming to the U.S., I worked for my father as his assistant. He owns a small business related to home decoration.

This is the last class of the program and I hope that I shall enjoy and learn a lot from the class.

John Aitchison Introduction Post

Hello All,

I am a final semester MBA candidate.  While I do not currently work full time, I have worked internships in the government during several of my graduate semesters.  I worked in the cost estimating and schedule analysis office.  Much like most of the class, this is my first experience with business blogging and the social media aspect of business.  I do hope to cultivate a valuable resource of information that I can reference in the future.