business

1Corporate Governance

Literature Review

Corporate Governance in Financial Institutions (Aslam Shahriar)

Proper implementation of corporate governance generally helps to mobilize the capital in

addition to an efficient use of resources both within the company and the larger economy

(Rehman and Mangla, 2010). If funds can be mobilized easily then it can be allocated to places

where it can be used the most effectively and probably can earn positive returns. An efficient use

of resources can help to reduce waste and save money which is beneficial for long term

competitiveness. As a result of good corporate governance, the domestic and international

investors’ confidence in the institution can increase and lead to a lower cost investment capital

(Rehman and Mangla, 2010). The investors thus have the perception that the financial institution

is stable and predictable.

There are a lot of channels through which governance may have an effect on performance. A

particular focus is on the influence of financial institutions. Mayer (1998) states that in countries

like UK and the US, many financial institutions have important, sometimes dominant ownership

of many corporations. This puts them in a position of influence and ability to dictate how those

corporations are run. Secondly Mayer (1998) acknowledges that even if the financial institutions

cannot influence as dominant shareholders, they can have a major influence as the creditors of

the corporations. Though Harner and Griffin (2011) argue that due to the negotiations between

the corporation and creditors over refinancing terms behind closed doors, forbearance

agreements, covenant waivers, or rescue financing, it is hard to measure the creditors’ influence

on corporations. Thirdly, Mayer (1998) says that since economic theory relates financial

institutions with a specific governance function such as collecting information and thus


exercising control over corporations, financial institutions therefore should play a major role in

corporate governance.

A corporate governance system is important for a banking organization to act wise and in regards

to the risks that a banking corporation is involved in. Zhou and Li (2002) state that a good

corporate governance system is of utmost importance to maintain financial stability in a country.

This important realization was reached after a series of well-known banking failures: the collapse

of the Bank of Credit and Commerce International, the debacle of the Barings Bank, and the

scandal in the Daiwa's New York branch. In addition to even more significant financial crises in

Asia, Russia and other transition economies, this has given rise to the need for regulatory, legal

and internal systems for corporate governance in banking organizations. Therefore, the need for

good corporate governance has become a global concern of sorts.

In his review, Stanford (2005) cites that proponents of corporate governance should be wary of

what they actually ask for as it comes with a lot of baggage. Compliance with corporate

governance means complying with a lot of laws and regulations and this can burdensome and

expensive for financial institutions. For example, the Securities and Exchange Act of 1933

requires companies seeking to list on a stock exchange to make such extensive disclosures to

potential investors that compliance can cost hundreds of thousands of dollars.

Data on the Indian banking system for the period 1996-2003 reveal that CEOs of poorly

performing banks are likely to face higher turnover than CEOs of well performing banks (Das &

Ghosh, 2004). It has been shown by evidence that before the economic crisis, firm profitability

and corporate governance from Korea has shown some interesting insights. Even with weak

corporate governance, financial institutions continued to carry on with their business year by

year with inefficient resource allocation despite with low profitability (Joh, 2003). Thus, it is


witnessed that firms can still continue to be in business with weak corporate governance even

though there is so much room for improvement which would dramatically improve key financial

indicators for the firm. Corporate governance standards in banks also have a positive correlation

with the HR policies that the organization introduces. HR policies linking compensation to

performance can have positive effects for financial institutions (Datar, 2004).

Socially optimal corporate decision making is encouraged by both the Japanese main bank

system and the German universal bank system as suggested by the current paradigm of corporate

governance theory (Macey and Miller, 1995). Unlike their Japanese and German counterparts,

American banks are prevented from taking an active role in corporate governance, both by laws

restricting share ownership, and by legal rules which hold banks liable for exerting managerial

control over borrowers.

Despite a lot of efforts, however, the situation of corporate governance sometimes cannot be

improved especially in state-owned banks. For example, Zhou and Li (2002) state that the

situation of corporate governance in China's state- owned banks has not been satisfactory. Low

efficiency, political intervention, nonperforming loans, corruption, and the like have been

frequently described as characteristics of the four biggest wholly state-owned commercial banks

(i.e., the Industrial and Commercial Bank of China, the Bank of China, the Construction Bank of

China, and the Agricultural Bank of China). For this reason, a number of calls for privatization

of the four banks have emerged. It seems that privatization is a panacea for improving corporate

governance in China's wholly state-owned commercial banks. Similar trends have been seen in a

lot of state-owned banks in Bangladesh as well.

The developed countries like US, UK, Germany, Hong Kong and etc. have developed different

models of corporate governance which now implemented there in true spirit. The World Bank


also showed interest in this topic and developed a World Governance Index (WGI). The

objective of this index is to evaluate the corporate performance of different countries on the basis

of Regulations, Corruption and Rule of Law. The results of the index showed that the performer

in corporate governance was Germany with a score of 90.8 percent and worst performer is

Bangladesh with a score of 24.3 (Rehman and Mangla, 2010). The improvement of corporate

governance practices is widely recognized as one of the essential elements in strengthening the

foundation for the long-term economic performance of countries and corporation.

Average Return on Equity (Zakia Sultana)

Return on Equity (ROE) measures the rate of return on the ownership interest (shareholder's

equity) of the common stock owners. It measures a firm's efficiency at generating profits from

every unit of shareholders' equity (also known as net assets or assets minus

liabilities).In financial economics, a financial institution is an institution that provides financial

services for its clients or members. Probably the greatest important financial service provided by

financial institutions is acting as financial intermediaries. Most financial institutions

are regulated by the government. Broadly speaking, there are three major types of financial

institutions:-

Depositary Institutions: Deposit-taking institutions that accept and manage deposits and

make loans, including banks, building societies, credit unions, trust companies, and mortgage

loan companies.

Contractual Institutions: Insurance companies and pension funds; and

Investment Institutions: Investment Banks, underwriters, brokerage firms.


Some experts see a tendency of global homogenization of financial institutions, which means

that institutions tend to invest in similar areas and have similar investment strategies.

Consequences might be that there will be no banks that serve specific target groups and e.g.

small scale producers are left behind. Financial institutions provide service as intermediaries of

financial markets.

ROE offers a useful signal of financial success since it might indicate whether the company is

growing profits without pouring new equity capital into the business. A steadily increasing ROE

is a hint that management is giving shareholders more for their money, which is represented by

shareholders' equity. Simply put, ROE indicates know how well management is employing the

investors' capital invested in the company. ROE shows how well a company uses investment

funds to generate earnings growth.

ROEs between 15% and 20% are considered desirable. It turns out, however, that a company

cannot grow earnings faster than its current ROE without raising additional cash. That is, a firm

that now has a 15% ROE cannot increase its earnings faster than 15% annually without

borrowing funds or selling more shares. But raising funds comes at a cost: servicing additional

debt cuts into net income and selling more shares shrinks earnings per share by increasing the

total number of shares outstanding.

So ROE is, in effect, a speed limit on a firm's growth rate, which is why money managers rely on

it to gauge growth potential. In fact, many specify 15% as their minimum acceptable ROE when

evaluating investment candidates.

One accounting based measure of performance in corporate governance research is return on

equity (ROE). (Baysinger & Butler 1985; Dehaene, De Vuyst & Ooghe 2001).The primary aim

of an organization’s operation is to generate profits for the benefit of the investors. Therefore,

http://www.investopedia.com/terms/o/outstandingshares.asp

http://www.investopedia.com/terms/e/eps.asp


return on equity is a measure that shows investors the profit generated from the money invested

by the shareholders (Epps & Cereola 2008). It measures the profitability of shareholders’

investment and shows the net income as a percentage of shareholders’ equity.

Cost recovery and the elimination of subsidies would only force MFIs to shed the poorest from

their portfolios of borrowers because they are precisely the most difficult and costly to attend,

Hulme et al (1996). These findings are circuitously relates with the return on equity as net

income is considered in return on equity excluding grants or donations. Whereas, MFIs generate

lower return on equity compared to commercial banks in developing countries, a fact which they

explain as being ‘‘due to their very low levels of leverage”, (Christen and McDonald 1998). The

return on equity is an inevitable measure of profitability, Zeynep & Ugur (2006). Finally

supporting evidence to Zeynep & Ugur (2006) can be found in Befekadu B. Kereta’s (2007)

studies. Stating, MFIs are operational sustainable measured by return on equity and the industry's

profit performance is improving over time. Meanwhile, Michael Tucker and Gerard Miles

declared stating, there is a possibility that self sufficient MFIs with positive return on equity may

be attaining those results by reducing levels of services to the poorest of the poor, those with the

greater needs.

In order to more effectively evaluate operational managers, Nissim& Penman (2001) suggest

using a modified version of the traditional DuPont model in order to eliminate the effects of

financial leverage and other factors not under the control of those managers. Using operating

income to sales and asset turnover based on operating assets limits the performance measure of

management to those factors over which management has the most control. The modified

DuPont model has become widely recognized in the financial analysis literature. See, for

example, Pratt & Hirst (2008), Palepu & Healy (2008), and Soliman (2008). In addition, Soliman


(2004) found that industry-specific DuPont multiplicative components provide more useful

valuation than do economy-wide components, suggesting that industry-specific ratios have

increased validity.

Average Return on Assets (Israt-E- Rahman Pushpa)

Return on assets (ROA) is a financial ratio that shows the percentage of profit a company earns

in relation to its overall resources. It is commonly defined as net income divided by total assets.

ROA can be computed as:

This number tells you what the company can do with what it has, i.e. how many dollars of

earnings they derive from each dollar of assets they control. It's a useful number for comparing

competing companies in the same industry. The number will vary widely across different

industries. Return on assets gives an indication of the capital intensity of the company, which

will depend on the industry; companies that require large initial investments will generally have

lower return on assets. ROAs over 5% are generally considered good.

Net income is derived from the income statement of the company and is the profit after taxes.

The assets are read from the balance sheet and include cash and cash-equivalent items such as

receivables, inventories, land, capital equipment as depreciated, and the value of intellectual

property such as patents. Companies that have been acquired may also have a category called

"good will" representing the extra money paid for the company over and above its actual book

value at the time of acquisition. Because assets will tend to have swings over time, an average of

assets over the period to be measured should be used. Thus the ROA for a quarter should be


based on net income for the quarter divided by average assets in that quarter. ROA is a ratio but

usually presented as a percentage.

Return on Assets is one of the handful of really important metrics every investor should

knowReturn on Assets (ROA) tells you how efficiently (or inefficiently) a company turns assets

into net income. It is a way to tell at a glance how profitable a company is Consider that

companies take capital from investors and turn it into profits, which are in turn returned to the

investor in one form or another. ROA measures how efficiently the company does this.

Obviously, the more efficient a company is in converting assets (capital) into profits, the more

attractive it will be to investors. That’s about as simple as it comes: companies that make more

money for the owners are worth more than companies that don’t make as much money.ROA is

made up of two components: net margin and asset turnover. When used together, these two

metrics tell an important story.

Depositary Institutions: Deposit-taking institutions that accept and manage deposits and make

loans, including banks, building societies, credit unions, trust companies, and mortgage loan

companies.

Contractual Institutions: Insurance companies and pension funds; and

Investment Institutions: Investment Banks, underwriters, brokerage firms.

Jensen and Murphy (1990) and Ely (1991), who argued that applying return on assets (ROA) as a

firm performance measure is considered highly important in determining executive

compensation. This is supported by Finkelstein and Boyd (1998) and Finkelstein and Hambrick

(1996), who have used ROA in their respective executive compensation studies. Antle and Smith

(1986) find that there is a strong correlation between CEO compensation and ROA. This is

supported by Shawn and Zhang (2010), who find that changes in CEO cash compensation is


significantly and positively correlated with changes in ROA. However, from the meta analysis

conducted by Tosi, Werner, Katz, and Gomez-Mejia (2000), they find that estimated correlation

between CEO pay and ROA is 0.117 which accounts for less than 2% of variance in CEO pay

levels. On the other hand, Mehran (1995) finds that ROA is inversely related to the percentage of

CEOs’ total cash compensation, despite controlling for firm’s growth opportunities, assets in

place, leverage ratio, business risk, and size. Sigler (2011) argued that rewarding cash bonuses to

executives may encourage the undesired behavior. That is, cash bonuses tied to accounting

performance such as ROA may motivate executives to manipulate the timing of revenues and

expenses. Balsam, Fan, and Mawani (2011) find in their study that CEOs of large firms (as a

proxy by Sales) earned higher levels of compensation. The accounting profitability (ROA) is

positively associated with total cash compensation, and the market return is positively associated

with CEO salary and total compensation. Their study is based on a sample of 300 companies

obtained from TSX/S&P index from 2001 to 2006. On the other hand, Leone et al. (2006) find

that there is no change in CEO pay to changes in ROA based on positive and negative stock

returns. Overall, most of previous studies have found weak relationships between CEO

compensation and ROA. Overall, these specific studies lacked extensivity and robustness. In

addition, firm size has never been used as a control variable towards understanding the

relationship between CEO cash compensation and ROA.

Average Technical Efficiency (Siam Imtias Khan)

Abstract:

This paper examines technical and pure technical efficiencies of ten major financial institutions

in Botswana for each year during the period 2001-2006 using data envelopment analysis. In


order to obtain more robust and reliable results, the sensitivity of our efficiency indices were put

into test by choosing three alternative approaches in specifying the mix of input and output. the

empirical result indicate that no after which approach and year taken into consideration Baroda

and FNB and BSB are consistently among the most efficient institution BDC, ABC and NDB

are the least efficient ones.

INTRODUCTION:

The review of the literature indicates that most studies examining empirical efficiency analysis

of financial institution focus mainly on developed economies, however this issue is also of

paramount importance for developing economies which recently initiated various economic

reform with the aim of improving efficiencies of financial institutions. The paper specifically

examines the relatives’ efficiency of financial institutions in Botswana through time and using

various input output classification criteria.

Efficiency Measurement using DEA:

The DEA approach is based on a mathematical model enveloped by Charens et al, (1978).

However according to Barr et al. (1999).since the several different mathematical programming

DEA models have been proposed in the literature. Each of these models seeks to establish how

the DMUs determine the envelopment surface. The geometry of this envelopment surface

depends on the specific DEA model adopted.

Specification of input and output:

There is no consensus I the literature regarding the specification of outputs and inputs in the

frontier mode. However it is commonly acknowledged that the choice of variables in efficiency

studies significantly affects the results. The problem is compounded by the fact that the choice of

variables is often constrain by the availability of data on relevant variables.


Technical efficiency and institution size:

The size of an instituting in this paper is determined by the amount of its assets.

Technical efficiency and non-performing loans:

Efficiency estimates under various nonperforming loan (NPL) classifications are presented in

table 7 which are based on the ratio of NPL as a percentage of total loans. The results show that

irrespective of the choice of inputs and outputs high level of NPLs are associated with low

efficiency estimates and vice versa.

Conclusion

This paper empirically analyzed the technical efficiency of ten major financial institutions in

Botswana using data envelopment analysis which is a non parametric approach for each year

during the period year 2001-2006. In order to assess the robustness and sensitivity of our result

we have employed three different approaches to specify different combinations of inputs and

outputs: value-added, intermediation and operating approaches.

Average Allocative Efficiency (Nishanul Islam)

Abstract

This paper specifies an empirical framework for estimating Avg. Allocative efficiency, which is

applied to a large panel of European banks over the years 1996 to 2003.The results suggest that,

on average, European banks exhibit constant returns to scale, that Allocative efficiency are close

to 75% respectively, and that overall economic efficiency shows a clearly improving trend.

Introduction


It has been established that banks, in their role as financial institute, Contribute significantly to

economic activity in a number of ways. During the last two decades the banking sector has

experienced major transformations worldwide in its operating environment. Both external and

domestic factors have affected its structure, efficiency and performance. An efficient banking

sector is better able to withstand negative shocks and contribute to the stability of the financial

system. Therefore, the efficiency of banks has attracted the interest of international research. The

results suggest that, on average, European banks are characterized by constant returns to scale,

although the conventional estimation methods tend to slightly underestimate the magnitude of

scale efficiencies.

Brief review of the literature:

Greene (1980) defined Allocative inefficiency as the departure of the actual cost shares from the

optimum shares, failing, in such a context, to derive the relationship between Allocative

inefficiency and cost increases from such inefficiency (Greene problem). Since then, the

literature has proposed an approximate relationship to model allocative inefficiency in the

fashion of Schmidt (1984) who modeled the cost of allocative inefficiency as the product of the

errors in the cost share equations and a specified positive semi-definite matrix. However, this

approximate relationship is not free of problems, as it may lead to inconsistencies that bias the

results by unknown magnitudes and in unknown directions. Kumbhakar (1997), in an important

contribution that followed the definition of allocative inefficiency in Schmidt and Lovell (1979),

used a translog cost function and established an exact relationship between allocative

inefficiency in the cost share equations and in the cost function. Empirical estimation of this

model has been restricted to panel datasets in which technical and allocative inefficiency are


either assumed to be fixed parameters or functions of the data and unknown parameters (Maietta,

2002)

While the above literature provides significant evidence on European bank efficiency, no attempt

has been made to model allocative inefficiency within a framework that offers an empirical

solution to the Greene problem. This paper aims to add to the existing literature in this direction

and extend the time frame of the dataset beyond 1997.

Data and empirical results

The proposed method is applied to a sample of European commercial banks for the period 1996

to 2003. We choose to limit the empirical analysis to the unconsolidated statements of

commercial banks in order to reduce the possibility of introducing aggregation bias in the results.

All necessary data is obtained from the Bank Scope database and includes 13 of the 15 EU

countries.

The first problem encountered in bank efficiency studies is the definition and measurement of

output. The two most widely used approaches are the ‘production ‘and the ‘intermediation’

approaches. While we acknowledge that it would probably be best to employ both approaches to

identity whether the results are biased when using a different set of outputs, sufficient data to

perform such an analysis on European banks is generally unavailable. Hence, this study uses the

‘intermediation approach’ for two main reasons: First, this approach is inclusive of interest

expenses that usually account for over one-half of total costs and second the Bank Scope

database lacks the necessary data for implementation of the production approach.

Conclusions


The world of European banking is in a constant state of flux, as bankers, governments and the

European Commission react to the pressures produced by new competition, new technology and

growing globalization. As the level of sophistication n the operation of the banking sector

improves, there is evidently less gain to be exploited from economies of scale, while there is still

considerable room for improvement stemming from higher levels of efficiency. In contrast, the

banking sectors of Ireland, Portugal and Italy have much more to gain from improving their

efficiency level. The high allocative inefficiency and its degree of differentiation in terms of the

efficiency scores among the countries examined suggest that much is to be done regarding the

optimization of banking inputs’ usage and management. Since the efficient use of individual

inputs in banking is substantially under investigated, this is a desideratum for future research.

Average Cost Efficiency (Nafia Rashid Neshee)

Cost efficiency is determined by how close a bank’s costs lie to the efficient cost frontier for a

given technology. The efficient frontier is determined by two conditions, they are

(1)Technological efficiency , (2)Allocative efficiency. If any of these is missing, either

technological efficiency or allocative efficiency , that will create inefficiency and will lead to a

departure from cost minimization. But since cost functions are not known or directly observable,

inefficiencies must be measured relative to an efficient cost frontier that is estimated from data.

Therefore, the minimization of efficiency is based on feasible efficient frontier. Bank cost

efficiency basically is the difference between observed cost and predicted minimum cost.

Foreign banks newly entered on the market presented a higher level of efficiency than the local

banks or than the foreign banks that acquired local banks. Asaftei and Kumbhakar (2008),

estimated the cost efficiency of banks in Romania for the period 1996-2002. The results of the


research indicate that the cost efficiency of with the adjustment of monetary policy to the market

conditions, Dardac and Boitan (2008) measured the relative efficiency of a homogeneous group

of credit institutions, They identified the factors generating inefficiency .On the other hand

Mihajlovic et al (2009) ranked some banks of Serbia based on the efficiency . Many theoretical

arguments and much empricial supports the notion that privately –owned firms are more efficient

.Our cost efficiency allow us to test this contention in the case of Croatian case. First ,

privatization was “passive” banks were privatized by the privatization of their owners, For many

big banks , this simply meant that a majority of the shareholders were now private companies ,

but in fact the same companies as before. Management did not necessarily change, and changes

in corporate governance or the behavior of shareholders was graual. Second during the period

from 1994 through mid-1996, very high real interest rates on the inter bank market offered

almost risk free returns to liquid banks.

1994 1995 1996 1997 1998 1999 2000

Private 1.418 1,448 1,440 1,438 1,510 1,406 1,237

State 1,341 1,305 1,240 1,308 1,345 1,264 1,358

Foreign 1,138 1,152 1.100 1,151 1,056

Banks

with 50%

foreign

1,394 1,177 1,119 1,046 1,041


ownership

Table1:Relative Efficiencies of Private, State and Foreign Banks by year

Table2:Relative Efficiencies by Age

1994 1995 1996 1997 1998 1999 2000

Old state 1,360 1,274 1,299 1,337 1,394 1,174 1,322

New state 1,290 1,341 1,200 1,280 1,285 1,354 1,378

Privatized 1,098 1,358 1,452 1,621 1,585 1,466 1,201

New

private

1,434 1,519 1,403 1,342 1,388 1,285 1,120

Table 1 shows that indeed private banks were less efficient than state banks until 2000.Also , the

relative efficiency of the Foreign banks in striking.

Table 2 provides a slightly different breakdowns , distinguishing between new banks formed

after the beginning of transition (1990) and old banks . One might have expected that new

private banks , because they would not be overstaffed , would have been more efficient than

other banks. But this is not borne out by data in fact , only in 1999 do new private outperform

even new state banks, By 2000, they have the best efficiency scores , but this is largely due to the

influence of the foreign banks.

A final explanation is the arrival of the foreign banks in 1995 and 1997. These banks clearly

“pushed out” the efficiency frontier. Since our efficiency scores a relative to the frontier and not

absolute , the deterioration in 1996 and 1997 may more be more reflection of the movement of

the frontier than a reflection of growing inefficiency in the private banks .


GDP Growth Rate (Mahmuda Akter)

GDP stands for gross domestic product. It represents the total value of all goods and services

produced over a specific time period. GDP expressed as growth of a country’s economy. GDP is

an accurate indication of an economy’s size. The GDP growth rate is probably the single best

indicator of economic growth.

Measuring GDP is complicated but it can be done in two ways. Either the expenditure approach

or the income approach. Both should produce the same result. Expenditure based GDP produces

both real and nominal values on the other hand income based GDP produces the nominal value.

There are some criticisms of GDP as a measure of economic output.

1. It does not account for the underground economy. GDP relies on official data so it does not take

into account the extent of the underground economy which can be significant in some nations.

2. It is an imperfect measure in some cases. Gross national product which measures output from the

citizens and companies of a particular nation regardless of their location, is viewed as a better

measure of output than GDP in some cases.

3. It emphasizes economic output without considering economic well being. Only GDP cannot

measure a nation’s development.

Average annual growth rate for some nations and the difference:

Nations 1990-2000 2000-2012

China 10.6% 10.6%

India 6.0% 7.7%

U.S. 3.6% 1.6%

Germany 1.6% 1.1%

Japan 1.0% 0.7%


Source: World Bank-World Development Indicators.

Since 1984 the U.S. economy has grown at a remarkably steady pace. Increased stability in the

growth of aggregate GDP and its individual components may reflect two broad types of changes

in the economic environment since the early 1980s. First reason will be the structural changes.

Such technological innovations and regulatory shifts may have helped smooth economic

fluctuations in some sectors. The second reason is the monetary policy and economic shocks in

the variability of economic growth.

China has been one of the world’s fastest growing economies and has emerged as a major

economic and trade power. Trade and foreign investment flows have been major factors in

china’s booming economy. The global economic crisis began to impact china’s economy in late

2008. After growing by 13% in 2007, China’s real GDP slowed to 9.0% in 2008 and 7.1% in the

1st half of 2009. But china recovered their economic crisis.

After china, India is now Asia’s one of the largest economy. At the time of its independence,

India had an investment rate of around 9% of its GDP and an average annual growth rate of GDP

around 3%. In 2005-2006, India had an investment rate of around 30% of its GDP and an annual

average growth rate of GDP around 8.4%.

China and India both are the world’s next major powers. But when it comes to GDP growth rate,

India is still no match for china.

The Organization for Economic Cooperation and Development (OECD), in a report released in

November 2012, forecasts major shifts in global GDP by the year 2060. The report said that

based on 2005 purchasing power parity (PPP) values, China would have GDP of $15.26 trillion

by 2016, exceeding the United States , GDP of $15.24 trillion for the first time and becoming the


world’s largest economy. The Chinese economy is forecast to be 1.5 times larger than the U.S.

by 2030 and 1.7 times bigger by 2060. India is also expected to overtake the U.S. economy to

become the second-biggest in 2051.

Annual Interest Rate (Helal Uddin)

This paper describes structure and financial formation of annual interest rate. As Fisher reveled,

the economic intuition behind adjusting nominal interest rates based on expected future inflation

(1930).On the other hand the interest rate is expressed as annual percentage yield (APY) when

the interested is earned, for example, from a savings account or a certificate of deposit. When the

interest is paid, for example, for a credit card, a mortgage, or a loan, the interest rate is expressed

as annual percentage rate (APR). So, monetary policy for a financial institution or from

consumer perspective is interest rates are known as Annual Percentage Rate.

Annual Percentage Rate (APR):

APR is the cost of credit on a yearly basis expressed as a percentage rate (e.g., 18 percent or 8.5

percent). The APR is usually slightly higher than the stated or advertised interest rate on closed-

end loans (e.g., mortgages and car loans) because the following additional fees that may be

required by the lender must be included in the APR calculation:

• Credit life insurance

• discount points

• Document preparation fee

• Loan application fee

• Loan processing fee

• Origination points

• prepaid interest


• Private mortgage insurance

• underwriting fee

Example

15-year mortgage

Advertised fixed interest rate = 8%

APR = 8.20%

APR and yearly interest rate are the same. The Federal Truth in Lending Act requires lenders to

provide APRs so borrowers have a tool to quickly compare the cost of loans. However, as with

any tools, users must know how to use them for their project or situation to get the best end

product. When comparing APRs on closed-end loans:

• compare loans with the same loan conditions (i.e., loan amount, repayment period, and interest

rate)

• ask the lender for a list of the fees to be included in the APR calculation

• ask for a good-faith estimate when looking for a home mortgage. Keep in mind that this is an

estimate and the final numbers may change.

Annual Percentage Yield (APY)

This is the annual rate of interest plus the effect of compounding on the interest earned. This is

the number quoted when banks and other financial institutions try to get you to deposit money in

savings accounts or buy certificates of deposit. In these cases, you are the lender, so the higher

the APY, the more money you will make from amounts on deposit.


Example

8-month CD

Interest rate = 4.65%

APY = 4.75%

This is the total amount of interest and other fees you paid to borrow money. On closed-end

loans, the amount of finance charge is stated on the contract. On open-ended loans, such as a

credit card, the finance charge is listed on each monthly statement.

How Interest Rates Work’s:

Interest rates are charged not only for loans, but also for mortgages, credit cards and unpaid bills.

The interest rate is applied to the total unpaid portion of your loan or bill. It's important to know

what your interest rate is, and how much it adds to your outstanding debt. If your interest rate

adds more to your debt than the amount you’re paying, your debt could actually increase even

though you are making payments. Although interest rates are very competitive, they aren't the

same. A bank will charge higher interest rates if it thinks there's a lower chance the debt will get

repaid. Some types of loans, like credit cards, are always assigned higher interest rates because

they are more expensive to manage. Banks also charge higher rates to people they consider

riskier. That's why it's important to know what your credit score is, and how to improve it. The

higher your score, the lower the interest rate you will have to pay.

Interest Rates Drive Economic Growth:

A country's central bank is responsible for setting its annual interest rates. For example, the U.S.

Fed funds rate is the amount banks charge each other for overnight loans. These loans are


necessary, because banks must have 10% of total deposits in reserve each night. Otherwise, they

would lend out every single penny they have on deposit. This would not allow enough of a buffer

for the next day's withdrawals. This is a critical interest rate, in that it affects the entire supply of

money, and hence the health of the economy. The interest rates that banks charge make loans

more expensive. When interest rates are high, that means fewer people and businesses can afford

to borrow. This lowers the amount of credit available to fund purchases, slowing consumer

demand. At the same time, it encourages more people to save (if they can) because they receive

more on their savings rate. Higher interest rates also reduce the capital required to expand

businesses, strangling supply. This reduction in liquidity usually slows the economy down.

As you would expect, low interest rates have the opposite effect on the economy. Low mortgage

interest rates have the same effect as lower housing prices, stimulating demand for real estate.

When savers find they get less interest on their deposits, they might decide to just spend more.

They might also put their money into slightly riskier, but more profitable, investments -- thus

driving up stock prices. Low interest rates make business loans more affordable. This encourages

business expansion, and creates new jobs.

If low interest rates provide so many benefits, why wouldn't you just keep rates low all the time?

For the most part, the government and Federal Reserve prefer low interest rates. However, low

interest rates can cause inflation. That's because, if there is too much liquidity, then demand

outstrips supply, and prices rise.

Relation between Average ROE and Corporate Governance (Zakia Afroz)


There is a positive and significant relationship between ROE and corporate Governance in

financial institution. One accounting based measure of performance in corporate governance

research is return on equity (ROE). (Baysinger& Butler 1985; Dehaene, De Vuyst&Ooghe

2001).The primary aim of an organization’s operation is to generate profits for the benefit of the

investors. Therefore, return on equity is a measure that shows investors the profit generated from

the money invested by the shareholders (Epps &Cereola 2008). It measures the profitability of

shareholders’ investment and shows the net income as a percentage of shareholders’ equity.

The authors criticize the findings of Gompers, Ishii, and Metrick (GIM, Quarterly Journal of

Economics, 2003), regarding the relationship between corporate governance and company stock

market performance. GIM analyzed company performance over the 1990–99 period and found

that companies with strong shareholder rights had higher risk-adjusted returns than those with

weak rights. According to GIM, the reasons for this anomaly include poor governance causing

increased agency costs that are underestimated by investors and poor governance creating

stronger protection from a corporate takeover, which leads to a smaller takeover premium and

lower risk-adjusted returns. To counter these findings, the authors argue that investors should not

be surprised by worse operating performance of poor governance companies and lower takeover

probabilities for companies with poor shareholder rights.

In addition, agency theory suggests that a better-governed firm is expected to have

better performance and higher valuation due to lower agency costs. This prediction is

supported by many empirical studies. For example, Gompers et al. (2003) find that better

corporate governance is associated with higher firm valuation measured by Tobin’s Q.

Brown and Caylor (2006a; 2006b) find that better-governed U.S. firms have higher return


on equity(ROE), higher return on assets(ROA), and higher Tobin’s Q.

Relation between Average ROA and Corporate Governance (Israt-E- Rahman Pushpa)

Corporate Governance is basically concerned with ways in which all parties interested in the

well-being of the firm (the stakeholders) attempt to ensure that managers and other insiders are

always taking appropriate measures or adopt mechanisms that safeguard the interests of the

stakeholders. Such measures are necessitated because of the separation of ownership from

management, an increasingly vital feature of the modern corporations .And Return on assets

(ROA) is a financial Return on assets (ROA) is a financial ratio that shows the percentage of

profit a company earns in relation to its overall resources. Return on assets (ROA) is a financial

ratio that shows the percentage of profit a company earns in relation to its overall resources a

way to tell at a glance how profitable a company is Consider that companies take capital from

investors and turn it into profits, which are in turn returned to the investor in one form or another.

This study aimed to examine the relationship between four corporate governance mechanisms

(such as board size , board independent director , chief executive officer duality and board audit

committee) and value of the firm measures ( return on asset , ROA and return on equity ,

ROE).The results provide evidence of a positive significant relationship return on asset and

board independent director as well as chief executive officer duality .The results further reveal a

positive significant relationship between ROE and board independent director as well as

executive chief officer duality .The study however , could not provide a significant relationship

between the value of the firm measures ( ROA and ROE ) and board size and board audit

committee.


It is widely believed that good corporate governance is an important factor in improving the

value of the firm in developing countries. However, the relationship between corporate

governance and the value of the firm d to understand the differences, which affect the value of

the firm for academic investigations, financial, and management practices and public regulation

of markets and corporations (Abdurrouf, et al, 2010). The relationship between corporate

governance and the value of the firm is important in formulating efficient corporate management

and public regulatory policies.

Relation between Average Technical Efficiency and Corporate Governance (Siam Imtias Khan)

Financial inclusion is important for improving the living conditions of the deprived sections of

society including poor farmers, rural non-farm enterprises and other vulnerable groups. Financial

exclusion, in terms of lack of access to credit from formal institutions, is high for small and

marginal farmers and other social groups. Apart from formal banking institutions which should

look at inclusion both as a business opportunity and social responsibility, the role of the self-help

group movement and microfinance institutions (MFIs) is important to improve and expand the

network of financial inclusion (Dev, 2006).

Database the Study:

Data used in the study is obtained from Mix Market Network (www.mixmarket.org). In the

present attempt a total of 41 microfinance institutions (out of a total 155 MFIs working in India)

have been sampled depending upon the availability of data for five consecutive years 2005-2009.

Technical Efficiency-Approaches:

The present study employs the DEA model as it integrates multiple inputs and outputs.

Furthermore, a parametric functional form does not have to be specified and DEA does not


require any price information for dual cost function as is required for parametric approaches. On

the same lines, the DEA has the potential to provide information to the supervisors in improving

the product/efficiency of the organization.

Analytical Model:

In the present attempt both the models of Data Envelopment Analysis – the constants returns to

scale (CRS) model (Charnes, Cooper and Rhodes Model) and the variable returns to scale (VRS)

model (Bankers, Charnes and Cooper Model) – under both input-oriented and output-oriented

versions have been used (Charnes, Cooper, Rhodes, 1978; Bankers, Charnes, Cooper, 1984).

Approaches for Efficiency Analysis of Financial Institutions

To make a rational selection and classification of inputs and outputs in the effective

measurement model, the previous studies resort to production approach and financial

intermediation approach which are commonly used for efficiency analysis among financial

institutions (Berger, Humphrey, 1997).

Relation between Average Allocative Efficiency and Corporate Governance (Nishanul Islam)

Allocative efficiency is a type of economic efficiency in which economy/producers produce only

those types of goods and services that are more desirable in the society and also in high demand.

According to the formula the point of allocative efficiency is a point where price is equal to

marginal cost (P=MC)or (AR=MC). At this point the social surplus is maximized with no

deadweight loss, or the value society puts on that level of output produced minus the value of

resources used to achieve that level, yet can be applied to other things such as level of pollution.

Allocative efficiency is the main tool of welfare analysis to measure the impact of markets and

public policy upon society and subgroups being made better or worse off. The most common


type of efficiency referred to in financial markets is the allocative efficiency, or the efficiency of

allocating resources. This includes producing the right goods for the right people at the right

price. A trait of allocatively efficient financial market is that it channels funds from the ultimate

lenders to the ultimate borrowers in a way that the funds are used in the most socially useful

manner.

CORPORATE GOVERNANCE FINANCIAL INSTITUTE

Corporate governance mechanism is an important method for companies to minimiseagency

cost and helps improve performance. Papers use various proxies to measure performance, such

as return on assets, return on equity, and Tobin’s Q, and study the relation between corporate

governance and a firm’s performance. In this paper we employ efficiency scores, calculated by

the DEA, to measure a firm’s performance. We use technical, allocative, cost, and revenue

efficiency scores, and expect that good corporate governance will improve its efficiency

performance. We review relevant literature and develop our hypotheses in this section.

Relation between Average Cost Efficiency and Corporate Governance (Nafia Rashid)

The group efficiency scores of each industry in each year are obtained from biased-corrected

bootstrapping estimation based on group-wise heterogeneous sub-sampling procedure. The

bootstrapped weighted mean, median, and standard deviation of efficiency scores, and 95%

confidence interval are all presented in the table. The weights of group aggregation are the

observed revenue shares, which is based on the theory developed by Färe and Zelenyuk (2003).

In line with Berger and Mester (1997), we measure cost efficiency by how close abank’s actual

cost is to what a best-practice bank’s cost would be to produce thesame bundle of outputs. Banks

that are cost inefficient are either wasting some oftheir inputs (technical inefficiency) or are


using the wrong combination of inputs toproduce outputs (allocative inefficiency), or both

(Mester, 2005). Similarly, profitefficiency is measured by how close a bank’s profit is compared

with what the bestpracticebank would produce given the same input conditions. The concept

ofprofit efficiency is derived mostly from the revenue side of the banking business.Although it is

affected by costs, it allows banks to offset their additional costs toachieve higher service levels.

Hence, for profitability and firm value considerations,profit efficiency is a better concept because

it also takes the quality of the outputsinto account (Mester, 2005). This study examines the

relation between corporate governance and the efficiency of the U.S. property—liability

insurance industry during the period from 2000 to 2007. We find a significant relation between

efficiency and corporate governance (board size, proportion of independent directors on the audit

committee, proportion of financial experts on the audit committee, director tenure, proportion of

block shareholding, average number of directorships, proportion of insiders on the board, and

auditor dependence). We also find property—liability insurers have complied with the Sarbanes-

Oxley Act (SOX) to a large extent. Although SOX achieved the goal of greater auditor

independence and might have prevented Enron-like scandals, it had some unexpected effects. For

example, insurers became less efficient when they had more independent auditors because the

insurers were unable to recoup the benefits of auditor independence.

Relation between GDP Growth Rate and Corporate Governance (Mahmuda Akter)

Effective corporate governance mobilizes the capital annexed with the promotion of efficient use

of the resources both within the company and the larger economy. It also assists in attracting

lower cost investment capital by improving domestic as well as international investor’s

confidence. Good corporate governance ensures legal compliance and takes impartial decisions

for the betterment of the business. The developed countries like U.S., UK, Germany, Hong Kong


and etc have developed different models of corporate governance to make growth in their

economy.

Corporate governance means the effectiveness of mechanisms that minimize agency conflicts

involving managers, with particular emphasis on the legal mechanisms that prevent managers

from expropriating minority shareholders (Sheilfer and Vishny 1997a).

Weaker corporate governance means lower short term expected returns or more risk or both. For

the lack of corporate governance if the traders lost a great deal of money cannot immediately

invest more in a country. Having lost money may indicate that the trader has bad judgment.

A bigger fall in asset prices due to worse corporate governance can plausibly trigger a large

reduction in the bank’s investment position in all the asset of the country.

Weaker corporate governance leads to more capital flight and deeper currency depreciation. So

weaker corporate governance will not be good for GDP growth rate.

Relation between Average Annual Interest and Corporate Governance (Helal Uddin)

Corporate governance (CG), broadly defined, is a set of processes, policies and laws affecting

the way an organization is directed, administered and controlled. Bansuch, Pate and Thies (2008)

defined CG as a set of formalized values and procedures implemented by the owners, directors

and the management of the business in its various operations as well as its interactions with

stakeholders. Holder-Webb, Cohen, Nath and Wood, (2008) defined CG as the provision of

effective boards, strong shareholder rights, and broad disclosures in managing a

business.Corporate governance is the system by which companies are directed and controlled.

This concept is appropriate for banks, too. Yet for banks and other financial institutions, the

scope of corporate governance goes beyond the shareholders to include debt holders. Some


include the state as stakeholder, but the role of the state is better understood as setting the rules

of the game in a regulated industry. Investor confidence in public companies is essential to the

functioning of the global economy. At this website, we intend to provide you with key

information about our corporate governance policies. These policies provide a framework for the

proper operation of our company, consistent with our shareholders' best interests and the

requirements of the law. Cisco is committed to excellence in corporate governance and maintains

clear policies and practices that promote good corporate governance. Corporate governance

practices are affected by attempts to align the interests of stakeholders. All parties to corporate

governance have an interest, whether direct or indirect, in the financial performance of the

corporation. Directors, workers and management receive salaries, benefits and reputation, while

investors expect to receive financial returns. For lenders, it is specified interest payments, while

returns to equity investors arise from dividend distributions or capital gains on their stock. The

board should be chaired by an independent director. The CEO and chair roles should only be

combined in very limited circumstances; in these situations, the board should provide a written

statement in the proxy materials discussing why the combined role is in the best interests of

shareowners, and it should name a lead independent director who should have approval over

information flow to the board, meeting agendas and meeting schedules to ensure a structure that

provides an appropriate balance between the powers of the CEO and those of the independent

directors. Supplemental plans should be an extension of the retirement program covering other

employees. They should not include special provisions that are not offered under plans covering

other employees, such as above-market interest rates and excess service credits.


Average Return on EquityAverage Return on AssetAverage Technical EfficiencyAverage Allocative EfficiencyAverage Cost EfficiencyGDP Growth RateAnnual Interest Rate

Corporate Image

Trust

Corporate Governance in Financial Institutions

Conceptual Framework


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