environmental alignment: an analysis of the performance of the banking industry in the united states

Alfred Lewis Environmental School of Management, Suny-Binghamton, P.O. Box 6000, Binghamton, alignment: an N Y 13902-6000. USA

analysis of the performance of the banking industry in the United States

he environment of the banking T industry in the US has evolved from a fairly stable environment to a dynamic and discontinuous environment. Banks not only have to adhere to government regulations, but in addition have to contend with changes in technological advances. Furthermore, banks are also faced with intense competition from non- bank banks, i.e. those entities that are directly competing with traditional banks in terms of product and service offerings.

Introduction

The environment of the banking industry in the US has evolved from a fairly stable to a dynamic and discontinuous one. Banks not only have to adhere to government regulations, but in addition have to contend with technological advances. Further- more, banks are also faced with intense competition from non-bank banks, i.e. firms that are directly competing with traditional banks in terms of product and service offerings.

The non-banks have had the greatest

impact in the rapidity of change in the environment of traditional banking. They include insurance companies, venture capitalists, financial subsidiaries of major corporations, big retail stores and stock- brokerage houses. Corporations are also increasingly bypassing banks by selling more volumes of commercial paper, thereby closing a major source of banks’ business of corporate short-term financing. Banks are also having significant difficulties in attracting customers to purchase certificates of deposit (CDs), due to higher yields offered by money market funds.

242 A. Lewis

According to FDIC (Federal Insurance Ileposit Corporation) statistics, banks’ share of all financial institution assets has declined from about 38% in 1974 to less than 28% in 1989. Furthermore, banks’ share of short- term corporate financing has dropped from about 80% in the mid-1970s to just 55% in 1989.

Jauch, Osborne and Glueck, 1980; Javidan, 1984; Miles and Snow, 1978; Porter, 1980; Snow and Miles, 1983).

This study will examine top management’s perception of their industry environment. If the top management cannot anticipate the future of the industry, then they cannot prepare their respective organizations to respond to future challenges.

Purpose Overview of the banking industry

The purpose of this study is to examine the strategic posture of the banking industry and its corresponding financial performance. The concept of strategic posture, as adapted from Llnsoff (l984), is composed of the level of environmental turbulence in an industry, the aggressiveness of strategy of a company, and its general management capability.

The aim is to find out to what extent a misalignment with the level of environmental turbulence in an industry results in adverse financial performance. Environ- mental turbulence, as defined by Ansoff (1984), is the level of changeability of the environment in which a firm operates and the discontinuity of events combined with the speed at which events surface and develop.

A number of studies have been conducted to

investigate the importance of environment to

performance

A number of studies have been conducted to investigate the importance of environment to performance. These include Aguilar, 1967; Lenz, 1980; Lewis, 1989; Miles, Snow and Pfeffer, 1974; Smart and Vertinsky, 1984; Steers, 1977; and Stodgill, 1966.

Other studies have focused on ithe match o r alignment between environment and strategy (Andrews, 1980; Bourgeois, 1980;

The history of the banking industry in the US can be traced back to the National Bank Act of 1864, which established the framework for the industry. The Federal Reserve Act of 1913 further refined the

The depression of the I930s was largely responsible for the

regulatory environment in which banks. . .

operate today

existing framework. The depression of the 1930s was largely responsible for the regulatory environment in which banks have to operate today. Two major pieces of legislation defined the parameters within which banks were allowed to conduct business. The first was the McFadden Act of 1927, which prevented banks from con- ducting business across state boundaries; the second was the Glass-Steagall Act of 1933, which prohibited banks from paying interest on demand deposits and restricted banks from engaging in securities trading. The Act also established the FDIC as an agency to instil confidence by protecting customer deposits. It was also charged with regulatory responsibilities in order to maintain standards within the banking industry.

The Monetary Control Act of 1980 was enacted to regain control in terms of money supply management by the government.

Journal of Strategic Change, August 1992

Environmental alignment 243

Prior to 1980 the Federal Reserve was able to monitor the M1 (value of currency in circulation, demand deposits and other transactionary accounts), based on the reserves that Federal Reserve member banks had to maintain. The increases in money market yields relative to the rates offered by banks led to an outflow of funds from banks to other investment vehicles. As a result of this imbalance some banks withdrew from the Reserve system and thus made it difficult for the Federal Reserve to accurately monitor M1. The Act led to mandatory reserve requirement for all financial institutions that offered transaction accounts. It furthermore created the template for the gradual elimination of interest rate ceilings on savings and time deposits.

In an effort to address the competitive disadvantages experienced by banks, the Garn-St. Germain Act was passed in 1982. The Act removed rate restrictions and thus made it easier for banks to compete with money market funds for customer deposits.

Thus, the year 1982 is commonly referred to as the turning point in US banking history, due to the provisions of the Money Act of 1980 and the Garn-St. Germain Act of 1982.

The environment of the banking industry

continues to be very discon tin uous

The environment of the banking industry continues to be very discontinuous, despite efforts by the US Congress to ease the various competitive disadvantages of banks in contrast to the various non-banks. Table 1 presents the composition of financial assets and respective shares of various intermediaries. Banks’ share of the market has fallen by about 8% and other intermediaries have increased their respective shares. Table 2 shows a gradual increase in the number of bank failures since 1982.

Table 1 . Market share of financial intermediaries.

Institution 1960 1989

Commercial banks 34.2% 26.6% Insurance companies 21.8 14.5 Other depository institutions 17.0 14.1 Pensionlretirement funds 8.8 15.6 Mutual and money market funds 2.6 8.1

1.7 10.8 Agencies and mortgage pools Other 11.6 10.4

~- .~

Source: Federal Reserve

Table 2. Number of bank failures in the IJS (1982- 1990).

1982 1983 1984 1985 1986 1987 I988 1989 1990 42 48 79 116 138 184 200 206 168

Source: FDIC Annual Reports

Methods

Primary data was obtained from 15 banks with a combined total of 105 branches located in San Diego, California. A set of data was obtained from the top management of the banks included in the study using a survey instrument. Another set was obtained from expert outside observers who were composed of leading financial columnists, FDIC officials and retired banking executives. Other background data were collected from a number of different sources. They include American Banker publications (e.g. 1986), Findley reports ( 1 986) on California banks and FDIC reports.

Secondary financial data were obtained for the banks. The financial data were utilized as performance measures.

The performance measures were divided into three subsets as follows:

1. Overall performance measures (a) Return on equity-measures profits

generated per dollar of bank capital and was computed as net income/ equity.

(b) Return on assets-measures the profits generated per dollar of the bank’s assets and was defined as net incomeltotal assets.


244 A. Lewis

2.

3.

Operating financial measures (c) Expenditure to net income-

measures the relationship between the expenses of the bank and its net income and was computedl as total expenditureshet income.

(d) Profit margin-measures thie profit- ability of the bank. It helps to differentiate high and low per- forming banks. It was defined as net incomekvenue.

Strategic financial measures (e) Loans to deposits - measures the

amount of loans advanced by the bank in relation to its deposits. A high ratio makes the bank relatively illiquid, whilst a low ratio suggests inefficient use of deposits. It is computed as total loans/total deposits.

( f ) Equity utilization-measures the turnover rate of the ownershhare- holders investment, defined as revenudequi ty .

(g) Assets utilization-measures what the bank can generate per dollar of its assets and was computed as revenuekotal assets.

A n a Zysis

The survey instrument utilized in the study was adapted from Ansoff (1979, 1984). It was designed to measure the perceived level of environmental turbulence in the pre- and post-deregulation period. The pre-deregulation period was determined to be the period prior to 1983 and the post-deregulation period was defined to be from 1983 onwards.

The instrument, which was based on a five-point Likert scale, was used to obtain data from the expert outside observers and banks' top management through personal interviews in 1988. A profile analysis was used whereby the horizontal axis represented the environmental turbulence levels and the

Level of growing environmental turbulence Repetitive Expanding Changing Discontinuous

1. Familiarity of events

2. Rapidity of change

3. Visibility of the future

4. Business scope

5. Decision- making in terms of: (a) Economic

changes (b) Techno-

logical changes

(c) Socio- political changes

Very familiar

Much slower than bank's response

Expected to remain unchanged

Local

Repetition of experience

S I ovver than ba in k ' s response

Predictable by extrapolation

Sta1:ewide

Understood in terms of history

bank's response

Forseen by analysis of threats and opportunities

Comparable to

Regional

Unfamiliar experience

Shorter than bank's response

Difficult to predict

Nationwide

Surprising ~ ~

Big lag in bank's response

surprises Unpredictable

Global

i Important > LOW HIGH 1 2 3 4 5

1 2 3 4 5

1 2 3 4 5

Figure 1 Matrix representation of survey instrument used to measure levels of environmental turbulence.

Journal of Strutegic Change, August 1992

Environmental alignment 245

Environmental Turbuience

4.5

4

3.5

3

2.5

2

1 5

1

0 5

0 A C D E

[23 PRE-DEREGULATION [24 ”OST-DEREGULATION

Figure 2 . B, rapidity of change; C , visibility of the future; D, business scope. changes; F, technological changes; G, sociological changes.

Top management responses for pre- and post-deregulation periods. A, familiarity of events; Decision-making in terms of: E, economic

vertical axis represented a list of attributes applicable to the banking industry.

Figure 1 is a matrix representation of the instrument. The responses of the bank 3. managers for both periods are presented graphically in Figure 2.

A significant dzyference 4 . was found in the bank

managers’ perception of the pre- and post-

deregulation environment

Analysis of the results revealed the following:

1 . There was no significant difference in the bank managers’ and outside observers’ perceptions of the level of

indicated the recognition of an increased level of uncertainty in the environment of the banking industry. It was also found that there was a significant difference between the outside observers’ and bank managers’ perceptions of the period following deregulation. Two significant results were obtained in terms of the environmental turbulence repsonses and financial measures. Figure 3 shows the turbulence perception gap and equity utilization. The turbulence perception gap was derived by com- paring a bank’s response with the mean of the responses of the expert outside observers. This result was then tested against individual banks’ financial data. Figure 4 shows the result of the relationship between the turbulence gap and banks’ respective ROES.

environmental turbulence in the pre- deregulation period. A significant difference was found in the bank managers’ perception of the pre- and post-deregulation environment. This

Both results indicate that a smaller gap results in better financial performance when compared with banks that exhibited larger gaps. The t-test results were at the p < 0.01 level of confidence.

2.


A . Lewis 246

TURBULENCE GAP/EQUITV UTILIZATION

2

‘ 9

z

4 0

N - c 3 > 3 0

c -

I

0 0 2 3 4 0 6 3 8 1

:UVIRONMENTAL TLIREULENCE SAP

Figure 3. Turbulence perception gap and equity utilization.

TURBULENCE GAP vs . RETURN ON EQUITY

I I , , I I I

-LIRHULEYCE SAP

Figure 4. Turbulence perception gap and return on equity.

Implications for management/practice

The study found that banks that exhibited Those bunks that were unable to make the required transition. . . failed or were

acquired by other banks

smaller gaps in their strategic ]posture performed significantly better than those with larger gaps. This finding should be helpful to management in determining how much deviation from the optimum gap will result in adverse financial performance. that were unable to make the required

The study further found that those banks transition from the pre-deregulation period


En v iro nm en tal a lign men t 24 7

to the post-deregulation period failed or were acquired by other banks. The signifi- cance of this finding is the need to optimize a bank’s performance within the immediate environment in which it exists. Banks also must continually adjust to the emerging environment in order to be able to respond to future environmental turbulence. The gap of a bank can be used as a predictor of future performance internally by a bank or by investors, and furthermore by bank regu- lators, in order to reduce the potential of insolvency.

Strategic posture analysis can be utilized by managers to determine areas of strengths or weaknesses, thereby maximizing the use of limited resources. The analysis can also be used by external stakeholders to determine how an organization stands in the context of the industry in which it exists. As an extension, threats from outside the industry will also become evident, e.g. micro and macro competitive threats.

It is also possible for top management to use the concept of strategic posture to determine the kind of human resource that provides the best fit. The results also indicate that the traditional qualifications for being a successful banker are no longer applicable

It i s . . . appropriate for banks to hire managers

with entrepreneurial abilities

in the current environment because of increasing levels of discontinuity. The former conduct of waiting for customers to approach bankers is no longer applicable, owing to alternatives in terms of investment and financing instruments. It is therefore appropriate for banks to hire managers with entrepreneurial abilities as opposed to formerly appropriate custodial type managers.

Conchs io n

This paper has addressed the performance implications of misalignment or fit in terms of the level of environmental turbulence. The industry investigated was the banking industry. The results of the study strongly support the proposition that top management must accurately perceive the current and future level of environment turbulence in their industry in order to ensure superior performance. Those banks that misperceived the environment in which they had to operate exhibited inferior performance in terms of financial measures.

Biographical note

Professor Alfred Lewis teaches International Finance and Strategic Management at the School of Management, State University of New York at Binghamton, USA. His research interest focuses o n changes in international trade volume and direction, issues in international finance, and organizations’ response to discontinuity in industry environments, using strategic management concepts. H e is the Associate Editor of the European Research Journal.

References

Aguilar, F. J. (1967). Scanning the Business Environment. Macmillan, New York.

American Banker (1986). Banking’s Past and Financial Services Future. American Banker, New York.

Andrews, K. R. (1980). The Concept of Corporate Strategy. Irwin, Homewood, IL .

Ansoff, H. I . (1979). Strategic Management. Macmillan Press Ltd, Hong Kong.

Ansoff, H. I. (1984). Implanting Strategic Management. Prentice-Hall, Englewood Cliffs, N.J.

Bourgeois, L. J. 111 (1980). Strategy and environment: a conceptual integration. Academy of Management Review, 5(1), 25-39.

Findley Reports (1986). California Banks. Findley Reports Inc., BREA, California.

Lenz, R. T. (1980). Environment, strategy, organization, structure and performance: patterns in one indus t ry . Strategic Management Journal, 1 , 209-226.


248

Lewis, A. 0. (1989). Strategic Posture and Financial Performance of the Banking Industry in California: A Strategic Management Study. Unpublished Dissertation, United States International University, San Diego.

Jauch, L. R. , Osborn, R. N. and Glueck, W. F. (1980). Short-term financial success in large business organizations: the envirionment- strategy connection. Strategic Management Journal, 1 , 49-63.

Javidan, M. (1984). The impact of environmental uncertainty on long-range planning practices of the US savings and loan industry. Strategic Managemenr Journal, 5 , 381-392.

Miles, R . E . , Snow, C. C. and Pfeffer, J . (1974). Organization-environment concepts and issues. Industrial Relations, October, :244-266.

Miles, R . E . and Snow, C. C. (1978). Organiza- tional Strategy, Structure and Process. McGraw-Hill, New York.

A. Lewis

Porter, M. E. (1980). Competitive Strategy: Techniques for Analyzing Industries and Competitors. Free Press, New York.

Smart, C. and Vertinsky, I . (1984). Strategy and environment: a study of corporate responses to crises. Strategic Management Journal, 5 ,

Snow, C. C. and Miles, R. E. (1983). The role of strategy in the development of a general theory of organizations. In Lamb, R. (Ed.), Advances in Strategic Management, Vol. 2 . JAI Press, Greenwich, CT.

Steers, R. M. (1977). Organizational Effective- ness. A Behavioral View. Goodyear Publishing Company, Santa Monica, CA.

Stodgill, R. M . (1966). Dimensions of organization theory. In James D. Thompson (Ed.), Approaches to Organizational Design. University of Pittsburgh Press, Pittsburgh.

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environmental alignment: an analysis of the performance of the banking industry in the united states

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