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The Financial Aspect of Enterprise Management Strategy

Prof. Jo B. Bitonio, DPAPangasinan State University

Urdaneta City

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Report Goals

To better understand the Financial Aspect of Enterprise Management Strategy, the following goals are the object of achievement in my report:

1. To be enlightened on the role of commercial banks in regional economic investment.

2. To understand the role of IMF / ADB and WB in global economy and venture capital.

3. To be aware of “financial traffic lights” as an instrument of overcoming economic insolvency of business structures.

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The Role of Banks in Enterprise Management Strategy

BANKS according to Mr. Arnold J. Padilla of the book in Philippine Financial Systems, are institutions that receive and hold deposits of funds from others, make loans or extend credit, and transfer funds by written order of depositors. Depositors may be individuals, organizations, or corporations.

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A BANK according to Wikipedia, July 2008, can also be defined as a financial institution and a financial intermediary that accepts deposits and channels those deposits into lending activities, either directly or through capital markets. A bank connects customers that have capital deficits to customers with capital surpluses.Banking in the modern sense of the word according to Wikipedia can

be traced to medieval and early Renaissance , Italy, to the rich cities in the north like Florence, Venice and Genoa. The Bardi and Peruzzi families dominated banking in 14th century Florence, establishing branches in many other parts of Europe. One of the most famous Italian banks was the Medici Bank, set up by Giovanni di Bicci de' Medici in 1397. The earliest known state deposit bank, Banco di San Giorgio (Bank of St. George), was founded in 1407 at Genoa, Italy. 

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The oldest bank still in existence is Monte dei Paschi di Siena, headquartered in Siena, Italy, which has been operating continuously since 1472.[It is followed by Berenberg Bank of Hamburg (1590) and Sveriges Riksbank of Sweden (1668).

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Banks offer many different channels to access their banking and other services:Automated Teller MachinesA branch is a retail locationCall centerMail: most banks accept cheque deposits via mail and use mail to communicate to their customers, e.g. by sending out statementsMobile banking is a method of using one's mobile phone to conduct banking transactionsOnline banking is a term used for performing transactions, payments etc. over the Internet

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Banks offer many different channels to access their banking and other services:Relationship Managers, mostly for private banking or business banking, often visiting customers at their homes or businessesTelephone banking is a service which allows its customers to perform transactions over the telephone with automated attendant or when requested with telephone operatorVideo banking is a term used for performing banking transactions or professional banking consultations via a remote video and audio connection. Video banking can be performed via purpose built banking transaction machines (similar to an Automated teller machine), or via a video conference enabled bank branch clarification.

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•Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds.

•Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds.

The bank profits from the difference between the level of interest it pays for deposits and other sources of funds, and the level of interest it charges in its lending activities.

The bank profits from the difference between the level of interest it pays for deposits and other sources of funds, and the level of interest it charges in its lending activities.

Banks uses the above resources to lend money by making advances to customers on deposit accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending.

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Banks also face a number of risks in order to conduct their business, and how well these risks are managed and understood is a key driver behind profitability, and how much capital a bank is required to hold. Some of the main risks faced by banks include:Credit risk: risk of loss arising from a borrower who does not make payments as promised.Liquidity risk: risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit).Market risk: risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors.Operational risk: risk arising from execution of a company's business functions.Reputational risk: a type of risk related to the trustworthiness of business.Macroeconomic risk: risks related to the aggregate economy the bank is operating in.

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The economic functions of banks include:

1.Issue of money, in the form of banknotes and current accounts subject to check or payment at the customer's order. These claims on banks can act as money because they are negotiable or repayable on demand, and hence valued at par. They are effectively transferable by mere delivery, in the case of banknotes, or by drawing a check that the payee may bank or cash.

2.Netting and settlement of payments – banks act as both collection and paying agents for customers, participating in interbank clearing and settlement systems to collect, present, be presented with, and pay payment instruments. This enables banks to economize on reserves held for settlement of payments, since inward and outward payments offset each other. It also enables the offsetting of payment flows between geographical areas, reducing the cost of settlement between them.

3.Credit intermediation – banks borrow and lend back-to-back on their own account as middle men.

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4. Credit quality improvement – banks lend money to ordinary commercial and personal borrowers (ordinary credit quality), but are high quality borrowers. The improvement comes from diversification of the bank's assets and capital which provides a buffer to absorb losses without defaulting on its obligations. However, banknotes and deposits are generally unsecured; if the bank gets into difficulty and pledges assets as security, to raise the funding it needs to continue to operate, this puts the note holders and depositors in an economically subordinated position.

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5. Maturity transformation – banks borrow more on demand debt and short term debt, but provide more long term loans. In other words, they borrow short and lend long. With a stronger credit quality than most other borrowers, banks can do this by aggregating issues (e.g. accepting deposits and issuing banknotes) and redemptions (e.g. withdrawals and redemption of banknotes), maintaining reserves of cash, investing in marketable securities that can be readily converted to cash if needed, and raising replacement funding as needed from various sources (e.g. wholesale cash markets and securities markets).6. Money creation – whenever a bank gives out a loan in a fractional-reserve banking system, a new sum of virtual money is created.

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According to the survey of Wikipedia, ASSETS of the largest 1,000 banks in the world grew by 6.8% in the 2008/2009 financial year to a record US$96.4 trillion while profits declined by 85% to US$115 billion.

Growth in assets in adverse market conditions was largely a result of recapitalization. EU banks held the largest share of the total, 56% in 2008/2009, down from 61% in the previous year. Asian banks' share increased from 12% to 14% during the year, while the share of US banks increased from 11% to 13%. Fee revenue generated by global investment banking totaled US$66.3 billion in 2009, up 12% on the previous year. All these banks are being regulated locally and internationally by an institution of national interest.

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Unlike most other regulated industries, the regulator is typically also a participant in the market, being either a publicly or privately governed central bank. Central banks also typically have a monopoly on the business of issuing banknotes. However, in some countries this is not the case. In the UK, for example, the Financial Services Authority licenses banks, and some commercial banks (such as the Bank of Scotland) issue their own banknotes in addition to those issued by the Bank of England, the UK government's central bank.

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The Philippine’s central bank is The Bangko Sentral ng Pilipinas (English: Central Bank of the Philippines) sometimes in (Spanish: Banco Central de las Filipinas) and abbreviated as BSP. It was rechartered on July 3, 2004, pursuant to the provision of the 1987 Philippine Constitution and the New Central Bank Act of 1993. The BSP was established on January 3, 1949, as the country’s central monetary authority.

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As prescribed by the New Central Bank Act, the main functions of the Bangko Sentral are:

1. Liquidity Management, by formulating and implementing monetary policy aimed at influencing money supply, consistent with its primary objective to maintain price stability,2. Currency issue; the BSP has the exclusive power to issue the national currency. All notes and coins issued by the BSP are fully guaranteed by the Government and are considered legal tender for all private and public debts,3. Lender of last resort, by extending discounts, loans and advances to banking institutions for liquidity purposes Ex. Case of Banco Filipino

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4. Financial Supervision, by supervising banks and exercising regulatory powers over non-bank institutions performing quasi-banking functions,5. Management of foreign currency reserves, by maintaining sufficient international reserves to meet any foreseeable net demands for foreign currencies in order to preserve the international stability and convertibility of the Philippine peso,6. Determination of exchange rate policy, by determining the exchange rate policy of the Philippines. Currently, the BSP adheres to a market-oriented foreign exchange rate policy, and7. Being the banker, financial advisor and official depository of the Government, its political subdivisions and instrumentalities and GOCCs.

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The Central Bank is active in promoting financial inclusion policy and is a leading member of the Alliance for Financial Inclusion. It is also one of the original 17 regulatory institutions to make specific national commitments to financial inclusion under the Maya Declaration[2] during the 2011 Global Policy Forum held in Mexico. This is one way that Central Bank participates internationally in global economic activities. However, let us differentiate Central Bank from Asian Development Bank, International Monetary Fund and World Bank because all of these banks contribute to financing most of the development programs and projects of a country.

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Over the past 6 years, ADB, through the Asian Development Fund has:

• built or upgraded over 135,000 classrooms; • trained over 660,000 teachers; • built or upgraded over 44,300 kilometers (km) of roads; • installed or rehabilitated over 17,800 km of water supply pipes; • upgraded sanitation in over 269,000 households; • improved over 1.8 million hectares of land as a result of irrigation, drainage, and flood management initiatives; • installed 300 megawatts of new generating capacity, and built or upgraded more than 34,127 kilometers of transmission and distribution lines; and • enabled new microfinance accounts and end borrowers to grow to over 2.7 million.

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The INTERNATIONAL MONETARY FUND OR IMF, according to the website of IMF itself, works to foster global growth and economic stability. It provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty.

The IMF has 188 member countries. It is a specialized agency of the United Nations but has its own charter, governing structure, and finances. Its members are represented through a quota system broadly based on their relative size in the global economy.

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The IMF primarily does the following in order to foster global growth and economic stability:

1. promotes international monetary cooperation and exchange rate stability;2. facilitates the balanced growth of international trade; and 3.provides resources to help members in balance of payments difficulties or to assist with poverty reduction.

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According to the World Bank Website, the World Bank is one of the five institutions started at the Bretton Woods Conference in 1944.

The World Bank says that there are five key factors necessary for economic growth: 1.Build capacity: Making governments stronger and more educated. 2.Infrastructure creation: Making laws to encourage business, and protect individual and property rights. 3.Development of Financial Systems: Starting strong systems that can lend and borrow in many different situations. 4.Combating corruption: Stopping corruption in governments. 5.Research, Consultancy and Training: helping students, academics and organizations who are interested do research into financial affairs.

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The World Bank is composed of two entities:

1. IBRD - International Bank of Reconstruction and Development. The IBRD deals with nations such as China, South Korea, and other developing nations that are more economically stabilized.2.IDA- International Development Association. More specifically, the IDA deals with the poorer nations such as Iraq, Afghanistan, and Libya that have the potential of being major contributors to the global economy in the future.

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The focus of the World Bank is broader than that of the Asian Development Bank (ADB), covering developing nations the world over that are credit-worthy borrowers for major infrastructure projects. The World Bank does not actually deal with humanitarian issues, but specifically large scale projects that serves regions and countries. Tax havens Monaco and  Liechtenstein, Norway, Luxembourg,* Switzerland, and Denmark were among the highest per capita Gross National Income (GNI) in the world in 2009, according to World Bank Development Indicators 2010.

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GNI (or gross national product in the terminology of the 1968 United Nations System of National Accounts) measures the total domestic and foreign value added claimed by residents. GNI comprises GDP plus net receipts of primary income (compensation of employees and property income) from nonresident sources. The World Bank uses GNI per capita in U.S. dollars to classify countries for analytical purposes and to determine borrowing eligibility.

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The International Monetary Fund and the World Bank at a Glance

International Monetary Fund

oversees the international monetary system

promotes exchange stability and orderly exchange relations among its member countries

assists all members--both industrial and developing countries--that find themselves in temporary balance of payments difficulties by providing short- to medium-term credits

supplements the currency reserves of its members through the allocation of SDRs (special drawing rights); to date SDR 21.4 billion has been issued to member countries in proportion to their quotas

draws its financial resources principally from the quota subscriptions of its member countries

has at its disposal fully paid-in quotas now totaling SDR 145 billion (about $215 billion)

has a staff of 2,300 drawn from 182 member countries

World Bank

seeks to promote the economic development of the world's poorer countries

assists developing countries through long-term financing of development projects and programs

provides to the poorest developing countries whose per capita GNP is less than $865 a year special financial assistance through the International Development Association (IDA)

encourages private enterprises in developing countries through its affiliate, the International Finance Corporation (IFC)

acquires most of its financial resources by borrowing on the international bond market

has an authorized capital of $184 billion, of which members pay in about 10 percent

has a staff of 7,000 drawn from 180 member countries

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The Financial Traffic Light model should be as fair as possible, while at the same time being a simple model that can be applied by all companies obligated to report. In principle, Financial Institutions are obliged to accept measuring interest-rate risk, equity risk and real-estate risk for both assets and liabilities without further breaking down these three risk factors. At present, such a solution would yield the same results as the somewhat more detailed model being proposed in this draft. Foreign interest-bearing securities and inflation-linked bonds would then be considered equivalent to Swedish interest-bearing securities. Credit risks and exchange-rate risks would then be ignored. Such a model has the advantage of being simple and clear.  

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 However, in order to obtain a better

impression of the financial risks to which a portfolio is exposed, FI has elected to also include simplified measurements of the foreign interest-rate risk, the real interest-rate risk and the credit risk. On the other hand, FI has deliberately refrained from measuring a specific risk in equities, real estate and credit exposures. The equity risk, however, is divided into a Swedish and a foreign equity risk. Even the ex-change-rate risk is treated schematically, in that the model measures the risk as the total net exposure to all foreign currencies.  

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The model measures how both assets and liabilities are affected by asset price changes, which means that it is the companies’ net risks that are being studied. Furthermore, the model assumes zero correlation between the various asset classes, which means that it takes into consideration diversification effects between asset types. Risk reduction and risk increases through the use of financial derivatives are captured by the model in a simplified manner.  .

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The traffic light model is only one of several supervisory tools used by FI. Since not all financial risks are measured by the model, it needs to be supplemented by other supervision. FI is interested in the companies’ actual risk profile. The traffic light model is only an approximation of the risk profile, which means that financial instruments or investment strategies that do not result in any measurement results in the traffic light model, despite constituting a financial risk for the company, are not regarded as risk free by FI. The opposite applies to financial instruments or investment strategies that de facto reduce the risk, but whose risk reduction is not indicated by the traffic light model. Accordingly, the traffic light model, like other supervisory tools, is used to sort out companies for more in-depth investigation.   .

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  The traffic-light model is a supervisory tool and measures the companies’ resistance to sharp asset-price changes over the short term. The traffic light is not an portfolio optimization model. Neither is the model designed to be used as an internal risk management tool. The companies are themselves responsible for developing models for these purposes that take their own operations into consideration.

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THANK YOU.