Capital Markets Metrics Essay

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Banking Development

One of the steps in determining the best countries to target for overseas subsidiaries is by examining different countries for the characteristics of their banking and capital markets. There are four main categories of characteristics that will be the focal point of this report, for each of the banking and capital markets. The four main characteristics are the access, the depth, the efficiency and the stability. For a company seeking a country in which to enter, each of these has particular relevance for both the size of the market and the potential of the market. Access reflects the market penetration for banking and finance, which can be seen as a proxy of sorts for market potential. Depth is another factor that can highlight the size and potential of a given market.

The efficiency reflects whether there are synergistic opportunities. Remember that companies making acquisitions will always pay an acquisition premium above and beyond the current market value of the acquired firm (Haunschild, 1994). While in some cases there will be synergistic benefits accruing from geographic diversification, especially when part of a broader globalization strategy, operational synergies can come when the acquiring bank brings its operational expertise to the acquired bank (Sirower, 1997). The acquiring bank would be able to improve the acquired bank, thereby increasing its value. The acquired bank is unlikely to be able to fully price this in, so there is opportunity to create shareholder value, ironically, when the acquisition target is underperforming (Krishan, Hitt & Park, 2007).

The Metrics

There are eight metrics that are the subject of this study, one for each characteristic for banking and capital markets. For the banking industry, the access metric is the availability of ATMs per capita. This data is widely available, and serves an effective proxy for banking density at the consumer level. Bank branches are sometimes cited, but since most branches have ATMs, yet there are freestanding ATMs as well, this measure is a more comprehensive study of a country's consumer banking infrastructure. The depth measure is going to be the financial system deposits to GDP. This percentage reflects the degree to which people in the country use their banking system, and a disparity between this and the access measure can highlight a country where wealth in concentrated such that a sizeable infrastructure does not necessarily mean that people can or are willing to use it.

The efficiency metric is bank noninterest income to total income, which illustrates the sophistication of the banking system. The world's most sophisticated banking systems have relied on ever-increasing use of non-interest fees in their revenue as a source of complementary revenue (DeYoung & Rice, 2003). Arguable, a lack of efficiency here creates an opportunity to adapt domestic UK non-interest revenue streams to the foreign context, to recapture some of the acquisition premium. The stability metric commonly used bank credit to bank deposits, a figure that highlights the leverage within the industry, and therefore its overall risk.

The capital markets measures used are as follows. The access measure is the market capitalization ex-top10 companies. In many countries, there may be a handful of dominant companies that skew the size of the local markets. But once the top ten companies are excluded, the size of the remaining market can be an indicator of the breadth of access that firms have for the capital market. The depth measure used here will be the stock market's value of total traded to GDP. While this measure does include the top 10 companies, the value of this measure is just how much the local stock market reflects the size of the local economy. While in some cases this could be skewed by companies listing overseas (i.e. Israeli companies listing in the U.S., making the Israeli market look smaller than it actually is), for most countries this measure should deliver an accurate reflection of the market depth. The stock market turnover ratio will be the efficiency measure used, as higher turnover indicates higher liquidity, which is to say the market is more efficient. Stock price volatility is the stability measure that will be used. This is probably best examined in context with major stock markets, as even they can have some volatility. This will also correlate a little bit with depth, as markets with less depth probably have less stability.

The Countries

The countries chosen for this examination are a motley mix, but were based on specifications that management wanted such a mix. The countries are as follows: Germany, Hong Kong, Mexico, Sri Lanka, Nigeria, Egypt, Malaysia, and Russia.

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For ease of comparison, figures for the UK will also be included in the report. The structure of the report will be to make comparisons of the different metrics, to highlight the strongest and weakest outliers among this chosen group of countries. This will be done for each of the eight metrics that are studied. The report will then render a conclusion that identifies what the authors believe to be the top three countries for further investigation for a potential acquisition partner.

The first step of this process is to provide a general sense of the state of the economies in these different countries. Several of these countries are known to be petro-economies (Malaysia, Russia, Nigeria in particular). Egypt is in a volatile state, and Sri Lanka was not too many years ago. Most of these countries lack any semblance of modern democracy, and several are borderline failed states. This report will not give undue discussion to matters of political risk, as it is assumed that future reports on target countries will investigate that and other subjects in greater detail. The focus of this report will be strictly on the metrics that inform the opportunities in the banking and capital markets of these nations. First, a brief table presenting the current and recent GDP, along with growth rates (all sourced from the CIA World Factbook, 2014).

2011

2012

Growth

2013

Growth

Germany

0.91%

0.50%

Hong Kong

1.51%

2.89%

Mexico

3.58%

1.21%

Sri Lanka

6.39%

6.24%

Nigeria

6.58%

6.22%

Egypt

2.23%

1.83%

Malaysia

5.65%

4.69%

Russia

3.41%

1.31%

UK

0.09%

1.88%

As the chart indicates, most economies are growing more rapidly than the UK economy. The Germany economy is an exception -- while a strong economy it is doubtless being dragged down by Eurozone weakness. Sri Lanka is the smallest economy being studied, but it is also the fastest-growing. This is not surprising, given the recent end of its civil war. Construction in particular has been a significant driver in this time of peace (ABD, 2014). Malaysia is also showing robust growth but even strong oil prices in these years was not enough to spur unusual economic growth in Russia. Nigeria, for its part, is becoming a robust economic story, rivalling Egypt and South Africa for status as Africa's largest economy.

Data Analysis -- Banking Industry

First, the banking industry will be discussed. Russia has the highest access in its banking industry, with strong showings coming from Hong Kong. Weak access is reported from Nigeria and Egypt. Germany banking access is at surprisingly low levels, far below what would be expected from a modern economy.

With respect to market depth, Hong Kong has incredible market depth, while the UK did not register on our chosen metric. Germany and Malaysia also held reasonable levels of market depth, while Mexico and Nigeria had low levels of depth. Despite its broad access, Russia also showed a fairly low level of market depth.

Russia and Hong Kong enjoy the highest scores for banking industry efficiency, well above UK levels. The Germans are on our level. The developing world nations all have relatively inefficient banking systems, in particular Sri Lanka. Of the countries studied, Russia has the greatest market stability. Say what you want about political risk, but Russia's oil wealth has allowed its banking sector to enjoy a higher level of stability than the other nations. German banks were less stable, having been weakened somewhat by the recession and the Eurozone crisis. Egypt has the least stable banking system, and this was always the case even before that country's recent political troubles. Sri Lanka's banking system has a relatively high level of stability, as does that of Malaysia, both countries roughly at Germany's level.

Overall, the country that stands out as having the best metrics for the banking industry is Hong Kong. While the bank stability is not great -- perhaps a reflection of PRC control over the territory and consequent departure of major banks like HSBC to safer places, the other metrics are strongly in Hong Kong's favour. There is still a significant opportunity as Hong Kong is seen as the West's window into China, a proxy investment in Chinese growth, but with a more or less British legal system and Western capitalist characteristics.

Sri Lanka is the only other really promising country in this group. While Mexico and Malaysia are decent performers on the metrics, there is no excellence in.....

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