financial economics

                             Financial Economics (FS6061)

Net present value and capitalization (valuation) models

Introduction

Valuation model is a mechanism to convert a set of forecasts of, or to observe, a series of company and economic variables into a forecast of market value for the company`s stock. In this model we take input in terms of economic variables such as dividends, futures earning, variability of earnings, interest rate etc. and the output is in terms of expected market value or expected return from the stock variables. Valuation model helps to describe the relationship that is assumed to exist between a set of economic and corporate factors and the valuations of these factors in market.

The use of valuation models in investment decisions are based upon the perception that markets are inefficient and assumption about how and when these inefficiencies will get corrected. Nowadays every financial organization employs a valuation model and with this model they make their financial decisions.

                                                Valuation Models

         

    Assets Based            Discounted Cash flow model           Relative valuation              Contingent claim model

1)       Liquidation value                                         1) Equity and firm                    1) Option to delay

2)       Replacement Cost                                         2) Sector and market               2) Option to expand

                                                                                                                       3) Option to liquidate

                                                                                                                                      

1)       Equity valuation model(Dividend and free cash flow to firm)

2)       Firm valuation model (Cost of capital, AVP approach, and excess return model.)

Discounted cash flow model (DCF)

According to discounted cash flow approach the value of share of stock is equal to the present value of the cash flow that shareholders are expected to receive from it. The concept of DCF valuation is based on the principle that the value of a business is inherently based on its ability to generate cash flows for the shareholders or investors.

Key components of DCF model

1)      Free cash flow (cash generated by the assets of business available for shareholders)

2)      Terminal value (value at the end of the free cash flow projection)

3)      Discount rate (the rate used to discount the projected free cash flow and terminal value to their present values)

Let’s see one example to be clear on above discussions:

According to DCF approach value of shares is equal to the present value of its expected cash flows.

Let us assume if a stock is held for one period (t), then cash flows received from stock are dividend (d) and the value of stock when sold is P_t+1, then

                        P_t   =       D_t+1           +         P_t+1

                                             (1+K)                 (1+K)

                        Where, P_t= the price of share at time t/ current price of share

                                    D_t+1=the dividend received at time t₊₁/ last year dividend

                                    P_t+1= the price at period _t+1

                                    K= the appropriate discount rate

This is the case for one period if we will hold stock more than a period suppose for 3 year, then

                        P_t    =       D_t+1     +    D_t+2            +    D_t+3    +   P_t+3                    

                                                (1+K)          (1+K) ²        (1+K) ³    (1+K)³

The DCF equation can be employed in three ways:

₁₎        P_t  can be treated as an unknown

₂₎        K can be treated as an unknown

₃₎        Converted to a price earnings ratio.

Dividend stream: This model is typically the DCF using dividend forecasts over several stages. Under this model it is necessary to forecast the growth rate in dividend each year. A number of different assumptions about the growth rate patterns are made in this model. In particular we examine three sets of growth assumption. They are:

a)      Zero growth (assume constant dividend).

b)      Constant growth in dividend

c)      Super normal growth (growth for a finite number of years at a constant rate, followed by a period during which growth declines to a steady and remains the same.)

Now, we will examine these three DCF dividend model in brief.

Zero growth

In the case of zero growth in dividend, the company pays a fix and constant amount of dividend every year, there will be no change in dividend paid in 1^st year and 2^nd year or any year.

Let us assume the constant dividend amount be $ D, then,

dividend paid last year(D_o)= $D

dividend expected at the end of year 1(D₁)= $D

dividend expected at the end of 2^nd year(D₂)= $ D

Since the dividend is always the same with cash flow equal to $D, therefore price of share is given as:

                                    P_o= D/r

where, r= required rate of return

            D= constant dividend per year

            P_o= Price of share

Example, CASIO Company has policy of paying $ 20 per share as dividend every year. If this policy is to be continued indefinitely, what is the value of the share of the stock if required rate of return of the investment is 18%.

Solution:

We are given that,

                        D=$ 20

                        r= 20% or (0.2)

Present value per share (P_O) =   20/0.2

                                           = $ 100

Constant growth in dividend

In the case of constant growth rate the dividend for company always grow at a steady rate. Suppose the dividend growth rate of company is g% then it will be the same rate for indefinite future. The price of share in constant growth rate can be calculated as:

                        P_O= D₁/r-g

                        We can write D₁= D_O (1+g)

                        D₁=dividend at year 1

                        g= growth rate of dividend

                        D_O= dividend paid at year 0 (just paid dividend)

The above equation of constant growth model can be interpret as, the price of share should be equal to next year`s dividend divided by the difference between appropriate discount rate for the stock and its expected long term growth rate.

Example, A company has just paid dividend of $0.8 and is expected to exhibit of growth rate of 12% into the indefinite future and expected rate of return on investment is 15%. What is the value of stock?

Solution

We are given that,

D_O= 0.8$

g= 12%

r= 15%

The present value of share (P_O) = D₁/r-g

                                                = D_O (1+g)/r-g

                                                =0.8(1+0.12)/0.15-0.12

                                                =$29.867

Super normal growth model (two- period growth)

In this case, it is assumed that irregular amounts of dividend are paid during the first few years and then followed by a constant growth rate. Assumption of growth to be constant after some period of time is followed by the reasoning like after some period of time the firms are not differentiate on the basis of growth. The firms with higher growth will no longer have high growth and firm with less growth can generate high growth in future. Thus after some years, it is sensible not to differentiate between firms but simply to assume they all grow at same rate.

The price of share in super normal growth can be calculated as:

P_O=      D₁          +     D₂              + …………              D_n          +       P_n

          (1+r)             (1+r)²                                     (1+r)ⁿ            (1+r) ⁿ  

Where P_n=   D_n(1+g)

                        r-g

Example, A company is expected to pay dividend $ 0.10 per share in 1^st year, $0.20 in 2^nd year and $0.25 per share in third year. After third year the dividend will grow at a constant rate of 5% per year. The required rate of return for your investment is 10% per year. What is price of share now?

Solution,

From question we are given that,

Dividend for 1^st year (D₁) = $0.10

Dividend for 2^nd year (D₂) = $0.20

Dividend for 3^rd year (D₃) = $0.25

Required rate of return(r) =10% (0.10)

Growth after third year (g) = 5% (0.05)

First we calculate the share price at third year,

                                    P_n  =      D_n(1+g)

                                                     (r-g)

                                    P₃   =        D₃ (1+g)      =   0.25(1+0.05)     = $ 5.25

                                                        (r-g)                 0.10-0.05

Now calculating share price,

P_O  =       D₁             +            D₂                 +      D₃               +    P₃

                  (1+r)                         (1+r)²                  (1+r)³            (1+r³)

            =      0.10         +     0.20            +    0.25            +    5.25

                   (1+0.10)         (1+0.10)²           (1+0.10)³         (1+0.10)³

            =    0.09    +       0.17        +   0.19     +    3.94

            =   $4.93

Model based on Price- Earnings ratios

This model argues common stocks are possible to analyze by applying price-earnings ratio to either present or forecasted earnings. The major factor that separates this model from DCF model is the selection of a terminal P/E ratio. Under this model we have to compare the price and earnings per share for a company. By comparing these two factors we can analyze the markets stock valuation of company and its shares relative to the income company is generating. Stocks with higher or certain forecasts earnings growth will usually have a higher P/E and those expected to have lower or riskier earnings growth will usually have a lower P/E. To use this model one should at least explore growth rate implicit in the use of terminal P/E ratio.

Basically P/E ratio is calculated as:

                                                P/E= MPS/EPS

                                        Or, MPS= EPS× P/E ratio

                                                P­_O = EPS× Multiplier (m)

                                                Where, MPS= market price of share

                                                            EPS= Earnings per share

                                                           

 Under this model we examine two sets of growth assumption. They are:

1)      Zero growth

2)      Constant growth

Zero growth: In zero growth all earnings of firms are distributed as a dividend. Here,

                                    Price of share (P_O)= EPS × m

                                    Where m= multiplier and calculated as

                                                = dividend payout ratio/ required rate of return

Example: A company has a earning per share of $4 and required rate return is 16%. If company decided to pay all earnings as a dividend then what is the price of share now?

Solution,

We are given that,

EPS= $4

r= 16% or 0.16

First calculating multiplier,

                        m= DPR/r

                           = 1/0.10

                           = 6.25

(Since company have decided to pay all earnings as a dividend, DPR=100% or 1)

P_O= EPS× m

     = 4× 6.25

      = 25$

Constant growth: in constant growth the company has a policy of constant retained earnings for future investment. Here,

                                    Price of share (P_O) = EPS × m

                                    Where, m= multiplier= DPR (1+g)/r-g

Example: A firm has decided to pay 60% of their earnings as a dividend and remaining 40% is retained for future investment. Earnings per share are $4 and required rate of return is 16%. What is the price of share?

Solution,

We are given that

Dividend payout ratio (DPR)= 60% or 0.60

Required rate of return(r) = 16% or 0.16

Earnings per share (EPS) = $4

Now, multiplier (m) = DPR/ r

                                    = 0.60/0.16

                                    =3.75

Price of share (P_O) = EPS ×m

                                    = 3.75× 4

`                                   = $15

The theoretical Price earnings ratio can be estimated by calculating an average historical value, using an explanatory model assigning weights to certain factors by qualitative reasoning and using regression analysis to estimate the weights.

In 1963 Whitbeck- Kisor model was introduced which attempt to use multiple regressions to explain price earnings ratios. According to this model,

Price earnings ratio= 8.2 +1.50(earnings growth rate) +0.067 (dividend payout rate) – 0.200 (standard deviation in growth rate)

This equation represents the estimate of stock at a point of time and the impact of three variables, earnings growth rate, dividend payout and standard deviation on the price earnings ratio. The numbers represent the weight that the market placed on each variable at the point of time and the signs represent the direction of impact of each variable on the price earnings ratio.

 There are three reasons suggesting Whitbeck- kisor model does not work. They are:

i)                    Market tastes changes and with change in tastes the weight on each variable also changes over time.

ii)                  Inputs like dividend and growth in earning changes over time

iii)                This model has failed to show the firm effects.

Capital assets pricing model (CAPM)

Capital assets pricing model is tool used to analyze the relationship between risk and rates of return. CAPM model states that the relevant riskiness of an individual stock is its contribution to the riskiness of a well diversified portfolio.  Beta coefficients are key elements in this model, which measures the extent to which return of a given stock move with the stock market.

Under CAPM,

                  E (R_A) = R_f + [E (R_M) – R_{F] ×} B_A

The above equation is also known as Security market line (SML).

Where, R_f = risk free rate

              R_M = market return

               B_A= Beta coefficients

     

 DCF and the CAPM

Wells Fargo stock valuation system attempts to implement stock valuation and selection systems that incorporate the DCF approach and capital assets pricing theory. There normally three steps in Wells Fargo stock valuation system,

Step1

·         Estimation of expected rate of return implied by the market price.

·         Find the discount rate which equates the present value of all future dividends with price.

Step2

·         Estimation of the beta of each security.

Step 3

·         Using the expected return and expected beta from each of the stocks.

·         A graph is plotted and the straight line which fits these points is used as an estimated SML

Result: If the stock has return above the SML, given its risk, it should be a good buy and if it has a lower return, it should not be bought.  

Financial Industry Report of Nepal

Financial Industry of Nepal

History, Transformation and Challenges

                                      Industry Report

 

      

                                                                  

Acknowledgement

I would like to express the deepest appreciation to Islington College and my module teacher   Dr.Francisca Tej who helped me in every aspect of this report and convincingly conveyed a spirit of adventure in regard to research. Without her guidance and persistent help the research would not have been possible

I would like to thank my friends, various web and books publisher and Nepal Rastra Bank for their information and data, without these information I can barely finish my report.

Finally, I wish to thank my parents for their support and encouragement throughout the study.

                       

Executive Summary

Financial sector is the backbone of the economy. Basically, the financial sector has to be competitive, broad based and within the range of customers outreach and affordability for the general public. Over the past 20 years Nepal`s financial sector has become more deeper and the number of financial intermediaries have grown rapidly. There is no question that this sector has been serving as the major industry for job employment as well as helped in the economic development of country but there is still so much to be done for the smooth development of this sector. Though the financial institutions are increasing day by day, still access to financial services remains limited for many people in many parts of Nepal. This report try to examines the condition of banks mainly commercial and offers the recommendations by doing different analysis such as PEST, SWOT, Force field and Porters five forces.

The major findings indicate and suggest that despite government efforts, access to formal financial services is declining. Financial intermediation is stagnating; the number of banks deposits and loan account per inhabitant is falling. Access to bank infrastructures mainly in rural area has also decrease.

Contents

1)      Banking Industry Introduction and Its History:

1.1) History……………………………………………………………………………Page 5-6

1.2) Industry Overview……………………………………………………………… Page 6

1.3) Periodic Growth of Industry………………………………………………………Page 7

1.4) Trends of Commercial Bank………….…………………………………………………Page 8-9

           

2)      INDUSTRY ANALYSIS:

2.1) PEST Analysis……….……………………………………………………………Page 10-11

2.2) Porters Five force Analysis……………………………………………………….Page 12-15

2.3) SWOT Analysis…………………………………………………………………...Page 16

3)      FINDINGS

3.1) Findings and Challenges…………………………………………………………..…Page 17

4)      REFERENCES…………………………….……………………………………………. Page 18

5)      ACRONYM………………………………………………………………………………..Page 19

6)      APPENDIX……………………………………………………………………………..Page 20-23

7)      Table of Figures and Tables

Table 1: Growth of Financial sector over the period…………………………………..Page 7

Table 2: Commercial Banks Operating in Nepal……………………………………...Page 8-9

            Table 3: Commercial Banks Branches in Five Development Regions………………..Page 23

         

            Figure 1: Different Financial Institutions percentages cover In Pie Chart……………..Page 7

            Figure 2: Deposits and Credit trends of Commercial Bank………………………….…Page 21

Introduction on Banking Industry and Its History  

Financial sector reforms have been initiated in several countries including Nepal. Over the past 20 years Nepal`s financial sector has become deeper and the number and type of financial intermediaries have grown rapidly. Financial industry mainly includes the commercial banks and development banks, finance companies, cooperatives, insurance companies, and some NGO`s and INGO`s.

. Until mid 80`s, the financial sector of Nepal was not opened up for the private sector and in mid 80`s the financial liberalization started by opening banking system to the private sector. As there were only two commercial banks, Nepal Bank Limited (NBB) and Rastryia Banijya Bank (RBB) under government ownership, the banking sector was first opened up to the private sector.

Nepal bank Ltd. is the first modern bank of Nepal. It is taken as the milestone of modern banking of the country. Nepal bank marks the beginning of a new era in the history of the modern banking in Nepal. Nepal Bank has been inaugurated by King Tribhuvan Bir Bikram Shah Dev on 30^th Kartik 1994 B.S. Nepal bank was established as a semi government bank with the authorized capital of Rs.10 million and the paid -up capital of Rs. 892 thousand. Until mid-1940s, only metallic coins were used as medium of exchange. So the Nepal Government (His Majesty Government on that time) felt the need of separate institution or body to issue national currencies and promote financial organization in the country.

Nepal Bank Ltd. remained the only financial institution of the country until the foundation of Nepal Rastra Bank is 1956 A.D. Due to the absence of the central bank, Nepal Bank has to play the role of central bank and operate the function of central bank. Hence, the Nepal Rastra Bank Act 1955 was formulated, which was approved by Nepal Government accordingly, the Nepal Rastra Bank was established in 1956 A.D. as the central bank of Nepal. Nepal Rastra Bank makes various guidelines for the banking sector of the country. In 1957 A.D. Industrial Development Bank was established to promote the industrialization in Nepal, which was later converted into Nepal Industrial Development Corporation (NIDC) in 1959 A.D. Rastriya Banijya Bank, was established in 1965 A.D. as the second commercial bank of Nepal. The financial shapes for these two commercial banks have a tremendous impact on the economy.

As the agriculture is the basic occupation of major Nepalese, the development of this sector plays in the prime role in the economy. So, separate Agricultural Development Bank was established in 1968 A.D. This is the first institution in agricultural financing.

For more than two decades, no more banks have been established in the country. After declaring free economy and privatization policy, the government of Nepal encouraged the foreign banks for joint venture in Nepal.

Today, the banking sector is more liberalized and modernized and systematic managed. There are various types of bank working in modern banking system in Nepal. It includes central, development, commercial, financial, co-operative and Micro Credit (Grameen) banks. Technology is changing day by day. And changed technology affects the traditional method of the service of bank.

Banking software, ATM, E-banking, Mobile Banking, Debit Card, Credit Card, Prepaid Card etc. services are available in banking system in Nepal. It helps both customer and banks to operate and conduct activities more efficiently.

  

Table- 1

 Growth of Financial Institutions in Nepal

Source: Nepal Rastra Bank Statistics Report, 2012

The above data are presented in Pie Chart as below:                        

Figure-1                                     Pie Chart                  

Trends of commercial Banks

The Nepal Rastra Bank (NRB) has classified the institutions into “A” “B” “C” “D” groups on the basis of the minimum paid-up capital and provides the suitable license to the bank or financial institution. Group ‘A’ is for commercial bank, ‘B’ for the development bank, ‘C’ for the financial companies and ‘D’ for the Micro Finance Development Banks. As the data shows the commercial banks have been gradually increased over the decades. There are currently 32 commercial banks operating in the country. They are listed below:

Table- 2

S.N.	Name of Commercial Bank	Year of establishment A.D.	Head office	Links to Related bank
1	Nepal Bank Limited	1957	Kathmandu	www.nepalbank.com.np
2	Rastriya Banijya Bank Limited	1966	Kathmandu	www.rbb.com.np
3	Agriculture Developnment Bank Limited	1984	Kathmandu	www.adbl.gov.np
4	Nabil Bank Limited	1984	Kathmandu	www.nabilbank.com
5	Nepal Investment Bank Limited	1986	Kathmandu	www.nibl.com.np
6	Standard Chartered Bank Limited	1987	Kathmandu	www.standardchartered.com.np
7	Himalayan Bank Limited	1993	Kathmandu	www.himalayanbank.com
8	Nepal SBI Bank Limited	1993	Kathmandu	nsblco@nsbl.com.np
9	Nepal Bangladesh Bank Limited	1993	Kathmandu	www.nbbl.com.np
10	Everest Bank Limited	1994	Kathmandu	www.everestbankltd.com
11	Bank of KathmanduLimited	1995	Kathmandu	www.bokltd.com
12	Nepal Credit and Commerce Bank	1996	Bhairawa	Nccbank.com.np
13	Lumbini Bank Limited	1998	Narayangrah	www.lumbanibank.com
14	Nepal Industial and Commercial Bank	1998	Biratnagar	www.nicbank.com.np
15	Machhapuchre Bank Limited	2000	Phokara	Machbank.com
16	Kumari Bank Limited	2001	Kathmandu	www.kumaribank.com
17	Laxmi Bank Limited	2002	Birjung	www.laxmibank.com
18	Siddharth Bank Limited	2002	Kathmandu	www.siddharthabank.com
19	Global Bank Limited	2007	Birjung	Globalbanknepal.com
20	Citizens Bank International Limited	2007	Kathmandu	Ctznbank.com
21	Prime Commercial Bank Limited	2007	Kathmandu	Eprimebank.com
22	Bank of Asia Nepal Limited	2007	Kathmandu	Boanepal.com
23	Grand Bank Nepal limited	2008	Kathmandu	www.dcbl.com.np
24	NMB Bank Limited	2009	Kathmandu	Nmb.com.np
25	Kist Bank Limited	2009	Kathmandu	Kistbank.com
26	Mega Bank Limited	2009	Kathmandu	Megabanknepal.com
27	Sunrise bank limited	2009	Kathmandu	Sunrisebank.com.np
28	Janata Bank limited	2009	Kathmandu	Janatabank.com.np
29	Commerz and Trust bank limited	2010	Kathmandu	Ctbanknepal.com
30	Civil Bank limited	2010	Kathmandu	Civilbank.com.np
31	Century commercial Bank limited	2011	Kathmandu	Centurybank.com.np
32	Sanima Bank limited	2011	Kathmandu	Sanimabank.com

The deposits and credit trends of commercial banks for the past 10 year is shown in Appendix 1.

Industry Analysis

There are different types of business analytical tools to determine the opportunities, challenges and other various environmental factors which will help the business in forecasting and to remain in the track of business. For financial industry analysis, here we mainly use PEST, Porters Five forces and SWOT.

PEST Analysis

The PEST analysis is the external analysis which includes the external factors to the industry such as political, environment, social and technology. These factors and their impact on industry are discussed as below:

Political factors

1)      Regulatory framework: The banking industry is affected more in compared with other sector due to the poor policy frame work of Nepal government and central bank NRB.

2)      Budget and Budget measures: Due to the political instability the budget distribution in this sector is inconsistent and banks are forced for limited transactions with the client.

3)      Stricter prudential regulations with respect to capital and liquidity give advantage to the Banking sector in terms of credibility over the other industries.

Economic factors

1)      Economic Growth: Though the country`s gross domestic product (GDP) is in increasing trend, there has not been a noticeable increase in economic growth. The 30% of people still live below the poverty line and these people are far from the use of any banking products and services.

2)      Interest Rates: Nepal Rastra Bank monitors and controls regularly the interest rates. Recently Nepal Rastra Bank reduces bank rate to stimulate the growth of banking industry but in past interest rate was increased due to the more investment in unproductive sector such as real estate.

3)      Inflation Rates: Nepal is facing big trouble due to inflation as it has touched up to double figures 10.07%. To curb the inflation, NRB has lowered the interest rates to increase the demand in banking industry.

Socio- Cultural factors:

1)      Traditional Trends: Nepal is country with different ethnic groups and people here follow different religions and customs’. People used to borrow money from “Sahu and Mahajans” in early period when bank and other financial industry were not in practice and there is still these trends in rural areas of country.

2)      Change in Lifestyle: Life style of people is changing rapidly. People are demanding high class products and the needs and wants are increasing day by day. And this has opened the opportunities for banking sector to tap the change.

3)      Population: Increase in population is one of the important social factors which affect the private sector banks. Banks would open their branches after looking into the population demographics of the area.

Technological Factors

1)      Investment in technology: Technology plays important role in bank`s control mechanisms as well as services offered by them. The imports of new technology and investment made for the updates are important as they increases the standard as well ease in delivering products and services. The government as well as private investment in technology is increasing day by day. Now a day’s banks introduce different technology to deliver the standard services to customers.

2)      IT services and online banking: Theses day’s banks are also using Internet and Mobile as a tool of promotions and give great utility to customers.  These IT services have changed the face of traditional banking systems.

Porters Five Force Analysis

 The Porter's Five Forces model is a simple and powerful for understanding where power lies in business situations. This is useful, because it helps to understand both the strength of our current competitive position, and the strength of a position we are considering moving into.

With a clear understanding of where power lies, we can take fair advantage of a situation of strength, improve a situation of weakness, and avoid taking wrong steps.

Five forces analysis take five important forces into consideration that determine competitive power in an industry. These are:

1)      Bargaining power of supplier

2)      Bargaining power of buyer

3)      Competitive rivalry

4)      Threats of substitutes

5)      Threat of new entry

Bargaining Power of Supplier

A banking industry requires enough capital from shareholder and debt holder, and working integration from workers and staffs, other components and supplies. This requirement leads to buyer-supplier relationship between industry and various parties. Bargaining power of supplier is always high in banking industry. The following table outlines some factors that determine supplier power:

Suppliers are powerful if	Suppliers are weak if
Credible forward integration threat by suppliers.	Many competitive suppliers are – products and services are standardized.
Suppliers concentrated.	Credible backwards integration threat by purchasers.
Customers are powerful.	Customers weak.
	Concentrated purchasers.

Bargaining Power of Buyer

The power of buyers in banking industry is limited. As there are different external forces which leads this industry towards to the success as well as to the failure. Here power of buyer is generally indicated by the borrowing rate of interest and the interest rate is generally influenced by external factors such as economic conditions, market fluctuations and international trade. Though the bargaining power of buyer is limited, banks always provide the standard services to its customers which help them to be superior. The following table outlines some factors that determine buyer power:

Buyers are powerful if	Buyers are weak if
Buyers possess a credible backwards integration threat.	Producers are threaten forward integration.
Buyers purchase a significant proportion of output	Buyers are fragmented – no buyer has any particular influence on industry.
Government provides certain right and authority.	Government provides only limited right on the industry.

Competitive Rivalry

The competitive rivalry in the banking industry seems to increase as the banks and other financial institutions are growing year by year. As you can refer to, Table 1 to see the growth in this industry. As banks increases in numbers the competition among them are also increased. In pursuing advantage over the rivals, banks started to choose different competitive moves. Some of them are:

1)      Changing borrowing interest rates and lending rates.

2)      Improving offered product and services, improving feature and implementing innovations and new strategies.

3)      Creatively using channels of distributions.

The intensity of rivalry among the banks is influenced by the following industry characteristics:

1)      A large number of firms

2)      Slow economic growth and market growth

3)      High exit barriers

4)      Low levels of product differentiation.

5)      Mergers and Acquisitions trends

6)      Low switching costs.

Threats of Substitutes

According to the Porters, threat of substitutes refers to the ability of the customer to find a different way of doing what you do. In financial industry the threat of being substitutes is high as there is a stiff competition among the banks. A threat of substitutes typically impacts an industry through price competition. Customers always want the quality product and services and they want in a low and cheap price.

Threats of New Entrants

The possibility of new entrants in the industry is always a prominent threat. As the commercial banks for the past decades has dramatically grown the NRB has impose some restrictions. They have increases the amount of authorized capital required by the bank. NRB has also motivates the banking sector in M&A policy. These types of barriers are imposed by government to make the sound economic environment in the financial sector.

SWOT Analysis

SWOT analysis take into account the strengths, weaknesses, opportunities and threats facing a business, organization or operation, in terms of serving customers, stakeholders and their own employees. A SWOT analysis of the banking industry will list these four components and illustrate how to capture the opportunity for strengthening the company by diminishing the threats and weaknesses.

Some Major areas of Banking are:

1)       Retail Banking

2)       Corporate banking

3)      Corporate Credit

4)       Treasury

5)      Capital Markets

6)      Lending to micro, small and medium enterprises, agriculture and micro finance.

7)      International banking

For the detail explanations of all SWOT factors, please refer Appendix 2.

Findings

Over the last decade, the banking sector has become the fastest growing sector. As we can see the Table 1, number of financial institutions has grown from 5 in 1985 to 265 in 2012.  With this growth and rapid expansion of branches, total assets of banks and financial institutions have grown from Rs. 699 billion in 2007/2008 to around Rs. 1.4 trillion at present. This exploding banking sector, however, has failed to deliver quality because of limited supply of quality human resources, political instability and poor regulating norms from the regulating bodies and authorities.

For developing country like Nepal, the numbers of commercial bank is very high. Most of the commercial banks are located in capital Kathmandu and there is stiff competition among them. Opening branches and the installation of ATM machines has led to more idle cash lying around at branches and machines which is also believed to be the reason for rise in inflation in country. You can refer to, Appendix 3, for the total number of bank branches all over the country separated according to the five region.

Challenges

Banking industry faces mainly two challenges. They are:

1)      Regulation: Regulation in terms of banking policy which have increase liquidity crisis, high interest rate, declining deposits, and danger of collapse of different industrial sectors such as real estate, hydropower etc.

2)      Distribution: Distribution requires more manpower to be deployed in rural area and full commitment from the deployed manpower to the industry. 

 I think these challenges can be overcome with the combine effort of staffs working in banks and the regulating governing bodies. NRB have to involve more and play more central role. They should formulate new policies which should eliminates most of the problems banking industry are facing.

REFERENCES

Hill, T.  and Westbrook, R. (1997) SWOT Analysis: It’s Time for a Product Recall, Long Range Planning, Vol. 30, No. 1, pp. 46–52.

Porter, M. E. (2004) Competitive Strategy: Techniques for Analyzing Industries and Competitors, New York; London: Free Press

Wagle, K. N., (2001). Financial Industry Analysis and Planning, M. K. Publishers & Distributors: Kathmandu

HARMA, RUPAK D(2013),”Banking sector`s does not resonate with growth,” republica,24 April 2013

Financial Sector Reform in Nepal 2007, Available from < http://saneinetwork.net/Files/08_05.pdf > [April 22, 2013]

Commercial Banks in Nepal, 2012, Available from < http://imnepal.com/name-list-of-all-the-commercial-banks-in-nepal/ > [May 2, 2013]

Acronym

NRB    Nepal Rastra Bank

IT         Information Technology

ATM    Automated Teller Machine

M&A    Merger and Acquisitions

GDP      Gross Domestic Product

Appendix 1

Figure - 2

                      Source: Banking and Financial Statistics Report (NRB), 2012           

Both the deposits and credit are in increasing trend from 2001 to 2012, with credit of commercial banks are slight more than the deposits in year 2012.

Appendix 2

Strength

1)      Nepalese banks have compared favorably on growth, asset quality and profitability with other economies banks over the last few years.

2)      Policy makers have made some notable changes in policy and regulation to help strengthen the sector. These changes include strengthening prudential norms, enhancing the payments system and integrating regulations between commercial and co-operative banks.

3)      Bank lending has been a significant driver of GDP growth and employment.

4)       Extensive reach: the vast networking & growing number of branches & ATMs.

5)      Nepalese banking system started to reach even to the remote corners of the country.

Weakness

1)      The central bank NRB need to fundamentally strengthen institutional skill levels especially in sales and marketing, service operations, risk management and the overall organizational performance ethic & strengthen human capital.

2)       The cost of intermediation remains high and bank penetration is limited to only a few customer segments and geographies.

3)       Structural weaknesses such as a fragmented industry structure, restrictions on capital availability and deployment, lack of institutional support infrastructure, restrictive labor laws, weak corporate governance and ineffective regulations have been really pain for this sector.

Opportunities

1)      The market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-based income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations.

2)      Given the demographic shifts resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks.

3)       New private banks could reach the next level of their growth in the Nepalese banking sector by continuing to innovate and develop differentiated business models to profitably serve segments like the rural/low income.

4)      Nepal Rastra Bank (NRB) has approved a proposal from the government to amend the Banking Regulation Act to permit banks to trade in commodities and commodity derivatives.

Threats

1)      Threat of stability of the system: failure of some weak banks has often threatened the stability of the system.

2)       Rise in inflation figures which would lead to increase in interest rates.

3)      Political instability has threatened the whole industry as the economy and trade is affecting day by day.

Appendix 3

The number of commercial bank branches operating in the country has increased to 1425 in mid July 2012 from 1245 in mid July 2011. Among the total bank branches 49.7 percent is concentrated in the central region followed by Western 17.9%, Eastern 17.8%, Mid Western 8.4% and Far Western 5.9%.

Table-3

Region	Number of Commercial Bank branches
Eastern region	255
Central region	709
Western region	256
Mid Western region	120
Far Western region	85