Question

Q3. In thrift banks in USA, the structure of income has been changed because the intermediation role is no longer the main source of income, discuss this statement and explain the structure of income of banks in Saudi Arabia. Accounting for Financial Institution

Answer 1

THE CHANGING STRUCTURE OF BANKS’ INCOME

1.The evolution of financial systems

The changes in banking and its income structure are a part of wider evolutionary changes in the financial system as a whole. While financial systems appear to move more or less slowly through the phases, and may “pause” at one stage for decades, a broad form of evolution is nonetheless widely apparent – and appears to be accelerating, owing to technological change, deregulation and the increased scope of cross border financial activity affecting previously segmented financial systems

2 .Data issues

The data sets used in this study are two-fold. First, we employ the OECD data on bank profitability (OECD 1997). These data provide information on financial statements of banks in 28 OECD countries for 1979-95, although for some countries the time series are shorter (see Table 5). Banks are defined broadly as “institutions primarily taking deposits from the public and providing finance for a wide range of purposes”. The data cover both balance sheets of banking sectors and the corresponding income and expenditure accounts. Note that the data are at a macroeconomic or sectoral level and do not give any information on individual banks. They cannot be used systematically to assess how behavior varies across sizes of institution (although subsectors are provided for some countries). In this paper we focus largely on the national patterns given by the sector “all banks”

3. Empirical findings

(a) Time series results

We focus first on the OECD macroeconomic data. Table 6 shows tha t for the EU and the euro area there has been a rise in the ratio of non-interest income to assets, taking successive four-year periods to smooth out cyclical irregularities. But the upward pattern is much less marked that is often stated, and contrasts sharply in terms of both levels and growth rates with the US, Whereas the EU banking sector has shown an increase in non interest income from 0.9% of assets in 1984-7 to 1.0% in 1992-5, the corresponding figures for the US are 1.3% and 2.1%. The most marked contrast is between the US and the euro area. In the euro area, non-interest income has played a minor role, while in the US it has increased considerably

(b) Cross sectional results

Turning to the microeconomic data on individual banks, one may start with two notes of caution; first that the patterns being only for one year may be affected by cyclical patterns. Hence their value in cross-country comparison is limited. Second, for some countries there are limited numbers of observations and hence the results may be distorted by patterns for individual institutions . And third, as noted, both public and private banks are included in the sample

(c) Simple econometric results

To conclude the empirical section, we examined the cross sectional sample using simple econometric estimates. Note that the samples for Greece, Ireland, Finland and Sweden are very small and hence results should be regarded particularly cautiously. We assess the determinants of on the one hand noninterest income as a proportion of the total, and on the other non-interest income as a proportion of total assets. The intention is merely to show what variables are strongly correlated with non-interest income, controlling for other influences; there is not any attempt to infer causality

structure of income of banks in Saudi Arabia

   I – The Banking System

Saudi Arabia’s banking system is well integrated with international banking, as seven out of eleven banks operating in the Kingdom have foreign shareholders, including branch or joint venture set-ups. This cross-fertilization has ensured a competitive and diversified banking environment which meets the best international banking practices. Our choice of branch banking across the country has been quite instrumental in extending financial services to small businesses and retailers.

  

II - Monetary Stability

SAMA is vested with the conduct of monetary policy, which includes exchange rate policy within the broad framework set by the Government. The role of monetary policy is to provide a stable monetary environment for the economy. We do not have a precisely defined framework of action for the central bank as it exists in some other jurisdictions, which is sometimes regarded as a necessary formal safeguard to monetary stability. The distinction may be less important under our firmly pegged or rule-based exchange rate system than it might be in other circumstances.

Let me put to you a few facts about our monetary stability.

• Saudi Arabia’s currency convertibility undertaking is a clear demonstration of the Government’s unwavering commitment to the linked exchange rate system. The Riyal has remained stable at 3.75 to the Dollar since June 1986. In terms of its real effective exchange rate, the Riyal is a fairly-valued currency at 98.6% of its 1995 value (Q1 03: 98.60, 1995 = 100).
• It is mandatory for Riyal banknotes to be backed by foreign currency reserves, and this puts a ceiling on our monetary base.
• Essential attributes that make us a successful example of an economy doing well under a linked exchange rate system are flexible cost/price structure, strong banking sector to cope with interest rate volatility, adequate Fx reserves and low inflation.
• Price stability has been the hallmark of our economy over a prolonged period of time, with the cost of living index recording an average rise of about 0.1% per annum over the last 20 years.

III – Capital Markets

Monetary policy has an important bearing on capital markets. The exchange rate stability is vital for attracting capital flows and lowering the cost of debt. Riyal interest rates are influenced by global interest rates and domestic money market conditions. SAMA’s monetary policy stance has been accommodative over the last two years in response to global monetary easing and favourable domestic money market conditions. With the growing market sophistication, the shape of the yield curve is often analysed for expected growth, inflation and investment. SAMA does not seek to manipulate the yield curve for managing Government debt.

Conclusion

In line with the stylised facts of long-term financial evolution and the key drivers of recent financial change, there is evidence of changes in income structure for most EU countries, le ading banks to have a greater relative dependence on non-interest income. The rise in the relative share of non-interest income has not led to a higher non-interest income to assets ratio; indeed, it has in many cases accompanied a decline in overall profitability, giving some grounds for concern regarding overall financial stability. Banks in the EU have not been able to increase their non-interest income sufficiently to offset falling interest income, given accompanying changes in other aspects of profit and loss. However, the fact that the relation of non-interest income to profitability tends to be positive for the more liberalised financial systems gives some grounds for comfort about the likely long-term consequences for financial stability. There remain potential concerns about the medium term outlook or the adjustment process of banks to increased profitability in the new financial landscape of EMU.