How Banks Create Shareholder Value
Increasing the expected cash flows to equity, i.e. the residual cash flows after meeting all expenses, tax obligations, interest and principal payments. For banks, this can be achieved in several ways such as by increasing sales (e.g. increasing deposits, loans, off-balance sheet activities, inter-bank operations, etc.), increasing prices (e.g. increasing commissions, interest rates, etc.), increasing returns on risk-activities (such as trading on security, derivatives, etc.) and reducing operating costs (such as operating and administrative costs) and financial costs (such as interest expenses).
Reducing the hurdle rate (i.e. the cost of equity or capital). In order to reduce the bank’s cost of equity, managers can only attempt to reduce the systematic (or market) risk of the bank, i.e. measured by beta (β). Since β expresses the relative correlation between the bank’s share returns with the market portfolio returns,1 managers can increase shareholder value by reducing this correlation. For instance, managers can diversify corporate activities abroad and, therefore, lower the covariance between the company’s share price and the market portfolio. Since the risk free rate (i.e. the rate of return of a risk free asset) and the market portfolio returns (i.e. the rate of return of a portfolio composed of all activities in the stock market) cannot be influenced, these are exogenous variables out of the managers’ control.
Matching as closely as possible bank’s financing sources with bank’s investments. If a bank is able to employ financial sources with similar features (e.g. in terms of maturity, credit and/or interest rate risks) to the assets being financed, this bank will increase shareholder value since this reduces cash outflow (due to the cost necessary to manage the company’s liquidity) and reduces its overall risk (which influences negatively both the cost of equity and cost of debt).
KeywordsCustomer Satisfaction Total Factor Productivity Corporate Culture Debt Ratio Saving Bank
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