Financial Sector Performance and Conceptual Framework

FINANCIAL SECTOR
PERFORMANCE AND
CONCEPTUAL
FRAMEWORK
REPORT FOR CORPORATE FINANCE
GROUP MEMBERS:
ATIF AHMED (9549)
AMMAR SAMANA (11391)
ABDUL SAMAD (11267)
JALALUDDIN KEHR (10038)
MUHAMMAD AZAM SIDDIQUI (1456)
SHAHZAIB ALI (7064)
MUHAMMAD NAJAM NASEEM(10636)
2015
SUBMITTED TO: Mr. NADEEM KHAN

Financial Sector Performance and Conceptual Framework
Email: atifahmed.talk@gmail.com, na-jamnaseem@hotmail.com Page 2
1. HISTORICAL BACKGROUND OF THE TOPIC:
“Money is the name of the game in the financial services industry. Companies of
this nature are involved in the creation, storage, utilization, management, and
manipulation of money. Such companies include banks, insurance agencies, brokerage
houses, accounting firms, and real estate agencies”.1
OR
“A category of stocks containing firms that provides financial services to
commercial and retail customers. This sector includes banks, investment funds, insurance
companies and real estate”.2
The financial services/sector industry is relatively new, but certain parts of it, such as
insurance coverage, go very far back in history.
Technology, specifically the internet, has drastically effected on the way companies do
business; clients can check their bank accounts online at any time, companies can pay
employees through direct deposit, operations in the securities industry have become
almost completely automated, and insurers can look up information such as a credit
report on potential subscribers more quickly. Computer technology is also used in many
other ways as these firms are dependent on computer generated models to help them
analyze markets and create investment strategies.
Future Outlook The financial services industry has been considerably shaken up by
deregulation, globalization, scandals, and other recent events including the market
collapse. The recent mortgage crisis in the United States, triggered by foreclosures, has
1
Michigan State University
2
Investopedia.com

resulted in the near collapse of the entire market and potentially a complete overhaul of
the industry from a political standpoint, with increased regulation and government-owned
companies a possibility for the future. There are just too many factors at play to
determine how the industry will recover from the collapse right now.
2. Primary versus Secondary Markets:
 Primary markets are securities markets in which newly issued securities are
offered for sale to buyers.
 Secondary markets are securities markets in which existing securities that have
previously been issued are resold. The initial issuer raises funds only through the
primary market.
3. Debt versus Equity Markets:
 Debt instruments are particular types of securities that require the borrower to
pay the lender certain fixed dollar amounts at regularly scheduled intervals until a
specified time (the maturity date) is reached, regardless of the success or failure
of any investment projects for which the borrowed funds are used.
 In contrast, equity is a security that confers on the holder an ownership interest in
the issuer. There are two general categories of equities: "preferred stock" and
"common stock."

4. Money versus Capital Markets:
 The money market is the market for shorter-term securities, generally those
with one year or less remaining to the maturity. Examples: Treasury bills;
negotiable bank certificates of deposit (CDs); commercial paper, Federal
funds etc.
 The capital market is the market for longer-term securities, generally those with
more than one year to maturity. Examples: corporate stocks, residential mortgages,
government securities (marketable long-term), state and local government bonds,
bank commercial loans, consumer loans etc.
5. Types of Financial Regulations:
Types of Financial Regulations Objectives
 Macro-economic
 To maintain control over
aggregate economic activity.
 To maintain internal and
external balance.
 Allocative
 To influence the allocation of
financial resources in favor of
priority activities.
 Structural
 To control the possible abuse
monopoly power by dominant
firms.
 Prudential
 To preserve the safety and
soundness of individual
financial institutions and sustain
public confidence in systemic
stability.
 Organizational  To ensure smooth functioning

and integrity of financial
markets.
 Protective
 To provide protection to users of
financial services, especially
consumers and non-professional
investors.
6. The Financial Services Industry in the United States:
Financial markets in the United States are the largest and most liquid in the world. In
2014, finance and insurance represented 7.2 percent (or $1.26 trillion).
Financial services and products help facilitate and finance the export of U.S.
manufactured goods and agricultural products. In 2011, the United States exported $92.5
billion in financial services and had a $23.0 billion surplus in financial services and
insurance trade (excluding re-insurance, the financial services and insurance sectors had a
surplus of $59.5 billion.) The financial services and insurance sectors employed 5.99
million.
6.1. Industry Subsectors US Economy:
Banking as of the end of 2012, the U.S. banking system had $14.45 trillion in assets. It
supports the world’s largest economy with the greatest diversity in banking institutions
and concentration of private credit. In the second quarter of 2013, earnings grew by 23
percent to $42.3 billion, marking the 16 consecutive quarters of rising earnings.
Asset Management the U.S. asset management subsector is unrivaled in its depth and
diversity. U.S. asset managers are currently meeting the pension management needs of
over 55 percent of the global retirement market. Total U.S. pension assets were $18.9

trillion at the end of 2012. Moreover, if insurance assets and mutual funds are included,
U.S. asset managers held more than $39.6 trillion of long-term conventional assets under
management in 2012, or 45% of the global total for these funds. Conventional funds
were equivalent to 298 percent of U.S. GDP.
Insurance In 2012, the insurance industry’s net premiums written totaled approximately
$1.27 billion. According to the Swiss Reinsurance Company, premiums recorded by life
and health insurers accounted for 45 percent, and premiums by property and casualty
insurers accounted for 55 percent. Additionally, about one-third of all reinsurance sold
worldwide is bought by U.S. firms.
Venture Capital the United States created the venture capital industry and maintains the
oldest and most dominant position worldwide. In 2012, venture capital-backed companies
employed more than 12 million people and generated nearly $3 trillion in revenue.
Respectively, these figures accounted for 11 percent of private sector employment and
annually VC-backed companies have generated revenue equal to 21 percent of U.S. GDP.
7. State of the Economy and Financial Sector in Pakistan:
The growth rate of GDP is extensively utilized measure of performance of any economy.
According to this measure, Pakistan’s economy has recorded an average growth rate of
over 5 percent during 1972-2010 periods. Overall this growth rate is not much
disappointing; however the last four decades were marked with different growth
episodes. The decade of the 1970s started in Pakistan not only with a separation of the
Eastern Wing of the country, but with the nationalization of various segments of the
economy under the nationalization policy followed by Bhutto Government. Against an

average growth rate of 6.8 percent during the1960s, the growth rate decelerated to almost
5 percent during the 1970s period.
Inflation rate also showed signs of stability from 2000-2003 as it moved from an average
of almost 10 percent in 1990-2000 to 3.15 percent, 3.29 percent and 2.91 percent during
0
1
2
3
4
5
6
7
8
9
10
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Growth rate of real GDP (%)
Growth rate of real GDP
(%)
0
5
10
15
20
25
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Inflation rate (%)
Inflation rate (%)

2001, 2002 and 2003. However, 2003 onward, it started to move on an upward trajectory
and it reached to as high as 20.29 percent, 13.65 percent and 13.88 percent in year
2008, 2009 and 2010 respectively. In contrast to this, the growth rate during these last
three years of the 2000s decade started to slow down. The intensification of inflationary
pressures is on account of both domestic and external factors. Excessive government
borrowing from the Central Bank to finance huge budget deficits, power breakdown
restricting the supply side along with the sharp spike in global commodity prices is major
contributors in fuelling the inflation rate in Pakistan after the mid 2000s.
The tax-to-GDP ratio showed no signs of improvement over the 2000-2010 period and
on average it even decreased from almost 13 percent of GDP during the 1990s
period to 10 percent of GDP during 2000-2010. The low tax to GDP ratio in spite of
introducing tax reforms highlighted the importance of correcting the structural
impediments in the economy, along with real implementation of reforms without any
political pressure/consideration. Besides this, a match between sources of growth in
the economy and tax revenue base needs to be considered.
0
2
4
6
8
10
12
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Tax Revenue (as % of GDP)
Tax Revenue (as % of GDP)

8. Current Structure of the Financial Sector:
Different measures under the financial liberalization regime adopted in Pakistan
and subsequent developments thereafter have altered the financial structure of the
economy. Today, the financial sector of Pakistan consists of different entities involved in
the transactions of financial instruments in money, capital and foreign exchange market.
These functions in the financial market are performed by a number of financial
institutions like specialized banks, commercial banks, development finance institutions,
national savings schemes, insurance companies, stock exchanges etc.
The banking sector in Pakistan has been transformed significantly since the introduction
of reforms in 1990s. From a state domination of the banking industry in the early 1990s,
the private sector participation has increased remarkably during the recent years. Today
the banking sector in Pakistan includes 36 commercial banks (including 4 public sectors
commercial banks, 25 local private banks, and 7 foreign banks) and 4 specialized banks.
Branches (No)
0
2000
4000
6000
8000
1748
7498
55 546
Branches (No)
Branches (No)

Advances (as %)
0
20
40
60
80
22.3
72.6
1.8 3.3
Advances (as %)
Advances (as %)
Assets (as %)
0
20
40
60
80
18.7
76.7
2.8
1.8
Assets (as %)
Assets (as %)

The competition in the banking sector in Pakistan has no doubt increased on account of
privatization in the banking industry. However, if we look at the market share
(concentration) of few large banks in Pakistan it’s still high. The share of the top five
banks has reduced to 50.8 percent in 2009 as compared to 63.2 percent in year 2000. The
share of top 10 banks has only marginally reduced from 76.5 percent to 73 percent. While
the share of the smallest five banks despite of increasing has declined further to 0.5
percent in 2010 from 0.7 percent in 2000.
9. Summary:
Financial reforms have successfully transformed the financial structure of the economy.
The state ownership of the banking industry in terms of assets, advances,
investment etc has decreased significantly from its 1990 level. Today private banks
own more than 70 percent of the banking assets. Financial sector work under the
mechanisms of market based monetary policy, market determined interest and
exchange rates, full current account convertibility with partial capital account
0
10
20
30
40
50
60
70
80
90
14.6
81.7
2.8
0.9
Investment (as %)
Investment (as %)

liberalization, and development in securities market. The foreign exchange regime is
more liberalized and working under floating exchange rate regime since July 2000.
Exchange rate is not tampered by SBP and work under market based price mechanism.
Current account is fully convertible while capital account is partially liberalized.
10.Empirical evidence from research work “The Impact of
Inflation on Financial Sector Performance” by Boyd et al
(2001):
A growing theoretical literature describes methods whereby even predictable increases in
the rate of inflation interfere with the ability of the financial sector to allocate resources
effectively.
In some cases, once the rate of inflation exceeds the critical level, perfect insight into the
forces that produces change do not allow an economy to meet to a steady state displaying
either an active financial system or a high level of real activity.
Thus, the theoretical literature on credit market frictions, finance, and growth delivers
empirically testable implications regarding the consequences of higher long-run or
permanent rates of inflation. Methodologically, we also examine potential non-linearities
in the data and we consider alternative theories regarding the relationship between
inflation and financial sector performance.
Quantitative technique that has been used here is dynamic-panel GMM estimator to
control for potential biases induced by country-specific effects and endogeneity. Data for
the research are two datasets based on longitudinal availability. The “banking data set”

focuses on measures of banking development. It covers the period 1960–1995. There is a
maximum of 97 countries, though most of the analysis focuses on 65 countries.
10.1. Data and Summary Statistics:
The “banking data set” focuses on measures of banking development. It covers the
period 1960–1995. There is a maximum of 97 countries, though most of the analysis
focuses on 65 countries.
LIQUID LIABILITIES is the ratio of liquid liabilities of the financial sector (currency
plus demand and interest-bearing liabilities of banks and non-bank financial
intermediaries) to GDP.
An alternative measure is BANK ASSETS, which is the ratio of total assets of “deposit
money banks” (commercial banks and other deposit taking banks) divided by GDP.
For inflation we computed the measure of average inflation from the CPI data. Finally,
our preferred financial intermediary development measure is PRIVATE CREDIT. This
measure equals banking institution credits to the private sector as a percent of GDP.
10.2. Results:
 At low-to-moderate rates of inflation, there is a strong negative association between
inflation and (a) lending by the financial sector to the private sector, (b) the quantity
of bank assets, and (c) the volume of liabilities issued by banks.
 At low-to-moderate rates of inflation, there is a pronounced inverse relationship
between inflation and measures of stock market liquidity and trading volume. There
is a robust positive relationship between inflation and stock return volatility.

 The data strongly support the presence of a nonlinear relationship between inflation
and financial sector performance, perhaps driven by threshold rates of inflation. As
inflation rises, financial sector performance falls, but the marginal impact of
additional inflation on the financial sector also diminishes rapidly. Thus, for
Example, we find that once the average rate of inflation exceeds 15 percent per year,
financial sector performance drops sharply, but at the same time, the partial
correlation between inflation and measures of intermediary or equity market activity
essentially disappears.
 The data support the presence of a nonlinear relationship between inflation and
nominal equity returns. Again, this non-linearity may be driven by threshold rates of
inflation. For example, we find that for economies with average rates of inflation
below 15 percent per year, nominal equity returns are approximately uncorrelated
with inflation. For economies with inflation rates above this threshold, however,
inflation and nominal equity returns vary essentially one-for-one.
Based on pure cross-sectional regressions, this paper’s findings are consistent with
models that emphasize that predictable inflation can exacerbate informational frictions
and impede financial sector performance with negative repercussions for economic
activity. Since past work demonstrates that the functioning of banks and equity markets
can materially affect long-run economic growth, this paper focuses only on the
relationship between sustained inflation and the functioning of banks and equity markets.
Thus, its main contribution is to elucidate the impact of sustained inflation rates on
financial sector performance. To assess the confidence with which we can make this
causal statement, we augment our cross-sectional investigation with an alternative
estimation strategy.

10.3. Conclusion:
The evidence indicates that there is a significant, and economically important, negative
relationship between inflation and financial development. This correlation emerges
essentially independently of the time period considered, the empirical procedure
employed, or the set of variables that appear in the conditioning information set. It is also
not sensitive to inclusion or exclusion of countries that have experienced extraordinarily
high rates of inflation. Finally, the negative relationship between inflation and financial
sector performance emerges even after controlling for simultaneity and omitted variable
biases. Thus, a preponderance of evidence indicates that sustained inflation and financial
sector performance display a strongly negative association. Moreover, we have found that
the empirical relationship between inflation and financial sector activity is highly
nonlinear.

11.References:
Vittas, D., 1992, “Introduction and Overview” in D. Vittas (eds.) Financial Regulations:
Changing the Rule of the Game, Washington, and D.C: EDI Development
Studies, World Bank.
Boyd, J. H., Levine, R., & Smith, B. D. (2001). The impact of inflation on financial
sector performance. Journal of monetary Economics, 47(2), 221-248.
SBP Handbook (2010), SBP Research Bulletins (various issues), and IFS (2010)
SBP “Economic Overview 2010"
Statistics and Data ware House Department SBP (2012)
http://globaledge.msu.edu/industries/financial-services/background
http://www2.deloitte.com/us/en/pages/outlooks/industry-outlooks.html
http://www.kpmg.com/us/en/industry/pages/default.aspx
http://www.pwc.com/gx/en/industries.html
http://www.ey.com/US/en/Industries
http://www.investopedia.com/terms/f/financial_sector.asp
http://www2.econ.iastate.edu/tesfatsi/finintro.htm

Financial Sector Performance and Conceptual Framework

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Viewers also liked

Viewers also liked (20)

Similar to Financial Sector Performance and Conceptual Framework

Similar to Financial Sector Performance and Conceptual Framework (20)

Financial Sector Performance and Conceptual Framework