Introduction
Background of the Study
The world economy is currently facing numerous challenges, ones that imped growth and continuous economic development. In reality, there is no such thing as a straight line when it comes to economic development, accounting, and asset management. If history is to serve as a basis, economic development, both on a national and international scale, has been and so can be characterized by a cycle of boom and bust . Based on the metrics that both accountants and economics experts look into when analyzing a for-profit organization, a bank, or a macro economy, the risk of being trapped in a low growth environment is real.
In fact, companies and even central banks appear to be preparing for a low growth environment characterized by miniscule GDP growth numbers that are becoming less and less responsive to monetary policy (e.g. interest rate manipulations and quantitative easing, among others) . The notion that suggests that policy makers know what they are doing may not be applied here; in fact, it might be a mistake for the public to think so. This is because the policies that they are implementing today to stimulate their respective national economy and prevent so-called threats to growth have been largely untested. They are unconventional and unorthodox so to speak.
Research Aims and Objectives
The objective of this paper is to look into one of the variables that can contribute to the relatively small number of studies about the state of the country’s finances (United Kingdom). This topic lies on the boundary of two disciplines, i.e. a convergence, namely economics and accounting. Broadly, accounting is a discipline that focuses more on transactions of financial nature and how to report and analyze them; economics, on the other hand, are more concerned with the concepts of consumption, production, and methods by which wealth is and can be transferred or anything related to these three.
Specifically, this proposed study aims to examine the relationship between equity prices and the performance of the United Kingdom’s banking industry. Naturally, the equity prices that will be checked will be the ones that are posted in the UK’s bourses and other exchanges. The same principle of localization will be applied to the banking industry.
Scope and Limitations
The scope of this research encompasses two disciplines, accounting and economics. In terms of practice, this will be more on the accounting side as the methods that will be used in analyzing the equity prices and the performance of the banking industry are variables that are under the scope of accounting—i.e. reporting and analyzing financial information. This is not to say that professionals working in the field of economics are not allowed to make use of the same set of information; as a matter of fact they are and they do. This is where the convergence of these two fields happens so it is important that the outcomes of this research would be significant for both accountants and economists. The focus would be on equity prices, and the banking industry’s performance.
As for the limitations, it would be easier to delineate them by suggesting what this proposed study is not designed to accomplish. This proposed study is not aimed at evaluating individual equity prices and its impact on the banking industry; it is rather meant to discuss both the equity prices and the banking industry collectively or as a whole. Any form of discussion that focuses on individual bank’s performance or individual company’s equity price may be considered out of scope, except for instances wherein they are used as an example to justify a point. Another limitation is that this proposed study is not meant to prove the effects of low or high equity prices on other factors except for the banking industry or the effects of excellent or poor banking industry performance on other factors except for equity prices. As far as the process of paring the variables are concerned, it will be limited to equity prices and banking industry performance only.
Literature Review
This literature review focuses on the two main variables in the proposed study namely equity prices and the baking industry and its performance. The working hypothesis in the proposed study suggests that the collective performance of the banking industry is significantly affected by and is therefore correlated with equity prices. In order to understand why there is a possibility for this hypothesis to be true, one has to rely on previously published studies.
Review of Relevant Studies
Banks play an important role in a country’s financial system . The financial system, in turn, plays an equally important role in the growth and development of businesses and therefore the broader economy. Bank is often used as an umbrella term to describe any institution that is involved in the lending business, both to entities belonging to the private and public sectors. The reality, however, is that there are numerous types of banks. There are, for example, universal banks, commercial banks, and investment banks. A more accurate and appropriate umbrella term would be financial institutions. Financial institutions serve as an intermediary between the different entities in a financial system (i.e. all banks are financial institutions but not all financial institutions are banks).
They are entities where people and businesses can safely store their wealth in the form of savings, certificates, and even securities such as equity holdings. Banks pay interest depending on the prevailing market rates for their deposit products. Banks and other financial institutions have also an important role to play in the ever-growing cash and cashless payment systems. With the rise in popularity and importance of electronic commerce, this feature will only be more highlighted.
The most important role of bank’s from an accounting and economic perspective perhaps would be their role as a lender. Financial institutions generate revenue by issuing loans to people and businesses and charging a corresponding interest on the principal value borrowed from them . Without these financial institutions, it would be significantly harder for people and businesses to fulfill their financial obligations. For people, for example, it would be harder for them to acquire a home, an automobile, or make big ticket purchases without the ability to pay for them in a staggered manner, through bank loans that is. This means that they would have to pay for cash in order to make such purchases, something which is just impossible for most people.
Not too known is the fact that banks help maintain a stable level of liquidity in the economy . Accountants working in corporate finance, for example, would be able to know that some of the biggest businesses and enterprises rely on debt (issued by banks through loans) to finance their expansion projects; some even rely on them for their operational activities. Without the liquidity provided by banks, the balance sheets and cash flow statements of a good majority of the corporations and businesses operating in various industries today would look differently .
Sure, there are other alternative sources of liquidity (which is needed otherwise these businesses would be bankrupt) like the capital markets (e.g. equity markets). However, studies suggest that financial institutions like banks are simply the first creditor of choice. This is a result of the two features that only banks offer: ease of doing business and guarantee of safe and regulated transaction.
As for the ease of doing business, it is significantly easier to secure a bank loan than be approved for an initial public offering or even a follow on offering in the capital markets. For the safety of the transaction, those who get approved for loans in a large financial entity can have the guarantee that the transaction would be legal and regulated as most, if not all major banks, are supervised by the government through its central banks . In the case of the United Kingdom, its banks are supervised and regulated by the Bank of England.
Needless to say, companies and the entire financial system would collapse without the banks. This leads to the next question on how the performance of the banking industry affects equity prices. Equity prices can be measured individually and collectively. To measure an equity price individually, one simply have to look at its current price in the stock exchanges.
Collectively, equity indexes can be used. The equity market, as the studies reviewed in this paper would support, is heavily dependent on prevailing sentiments . A negative overall market sentiment would naturally lead to decline in equity prices whereas a positive one would push them upwards. According to a study published in the Journal of Financial Intermediation, as a result of the recent global financial crisis, accountants and business consultants have started to use metrics that describe the stability of the banking system in their business and other investment decisions.
Additionally, even before the financial crisis, numerous studies have pointed out that the banking industry’s performance can indeed be used as an indicator or even a predictor of the future trends in the prices of equities . In a study published in the Research in International Business and Finance, for example the researchers examined the correlation between the equity markets, banks, and economic growth using empirical evidence from the Middle Eastern and Northern African regions.
The results of the said study showed that banks are indeed central to economic growth; however, it is important to note that they discounted the importance of the equity markets in economic development . This does not necessary go against the hypothesis in the proposed study, however, because the variables are between equity prices and the banking industry and not economic development.
As for previously published studies that support the hypothesis that suggest that equity prices and banking industry performance are related, there are many. For example, in a study published in the BIS Quarterly Review, the researchers examined the different causes and impacts of banking crises. One of the information they uncovered was that systemic risks in the banking system, in the past, has led to significant downward movements in equity prices and may continue to do so in the future .
In another book published by the New York University Press entitled Restoring Financial Stability, the authors noted that a financially unstable environment could create a lot of ripples, one of which would almost certainly affect equity prices . Such findings are expected considering how important banks are to the financial health of corporations. When corporations are financially weak, that often leads to a whole lot of other problems.
Theoretical Framework
The theoretical framework for the proposed study will be composed of the following variables:
Independent Variable
Banking Industry Performance in the United Kingdom
Dependent Variable
Equity Prices in the United Kingdom
Summary
In summary, what is being suggested is that equity prices can be significantly affected by the performance and or stability of the banking industry, as supported by the numerous literary evidences presented in the review of related literatures.
Research Methodology and Design
Introduction
This section discusses the different research methodology and research design-related choices being proposed for the study.
Research Paradigm
The research paradigm is based on the following hypotheses. These hypotheses are supported by a significant number of evidences composed mainly of secondary sources.
H0: Banking industry performance affects, both positively and negatively, equity prices in the United Kingdom
H1: Banking industry performance does not affect, both positively and negatively, equity prices in the United Kingdom
Data
As one of the set requirements, only secondary sources, mainly previously published studies, would be used in the study. Additionally, these secondary sources must not be older than ten years. An important question to answer is how would the banking industry performance be measured and the same goes for equity prices. This is a significant question because there are different ways how to measure and describe these two variables and those differences may become a problem when creating the collecting of secondary sources to be analyzed.
Equity prices, because they will be observed as a collection and not individually, will best be measured and described using equity indices . Because this study will be set in the United Kingdom, equity indices dedicated for the UK shall be used. Some examples are the Financial Times Stock Exchange (FTSE) 100 Index, FTSE 100 Total Return Index, FTSE 100 Net of Tax Index, FTSE 200 Index, FTSE All-Share Index, among others . These will be the ideal choices because they capture the most important sectors of the UK’s economy. An alternative choice would be global and international indices but it may only be used as a last resort because although they also cover the UK, other non-UK equities may be included.
For banking performance and stability measures, the choices are more diverse. Performance metrics for banks are often based on ratios. Some examples are Return on Equity (ROE), Return on Assets (ROA), Debt to Equity, Current Ratio (Assets over Liabilities), and the Non-Performing Loans and Assets ratios, among others. Among the banking industry ratios that were mentioned, the Non-Performing Loans and Assets ratio would be the most preferred because a higher level of NPL indicates that there is an increasing number of defaults in the system.
Nonetheless, studies that use the other ratios mentioned may also be utilized as a reference. An alternative data would be the equity indexes that are tied to the financial and banking sector. These are basically equity indices only that they do not contain equities of companies that do not belong to the financial and banking sector. Studies that contain these data will be prioritized in the analysis and interpretation of secondary data.
Empirical Methodology
The proposed study on the relationship between equity prices and the banking industry’s performance in the United Kingdom was supposed to make use of an empirical set of methodologies. Empirical research are those that try to prove the research hypothesis and answer the research questions by using observation and other verifiable means rather than just pure logic and or theories.
The fact that the study is intended to use only secondary sources means that the readers or any future critic would be able to verify the source of the information being presented and interpreted. Suppose that the collection of studies used in the research was able to prove that the performance of the banking industry is indeed one of the variables that significantly affect equity prices in the chosen setting, the readers would easily be able to verify the origin and read the actual literatures used to justify such position.
Summary
In summary, a qualitative approach will be used in analyzing and interpreting the data. Basically, a collection of previously published studies that have the same theoretical framework (i.e. makes use of the same pair of independent and dependent variables) would be created. They also have to follow the selected time frame for or age of the secondary sources. They will then be analyzed and interpreted and after which, a consensus will be generated. This essentially makes this paper a case study or review because no quantitative data were used to analyze the relationship which was partly due to the secondary source-requirement that was imposed. Additionally, the author will be investigating an event or a phenomenon, which is one of the indications of a case study.
Expected Results
Additionally, when an initial literature search was conducted, it was observed that not a lot of studies were designed this way. There were numerous studies that were about equity price and banking industry performance relationships but only few of them specifically set its scope to the United Kingdom.
Conclusions
In conclusion, what is being proposed is a study that aims to examine the relationship between equity prices and banking industry performance; whereas the banking industry performance will be the independent variable and the equity prices will be the dependent variable. The review of related literatures generated a consensus that suggest that equity prices and banking industry performance may indeed be correlated but deeper and more targeted research is needed to verify this.
References
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