During the Global Financial Crisis, banks suffered losses on a scale not witnessed since the Great Depression, partly due to two major structural developments in the banking industry; deregulation combined with financial innovation. In the aftermath of the financial crisis, the regulatory response concentrated on the Basel III recommendations, raising core capital requirements for banking institutions; affecting their business model and funding patterns.
Consequently, these changes have had significant implications on how banks grant loans, how they react to monetary policy shocks, and on how they respond to the occurrence of external shocks. It is now accelerating the evidence of significant interactions between the bank lending channel and both monetary and global shocks. It is now to know more the banks having significant role in reshaping the bank lending channel. Effect of rapidly changing regulations: frequently changing of regulations, financial innovations, financial crisis and regulatory response affecting banks’ business models and funding patterns.
In view of these events it is natural to expect that these changes have had implications on how banks grant credit and react to monetary policy. It is also pertinent the external shocks have affected the banks’ business models and these changes have reshaped the bank lending channel of monetary policy. But how relevant has been the role of banks have played in all of the above. It is observing that local banks shifted towards alternative sources of income and funding. It is also evident of significant changes in the business model of banks on the onset of the events and changes in the way external shocks and monetary policy interact with the granting of loans and bank lending channel.
In particular, whether it is weakening of the bank lending channel and also a shift in the business model of banks towards alternative sources of income such as trading and fees and commission activities. Since most of the existent fiction observed the change in banks’ business models has focused on advanced economies, there is lack of evidence for emerging economies. It has been observing that banks’ business model and market funding patterns have changed, affecting the monetary policy transmission.
For instance, it has found significant changes in the functioning of the bank lending channel of monetary policy transmission as result of financial innovation and changes in banks’ business model. Most of the literature on emerging markets, in spite of having well documented evidence of the existence of a bank lending channel in different countries for a group of selected Asian countries,
In a group of Asian economies, how individual bank characteristics such as, ownership structure of the banking system, and financial conditions affect the bank lending channel of domestic monetary policy, it has found that the aggregate response to monetary policy may mask significant variation of responses at the individual banks level, i.e. that banks with different ownership structures react differently to monetary policy changes, they also report that monetary policy in host countries could become less effective, and that bank credit responds not only to changes in domestic monetary policy but also to external financial conditions.
It is also evident of the bank lending channel, with banks’ characteristics either weakening (the higher the bank capitalization and liquidity) or strengthening (the greater the size of banks) the bank lending channel, and with the banking sector development in terms of banking activitiesand capital market development also weakening the bank lending channel.
As far as concerned of Bangladesh, a more formal analysis of the relation between banks’ specific characteristics and lending over time, based on banks’ specific characteristics and macroeconomic data, and an econometric model needed to review holistically. For the emerging economy and market and so far not exception for Bangladesh, it is evident that there is a negative relationship between the level of loan-loss provisions and credit growth.
It is also evident that a positive relationship between both retail loans and short-term funding and credit growth. Those are consistent with the related collected works and consistent across different specifications. Regarding the interaction with monetary policy, a tightening only affects bank capital ratios contemporarily, without significant spillover effects over credit supply. With respect to global conditions, every time there is an increase in commodity prices, those banks with high shares of retail loans will slightly cut back lending with respect to the other banks with lower shares. Banks with relatively lower deposits and poor asset quality transmit commodity price changes to lending more aggressively. So it could behave countercyclically and maintain credit growth. The effect of banks resorting to fees and commissions as a source of income only arises which is in line with the particular mandate banks have.
Concluding thoughts and remarks on bank business models in a changing regulation and macroeconomic environment: It is therefore crucial that banks continue to adapt their business models because, to remain viable, they cannot rely on interest rate margins alone. Moreover, while interest rate normalization should seemingly be consistent with higher profitability and costs associated to credit risk and asset valuations should remain contained, banks’ sensitivity to the interest rate cycle may also differ depending on their size or business model.
And evidently, interest rates in themselves will not do much to support bank profitability unless overall economic activity remains strong. Three areas will be particularly important for banks as they adapt their business models. The first is digitalization- low profitability has long been a challenge for the banking sector, often rooted in structural vulnerabilities related to excess capacity and cost inefficiencies. Digital technologies could be a key lever to improve efficiency, offering banks new avenues for revenue growth. By taking advantage of digital innovation, banks can also keep pace with competitors like fintechs, big techs and other digital natives. Of course, investing in digitalization entails short-term costs for banks before they can reap the benefits of such technologies.
Today, investment in digital technologies also entails operational risks to banks. But it would say that, in this day and age, banks can’t afford not to follow this path. The second area concerns climate-related and environmental risks. The sharp rise in the price of fossil fuels resulting from the war has made the need for alternative sources of energy even more urgent. While the war may hinder the transition to net zero in the short term, the quest for energy independence may accelerate the green transition in the medium term. As a result, transition risks could materialise much sooner, requiring banks to step up their climate risk management efforts. Investment in green technologies is also likely to outstrip divestment from carbon-intensive ones. On the supervisory side, it should to ensure that banks are well placed to address the challenges posed by the green transition.
Supervisors and banks are on this journey together. And the banks have already taken some steps, but most need to be more ambitious if they are to meet our supervisory expectations on incorporating climate-related and environmental risks into their practices by next few years at the earliest possible. The third area is bank funding- in the debate on how to make banks’ business models more sustainable, the level of central bank policy rates and their broader impact on the financial bottom line of banks tend to capture the headlines. This means that the issue of banks’ funding costs, which are also sensitive to the interest rate cycle, often receives much less attention.
Exceptional measures i.e., targeted longer-term refinancing operations, to reduce on central bank funding, to ensure effective deposit funding to protect banks from the increase in funding costs associated. However, the expected reduction in banks’ funding is likely to return the size of banks’ balance sheets and the composition of their liquid assets to pre-pandemic levels.This may cause banks to rely more heavily on market-based funding than before, and this wholesale funding may also come at a higher price, thereby affecting interest margins. Banks should therefore take this into account when considering their funding plans in the period ahead, as well as its potential implications for business model viability.
Perhaps, the greatest risk facing banks during this new phase of the interest rate cycle is that of complacency, with banks erroneously believing that higher interest margins make the need to adapt their business models less pressing than before. Spurning the opportunities offered by digitalization and the green transition will only widen the gap between profitability leaders and laggards, and banks that do so may leave themselves vulnerable. Markets and investors will likely favour banks which develop viable business models that carefully take these factors into account. This should be reflected in the lower cost of funding available to them.
However, while the macroeconomic environment, policy and regulations have been changing rapidly in recent periods, the need for banks to continue to refocus their business models and with that remain attractive to investors has not. While reshaping the business model, banks should keep in mind that In the leading banks of tomorrow, the traditional model of vertical integration will co-exist with an endlessly configurable kaleidoscope of non-linear models. This will allow these banks to both defend their existing business and seize new opportunities. By unshackling themselves from the traditional value chain, they can grow and scale in new markets while lowering the cost of growth.
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