Banking Industry: Study of Dollar Appreciation.

Name: Anmol Tushar Raykar

Institute: T. A. Pai Management Institute Manipal

Batch: 2018-2020, 1st year

Banking Industry: Study of Dollar Appreciation

Introduction:

When the value of one currency increases with respect to other foreign currencies, this phenomena is known as currency appreciation. The appreciating currency has now the ability to buy more of other currency than it previously did. Currency appreciation is good for any economy as it makes exports expensive, imports cheaper, lowers the aggregate demand which in turn lowers the demand-pull inflation and improves the living standards of the people. Forex market sets the currency price with respect to other currencies based on supply and demand in floating exchange rate system whereas government holds the entire power to determine the rate of exchange in case of fixed exchange rate.

Banking Industry overview:

An economy as a whole comprises of several major industries and business sectors. One among them is the Financial Service Industry. The main function of this sector is to raise funds by means of deposits or securities. They are into managing money and monetary assets. Banks are the subset of this sector and a major contributor to the growth of an economy.

Current Global and Indian Banking Industry:

According to McKinsey report titled “A brave new world for global banking: McKinsey global banking annual review 2016”, three major external factors are considered as possible threat to the profitability of the global banking industry. These factors are pressures of digitization, regulation and macroeconomic variables which weakens the economy. Regulatory costs have shot up the control costs in risk and compliance. Macroeconomic variables significantly impact the liquidity of the bank. Variables here refer to bank size, deposits, profitability, capital adequacy and inflation. Bank size and GDP tend to have negative impact whereas deposits, profitability, capital adequacy and inflation tend to have positive impact. Digitization is impacting banks as in developed economy tech companies, for example fintech startups are able to position themselves in between banks and customers capturing the vital customer relationship.

According to IBEF article on banking industry, asset under public sector bank stood up to $1577.04 billion in fiscal year 2018. With the government initiative to transfer funds or LPG many as 329.90 million accounts were opened in India.  Mudra scheme aimed at providing funding to non-corporate and non-finance micro and small scale enterprises has provided Rs 6 trillion (US$ 93.1 billion) loans to 120 million beneficiaries. [pic 1][pic 2]

Impact of Currency Appreciation on Banks:

U.S. dollar is the most important global currency also called as the reserve currency which makes about 64% of the foreign exchange reserves. In the forex market, 95% of trading takes place in U.S. dollar. Hence it is the most powerful currency.

Effect on bank stock returns: This is of immense importance to bankers, investors and policy makers as changes in stock returns due to currency appreciation (exchange rate variation) shows the banks’ exposure to risk.

Effect on bank profits: Increasing interest rates and flattening of yield curve reasons dollar appreciation which in turn affects the banks profit. Increasing interest rates attracts foreign direct investment which in turn increases the demand for home value currency.  

Effect on Commercial Banks: Banks hold assets and liabilities or any unhedged position known as “Open Position” in foreign denominated currencies and therefore are exposed to foreign exchange risk.

Effect of Interest Rate Risk: Inconsistency in the maturity patterns of the foreign assets and liabilities exposes a bank to Interest Rate Risk.

Dollar appreciation in Indian Banks:

According to the Moody’s Investors Service, Dollar appreciation or falling Indian Rupee has squeezed out the profitability of Indian banking systems. Indian Rupee being termed as the Asia’s worst performing currency having dipped record low due to crude oil prices, inflation and worst government finances, has given a tough time to banking sector as the funding cost of the latter is raised than earlier. Issue of liquidity is tight in the system and any further measures to strengthen the Rupee will deplete the foreign exchange reserves which will in turn squeeze the bank further. Banks main source of income is from the interest rate. In this case, RBI reasons out the increasing interest rates to match the interest rates in the U.S. According to an article in livemint, if RBI had not raised the interest rate, there would have been more cash sucked out of the country due to narrowing of the “yield differential” with the U.S. and this would have weighed further for the Indian Rupee.[pic 3][pic 4][pic 5][pic 6]

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