Literature Review on Systemic Risk on Bank of America & Case Study With EPS - Finance Assignment Help

Assignment Task

Introduction to Systemic risk on Bank of America 
Systemic risk is described as the risk of a financial system collapse through a crisis in which capital providers lose faith in capital users Rimkus (2016). A significant systemic risk attribute is the threatthat it may migrate to healthy organisations from unhealthy organisations through a medium like leverage. Due to this reason it can be difficult to identify and quantify the systemic risk. When banking system is incorporated with too much of systemic risk, the collapse of the entire network to society's detriment may occur. The financial crisis of 2008, which started in the United States and spread to 
other parts of the world, is a recent example. The crisis shows that there are interconnections between financial institutions. A case study of systemic risk will allow this theory to be better understood. By exploring the Bank of America case during the period of 2006-2017, this paper explains the relation between Systemic risk and financial organisation. Bank of America is the best example, as it is a bank that has been able to navigate the financial crisis and thrive even with Countrywide and Merrill Lynch acquisitions.

Literature Review
The key literature on this case study consists of three topics: financial institutions, systemic risk, and financial crisis. As per Schwarz (2008), financial institutions are main providers of capital and their failure may restrict availability of capital and raise its cost. The straight forward impacts of systemic 
failure are an increase in the cost of equity or a decline in the amount of capital accessible. Although banks and finance have endured a great deal of government and general public attention, their role in society is precious.Due to massive globalisation occurring in the last few years, all the financial institution across the world are highly connected and interdependent on each other. So, some fluctuations occurred in any organisation or industry therefore have large-scale consequences for many other organisations within the same industry. 

These fluctuations include factors relating to technology, Socio-economic, ecological aspects.Much research has been conducted on the subject of systemic risk and shadow banking, particularly after experiencing the financial crisis. One problem linked tosystemic risk is how it deals with the financial network as a whole. The banking sector framework and the inter-bank liabilities hinder diversification. Diversification is a one of the most prevalent risk-hedging strategy. This can be demonstrated by the relationship between systemic risk and the economic network.A heavier integrated banking system increases the system's capacity to survive the bank's insolvency(Freixas,2000). 

The losses of a bank in distress are split among more investors in a more integrated financial system (Allen and Gale ,2000). Consequently, it reduces the impact of adverse shocks on all institutions in the industry. The argument suggests that the higher interconnectedness could be misleading and could be a cause of systemic failure. With the Increase in number of bank’scounterparties the possibility for occurrence of a systemic collapse increases. (Viver-Lirimont,2006).The last area of interest is the financial crisis itself. The crisis directly influenced the transformation that has taken place in the post financial crisis banking environment.

A few decades ago, the regulations focused primarily on an individual bank's soundness. Regulators have now begun to focus on the steadiness of the whole banking sector (Borio, 2006). This is often referred to as the perspective of macroprudential. One good example of this is the implementation of International Monetary Fund and the efforts of the World Bank with the ultimate goal of promotinthe sustainability of economic systems in its Associate nations (Huang, Zhou, and Zhu (2009)).

Bank of America Detailed Case Study
Lehman brothers holding INC was the 4th biggest American financial organisation with 25 thousand employees worldwide. In 2008, a bankruptcy was filed by the organisation which was the largest at that time with assets valued at $ 639 billion and debt of $619 billion. Financial institutions and banks did not react well to this bankruptcy as the Dow Jones Industrial Average (DJIA) worsened by more than 450 points by the end trading session on that particular day. Primarily large banks and primary dealers are affected the most with reduction in stock values by −2.90% and −6.00%, respectively. One of such banks is Bank of America (BOA). So, Lehman Brothers bankruptcy is regarded as Systemic risk which caused downfall of US financial market and eventually paved a way to global recession.

EPS

Now let us discuss all the systemic risks in detail by taking the case study of Bank of America in the period of 2006-2017. Nonperforming loans (NPL): A loan is termed as a non-performing loan (NPL), if a borrower does not repay the loan on the principal or interest within 3 months. In order to make profits and issue new loans, performing loans are required for the banks Das (2017). NPLs hampers the capacity of a bank to issue new loans and obstructs making profits. As NPLs rises in a bank, systemic risk also rises. As Lehman Brothers failed to repay the loan, it adversely affected the NPL performance of BOA.In 2006, the NPLs of Bank of America as a percentage of total value are very less at 0.13% and in 2007, they expanded to 0.34%. The highest value of NPLs as a percentage of total value is found during the financial crisis i.e. with an exponential growth of 223% year by year from 2007 to 2008.

Earnings and Profitability

Earnings and Profitability These comprises of Several key ratios such as Return on Assets (ROA) and Equity (ROE), as well as Earnings per Share (EPS) etc, which are crucial to both internal and external stakeholders. Return on Assets (ROA) It is defined as the best parameter to measure return on investment. It shows the profit returns for the percentage of dollars invested. The bigger it is, the bigger are the profits for the company Gallo (2017). As ROA reduces, systemic risk increases and is calculated as mentioned below: Return on Assets = (Net Income / Total Assets)In 2006, Bank of America’s ROA was 1.50%. From 2007, it started deteriorating at a rate of 38.57% year by year and becomes severely low on 2010 with a negativevalue of 0.09%. To some extent, this is due to acquiring Countrywide in 2008, and Merrill Lynch in 2009. These would have been cheap buys if they didn’t require legal issues and fines to payoff. Because of these costs, Bank of Americaexperienced a negative net income in 2010 while other banks were in the mode ofrecovery after the crisis. From 2012, ROA has become positive and gradually increased to 0.82% in 2017.

Return on Equity (ROE) 

Return on Equity (ROE) It is helpful to specify the percentage of a profit made for every dollar investment in the company by the stakeholders and used to compare organisations within the same field.The greater the ROE, the more productive the organisation in using of funds provided by shareholders, increasing profits and returning them to stakeholders. As ROE increases, systemic risk will decrease.Return on Equity = (Net Income / Shareholder Equity)As some parts of the stakeholder’s investment is given to Lehman Brothers as debt, which cannot be recovered due to bankruptcy the value of ROE decreases as it resulted in complete loss to the bank.In 2006, the value of ROE is 17.85% and in the crisis period the value went from 10.62% in 2007 to 2.47% in 2008. It went to a negative value of 0.97% in 2010. To some extent, this is because of extra expenses related to acquisitions. The ROE become 6.8% in the year 2017, still close to third the value in 2006.

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Project Manager Role

Project Manager Role A project manager is responsible for preparation and implementation of effective risk framework, which should contain processes to identify, analyse, monitor and control risks. In a banking project like this, a project manager has to work on the indicators of systemic risk and must their impact on the overall organisation.Non-Performing loans: According to Alvarez& Marsal’s six steps are involved in effectively managing NPL. These steps are to be followed to decrease the non-performing loans, thus decreasing the systemic risk.

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