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Discuss about the Economic of Banking and Finance for Transaction Cost Theory.

The following report discusses about the role of financial market, financial intermediary, and the financial securities in the financial system of the company. Credit lending is an accounting term either it decrease the assets or increase the liability. Thus, lender checks the revenue and the financial position of the borrower. Moreover, this report discusses the role of asymmetric information before and after the transaction made. There are many problem and issue with the DBS bank at the time of transaction, which is resolve with the help different theories like transaction cost theory, delegated monitoring theory and economic scale theory.

This report also discusses the key business activities of the Noble group and role of financial market and financial securities in the financial system of the company.

With the increase in economic activities in any country, it becomes necessary that strong and healthy financial system is in place to support such activities. Kunt et al. (2011) and may other scholars validate the financial systems and their components hold importance in facilitating smooth conduction of business activities for economic development. Adrian and Shin (2010) propose that financial intermediaries can play an important role in ensuring that all rules, regulations and diligence is followed while conducting financial transactions of the business especially those that are heavily engaged in money and capital markets. This will involve taking appropriate measure before and after lending, reducing information asymmetry and act as an agent during any conflict.

Financial intermediary hold a very important role in the flow of money in the financial world. A financial intermediary is an institution or individual that acts as a middle man between two parties at the time of financial transaction, such as commercial bank, investment bank, and mutual funds.  A financial intermediary is typically a bank that provides the funds to the user of funds (Dilley, 2012). Financial intermediary can offer different types of benefit to the average customer such as- safety, liquidity and economies of scale. Bank is a financial intermediary that provides a dazzling variety of financial service.

Role of Financial Intermediary

Being a Financial intermediary, DBS bank plays several roles as a financial intermediary. It repackages the deposits of the investor into loans, which are provided to the firms. Through the implementation of this, small deposits of the individual consolidated in the form of large amount to firms. Bank diversifies the loans among several borrowers, because it has so much money. In this way, bank increase its ability to identify the individual defaulted loans by reducing the risk of loan defaulter (Golin and Delhaise, 2013). As a financial intermediary bank provides information to the market participants, by which they make the decision about the deposits. Further, financial intermediary is providing external finance to the firms that are new and it required funds to establish their business.

Financial Intermediary and Its Role

Credit Lending

Credit landing is the amount of money that lent to an individual or any firm for their personal, family, household, and business purpose. This loan is monitored by the government regulatory agencies for their compliance. Credit lending is contractual agreement in which borrower receive some amount and agrees to repay it to the lender at some date in future with the interest (Property Metrics, 2016). Credit lending is an accounting term that either decrease asset or increase liability of the business.

Cautions in Credit Lending

Being a financial intermediary, DBS bank cautions some factor, while lending money to its customers. In the present market context, lender is checked the financial condition and market condition of the borrower for successfully complete the proposed project at time. Apart from this, Lender checks the business revenue and annual income of the customer before lending money to borrower. Through the implementation of this, bank should find out the credit worthiness position of the customer (Ansaloni, 2012). In addition to caution in credit lending, bank should check the background position of the customer under which bank check the liquidity risk, defaulter risk, and interest risk in context of customer.

Asymmetric Information

Asymmetric information is a very important concept that is widely used in the financial world. It refers that one party has more or better information than the other party when making transactions. Improper information is the reason of an imbalance of power.

Role of Asymmetric Information

Lack of information causes for the economic imbalances that result in adverse selection and moral hazards problems occurs.  Under the adverse selection, sellers have more information about the product. If the quality cannot be measured, the buyer is willing to pay high price that reflects the average quality (Greebbaum et al., 2015). In the Moral hazard, action is taken by the borrower. This problem occurs after the transaction is made. For this reason, it reduces the probability that loan will repaid.

Measures before Loan Granted

Due to the asymmetric information, DBS bank has to follow some measures before granting loan to the borrower such as- Liquidity, data sharing, profitability, safely and security, purpose of the borrow amount, sources of repayment and social responsibility. Credit referencing is a very important tool by which bank can avoid the problem of Asymmetric information (Schwalbe, 2012). Under this, bank must rank to the firms on the basis of their repayment ability.

Credit Lending

Being a financial intermediary, DBS bank has to measure some information after the transaction is made. Bank has to check regularly the financial updates of the borrower. In addition to this, there are many factors which are measured by the lender after the loan granted such as- market value of the collateral security, business plan of the borrower, financial details and market position of the business (Onyiriuba, 2015).

Problems / Issues in Lending

There are many problems/ issues occur with the DBS bank such as transaction cost, selection issue and many other issues, while it lending money to its borrower. That can be defined with some theories, which are covered as below:

Transaction costs reduction theory

Transaction cost refers to the cost of transferring between the lender and Borrower. This theory followed by DBS bank to reduce the loss after issued the latter of demand to the company. Through the implementation of this theory, Bank reduces the cost of recovering the loan amount (Pilbeam, 2010). On the other hand, It also refer to reduce some risk, which always involve in the financial transaction such as- search cost, Arrangement fees, professional advise fee, and covenant compliance cost.

Informational Economies of Scale theory

Due to implementation of this theory, DBS bank faced the problem related to the adverse selection and moral hazard. To overcome this issue, bank should develop the expertise in information that enables them to select a good risk. So bank has to take care of this type of issue in future. At the same time, bank has to measure the information of borrower’s transactions held with bank (THE TREASURY, 2016). In addition to this, bank should used different types of tool reduce the risk after issued letter of credit to the company such as: monitoring, government regulation to increase information, financial intermediary active in the equity market, and debts contact.

This theory is useful by DBS bank for resolving the problems related to incentive between the borrower and lender after issued the letter of demand to company. On the other hand, this theory provides the best contract to the bank so that legal protection is strong for the bank. At the same time, delegated monitoring is helpful to reduce the transaction cost and deriving the technology in the bank (CESP, 2016). Benefit of delegated monitoring is raised because of skills and the reduction of duplication work.

 Financial system is the process and procedure used by the organization to exercise the financial control and accountability. A financial system is covered the financial transactions and exchange the money between lender and borrower. The Singapore financial system is highly developed and well regulated and it offers a wide range of non banking service. The financial system of Singapore has the analytical and operation capabilities to do effectively (Monetary Authority of Singapore, 2016). There are many component of Singapore financial system, which describe as below-

Cautions in Credit Lending

Financial market is a broad term that describes a market place, where buyer and seller equally participate in the trade of assets like equity, bond, currencies, and derivatives through the financial intermediaries. Financial market increased the overall production and efficiency of the economy. Financial market of the Singapore is unique in which government played a major role for creating an eco-system that nurtured quality growth (Burton el al., 2015). Financial market of Singapore was able to leverage on the competitive strength at the time of financial crises.

Financial intermediary is refers to a middle-men, who is involved in buying and selling of the financial securities such as Banks, Investment Banks, pension funds, and insurance companies. Bank is the most important financial intermediaries in the Singapore financial system, who works as middle men in the transaction of financial securities. They work as credit analyst, which has the ability to assess the creditworthiness of the firms, who wish to borrow funds (Valdez and Molyneux, 2010). Being a financially intermediaries, Singapore banks has so much money to lend and they can easily diversify loans between the borrowers. Singapore banks may facilitate the flow of funds to the business firms as intermediaries to the investor, who are willing to purchase the securities.

A financial instrument presents ownership position in a public traded corporation. Financial market can be divided in many types such as- money market instrument, capital market instrument and hybrid instruments. The financial market of the Singapore covers the capital market instrument, it generally consists the long term financial instrument like shares and bonds. The debts security refers the money, which can borrow and it must be repaid with a particular interest rate at maturity date (Parameswaran, 2011). Equity refers the ownership held by shareholders such as stocks. Generally, a financial security is like a money maker instrument by which companies and other enterprises can raise new capital.

There are many products and services offered by banking system of Singapore such as insurance, derivatives, and credit and loans. It can played different roles in the Singapore financial system that helps the Noble Group to achieve its business objectives and goals. Nature of financial product and services is described as below:

Insurance

Insurance service is provided by Singapore banks to the Noble Group for the financial protection and to cover the risk against a range of events such as- damage of property, financial crisis, and loss. There are many types of insurance, which offers by banking system like Life insurance, property insurance, and casualty insurance. In the present context, it is possible for business to insured against the risk but not necessary to cover all the risk. In that case, Bank provides a service of financial adviser by which it helps the noble group in the selection of insurance policy (Annual report, 2016). Insurance policies are helpful for the company at the time of risk. With the help of different insurance, it can easily overcome the losses occurred in the company and achieve its objectives and goals.

Asymmetric Information

Credit and Loans

Credit and loans is very important facilities provided by the banking system to the noble group. There are many types of credit facilities offer by the banks such as- loan for consumer durables, loan against deposits, loan against shares, and loan against LIC polices. Through the implementation of these facilities bank revolving the credit facilities and decide the amount, which the company want to withdraw. Apart from this, credit facility helps to manage the cost easily and it can help to take advantage of the opportunities (Noble Group, 2016). Banking system of the Singapore provides the facilities of financial advisor to the Noble Group by which helps to frame a plan for the use of amount to achieve the business objectives.

Derivatives

Singapore baking system provided derivatives facilities to the Noble Group, help to achieve the goals and objective of the company. Banks provides the derivatives facility related to hedging and commodity contract. With the implementation of this, company hedges their interest rate risk and increase the yield of the company. Bank is playing a role of intermediary, which maintains the relationship between the client and company (DBS Corporate Banking, 2016). It can help to reduce the FX exposure and increase the return on the currency investment of the company.

Brief Background Information

Noble Group Limited is a modern global commodities firm. It was founded in 1986 by Richard Samuel Elman and William James Randall. Noble group buy commodities and transform them into customized and consumable product through which they meet the requirement of the customer. Noble Group manages portfolio of supply chain across the range of industrial and energy products. The core strategy of noble group is to be best company in the whole world at the moving of physical commodity from producer to the consumer.

Key business activities of Noble Group

Figure-1 Key business activities of Noble Group

(Source Annual report, 2016)

Noble Group sources the physical commodities and transforms that into the customized product that meets the requirement of the consumers. It provides the logistic business service to the external as well as internal customers, providing the ocean transport. In additional to this, the logistic business provides the long term freight solution and the guidance to the external as well as internal customers of the company. Noble Group Limited provides the financial services that covering capital & origination and customer financing solutions (Noble Group, 2016). This service generates business by unblocking new opportunities within the existing customers and providing the financial coverage the relationships with banks, institutional and other global pool of capital.

Measures before Loan Granted

Noble group applies the cash flow hedging accounting for some financial derivatives that are used to hedge the risk of the foreign currency fluctuations. The value of the company is enhancing the solutions transforming commodities by helping the customer in the hedging service that reduce the price risk. It is supported by the flexible structure of the company and trade finance solutions that added the dimension of service for the business.

Financial system of the Noble Group can be access effectively through the different financial market, financial intermediary and financial instruments. It can be facilitated the business activities of the Noble Group.

Financial Market

Financial system of the Noble Group can be access through the capital market. Under the key business activities, price risk management and hedging facilities of the company is cover under the capital market. Capital market is used for the long term asset with the maturity date is more than one year. In additional to this, noble group includes the shares, bond, and derivatives to facilities the business activities of the company. It is executed forward in the freight derivatives market to hedges its physical freight exposures (Jackson, 2010). Further to this, it also engaged in the derivatives trading of crude oil. It mainly involve in the commodity contract such as physical commodity contract and cash commodity contract, which include commodity future, options swaps and forward freight agreements.

Financial Intermediaries

Banks act as a financial intermediary for the Noble Group to facilities its business activities effectively.  This company partnered with the Australian bank that facilities the medium term prepayment facilities, which secured by the iron ore off take to noble group. An Australian bank provides the guaranteed payment stream with the minimum risk to this group that helps in the growth of business. Being a financial intermediary, Banks facilities comprise different type of credit facilities to the company for their financial arrangements. It works as a credit analyst through which they have the ability to access the credit worthiness of the company.

Banks helps the company in the better management of its trade finance operations and improves the efficiency and effectiveness on global basis (Levinson, 2014). Further to this, banks play an essential role for accessing the financial system of the Noble group through managing the risk to achieve the positive rate of return. Bank plays an important role in the corporate governance of the company so that it can be maintain the legal and ethical environment and promote the interest of share holders.

Measures after Loan Granted

Financial Instruments

Financial instruments play a role for the future benefit of the company. Noble Group is dealing in the long term financial instrument such as derivatives (future, option or swap), bonds, and shares. Financial instruments can be used to hedge the financial risk and price risk of the company. Shares are issued by the company to raised the money from the investor that is helpful maintain the business activities (Baker and Filbeck, 2014). These instruments provides a link between the investor and the company and it also play a crustal role for the arranging of invest funds of the company.

Conclusion

Financial system can be access through the financial market, financial intermediary, and financial securities. This report is concluded that the financial intermediary should check the credit worthiness of the client at the time of credit lending. Moreover, it was found that lender and the borrower have to disclose all the information at the time of transaction. There are many problems arise at the time transaction, which are to be overcome with the implication of many theory that reduce the transactional cost, provides help in the selection of best risk.

Further to this, it can be concluded that many product and service provides by bank is helpful in achieving the key business activities of the Noble Group.

Reference

Adrian, T. and Shin, H.S. (2010) Financial intermediaries and monetary economics. FRB of New York Staff Report, (398). [online]. Available at: https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.189.809&rep=rep1&type=pdf (Accessed: 05/09/2016).

Annual report (2016) Our Business Management. [online]. Available at: https://www.thisisnoble.com/images/investors/financialInformation/annualReport/ar2015.pdf (Accessed: 3/09/2016).

Ansaloni, P.G. (2012) The Role of Asymmetric Information in Environmental Policy Settings. London: University of London.

Baker, K.H., and Filbeck, G. (2014) Investment Risk Management. UK: Oxford University Press.

Burton, M., Nesiba, F.R., and Brown, B. (2015) An Introduction to Financial Markets and Institutions. UK: Routledge.

CESP (2016) Financial Intermediation and Delegated Monitoring. [online]. Available at: https://www.cfsp.org/publications/papers/financial-intermediation-and-delegated-monitoring#.V8lPTVt97Dc (Accessed: 2/09/2016).

DBS Corporate Banking (2016) FX Derivatives. [online]. Available at: https://www.dbs.com.sg/corporate/treasury/derivatives/fx-derivatives (Accessed: 3/09/2016).

Demirguc-Kunt, A., Feyen, E. and Levine, R. (2011) Optimal Financial Structures and Development: The evolving importance of banks and markets. World Bank, pp. 1-38. [online]. Available at: https://www.researchgate.net/profile/Ross_Levine/publication/265202090_Optimal_Financial_Structures_and_Development_The_evolving_importance_of_banks_and_markets/links/5523c95b0cf2b351d9c336aa.pdf (Accessed: 05/09/2016).

Dilley, K.D. (2012) Essentials of Banking. US: John Wiley & Sons.

Golin, J., and Delhaise, P. (2013) the Bank Credit Analysis Handbook: A Guide for Analysts, Bankers and Investors. US: John Wiley & Sons.

Greebbaum, I.S., Thakor, V.A., and Boot, A. (2015) Contemporary Financial Intermediation. US: Academic Press.

Jackson, K.J. (2010) Financial Market Supervision. US: DIANE Publishing.

Levinson, M. (2014) The Economist Guide To Financial Markets. UK: Profile Books.

Monetary Authority of Singapore (2016) Singapore financial centre. [online]. Available at: https://www.mas.gov.sg/ (Accessed: 3/09/2016).

Noble Group (2016) about us. [online]. Available at: https://www.thisisnoble.com/#aboutus (Accessed: 5/09/2016).

Noble Group (2016) Financial information. [online]. Available at: https://www.thisisnoble.com/#aboutus (Accessed: 3/09/2016).

Onyiriuba, L. (2015) Emerging Market Bank Lending and Credit Risk Control: Evolving Strategies to Mitigate Credit Risk Optimize Lending Portfolios, and Check Delinquent Loans. US: Academic Press.

Parameswaran, S. (2011)  Fundamentals of Financial Instruments: An Introduction to Stocks, Bonds, Foreign Exchange, and Derivatives. US: John Wiley & Sons.

Pilbeam, K. (2010) Finance and Financial Markets. UK: Palgrave Macmillan.

Property Metrics (2016) the Commercial Credit Approval Process Explained. [online]. Available at: https://www.propertymetrics.com/blog/2013/06/12/credit-approval-process/ (Accessed: 2/09/2016).

Schwalbe, U. (2012) the Core of Economies with Asymmetric Information. Germany: Springer Science & Business Media.

THE TREASURY (2016) Current theories of financial intermediation. [online]. Available at: https://www.treasury.govt.nz/publications/research-policy/wp/2003/03-19/04.htm (Accessed: 2/09/2016).

Valdez, S., And Molyneux, P. (2010) An Introduction to Global Financial Markets. UK: Palgrave Macmillan.

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