PORTER FIVE FORCES MODEL ON BANKING INDUSTRY

Submitted by;
FAISAL REHMAN
PBA 02103007
M.Phil

Submitted to;
DR RIZWAN AHMAD

The University of Lahore

BRIEF HISTORY

The word “Bank” is of a European origin and is derived from the Italian word “BANCO”, which
means a table or a counter, in the opinion of the eminent scholars of banking, the reason why this
word was given to the banking business was the then prevailing traditions of Lombardian money
changers. It was at the end of the middle ages when the trade and the business of exchange of
money was flourishing in the Northern cities of Italy and the money changers used the wooden
benches to carryout their business in the markets of buying and selling of various currencies.
That was the just start of modern banking.

Moreover, it is a difficult task to establish the first starting point of the banking business, but one
thing is clear that the money as means of exchange at the beginning of organized agriculture.

The Greeks, in the early stages, had almost the similar banking activities to that of Babylonians.
At that time the sacred temples were the most popular place of banking operations but did not
monopolize it totally. The financial activities like accepting deposits giving loans, checking and
exchanging money and making remittances between different cities, to minimize the risk of
carrying money were being carried out during 4th Century B.C.

Banking in the modern sense of the word can be traced to medieval and early Renaissance Italy,
to the rich cities in the north like Florence, Venice and Genoa. The Bardi and Peruzzi families
dominated banking in 14th century Florence, establishing branches in many other parts of
Europe. The oldest Italian bank was the Medici bank, set up by Giovanni Medici in 1397 which
do not exist now.

Banca Monte dei Paschi di Siena S.p.A. (MPS) is the oldest

surviving bank in the world. Founded in 1472 by the
Magistrate of the city state of Siena, Italy, it consists of
approximately 3 thousand branches, 33 thousand employees
and 4.5 million customers in Italy
Scheduled Banks and NBFIs (excluding Modaraba and Leasing companies) are both regulated
by the State Bank of Pakistan’s Prudential Regulations, albeit through different wings, and are
subject to different SBP regulatory requirements such as capital and liquidity reserve
requirements. Prior to partition in 1947, banking in Pakistan was dominated by branches of
British banks. The State Bank of Pakistan, the central bank, was formed after partition in 1948.

STATE BANK OF PAKISTAN REQUIRMENTS

The business opening requirement are all imposed and checked by state bank of Pakistan, and
violation to them cause heavy penalties. The current target by SBP on paid up capital was 19
billion till 31-12-2011.

State bank ensure the 35% of total of liabilities and assets must be retained by SBP in form of
cash back. SBP also ensure with high liquidity ratio of bank with good return on assets.

Porter has identified five competitive forces that shape every industry and every market. These
forces determine the strength of competition and hence the profitability and attractiveness of an
industry. The objective of corporate strategy should be to modify these competitive forces in a
way that improves the position of the organization. Porters model supports analysis of the
driving forces in an industry. Based on the information derived from the Five Forces Analysis,
management can decide how to influence or to exploit particular characteristics of their industry.
     The Five Competitive Forces

The Five Competitive Forces are typically described as follows:

1         
Bargaining
Power of
Suppliers

The term
'suppliers'
comprises
all
sources
for inputs
that are
needed in order to provide goods or services. Supplier bargaining power is likely to be high
when:

     The market is dominated by a few large suppliers rather than a fragmented source of
supply,
       There are no substitutes for the particular input,
       The suppliers customers are fragmented, so their bargaining power is low,
       The switching costs from one supplier to another are high,
       There is the possibility of the supplier integrating forwards in order to obtain higher prices
and margins.
       The buying industry has a higher profitability than the supplying industry,
       Forward integration provides economies of scale for the supplier,
       The buying industry hinders the supplying industry in their development (e.g. reluctance
to accept new releases of products),
       The buying industry has low barriers to entry.
 

In such situations, the buying industry often faces a high pressure on margins from their
suppliers. The relationship to powerful suppliers can potentially reduce strategic options for the
organization.In Pakistan banking industry the threat of supplier is low due to high capital
investment. There are no of companies which investment in banking sector. In banking industry
the suppliers of capital might not pose a big threat, but the threat of suppliers luring away human
capital does. If a talented individual is working in a smaller regional bank, there is the chance
that person will be enticed away by bigger banks, investment firms, etc. We will start our bank
with huge capital.

2          Bargaining Power of Customers

Similarly, the bargaining power of customers determines how much customers can impose
pressure on margins and volumes.

Customers bargaining power is likely to be high when

       They buy large volumes, there is a concentration of buyers,

       The supplying industry comprises a large number of small operators
       The supplying industry operates with high fixed costs,
       The product is undifferentiated and can be replaces by substitutes,
       Switching to an alternative product is relatively simple and is not related to high costs,
       Customers have low margins and are price-sensitive,
       Customers could produce the product themselves,
       The product is not of strategical importance for the customer,
       The customer knows about the production costs of the product
       There is the possibility for the customer integrating backwards.
 The individual doesn't pose much of a threat to the banking industry, but one major factor
affecting the power of buyers is relatively high switching costs. If a person has a mortgage, car
loan, credit card, checking account and mutual funds with one particular bank, it can be
extremely tough for that person to switch to another bank. In an attempt to attract in customers,
banks try to lower the price of switching, but many people would still rather stick with their
current bank. On the other hand, large corporate clients have banks wrapped around their little
fingers. Financial institutions by offering better exchange rates, more services, and exposure to
foreign capital markets - work extremely hard to get high-margin corporate clients. We will most
dependent on the customer demand. We offer product which our customer wants and which they
can afford by their market segment.

3          Threat of New Entrants

New entrants in the banking industry are very rare as we have seen the worse circumstance of
multination banks. The only change which is not rare is merger and acquisition of local bank.
When such event occur , new scheme and attractive products are introduce by those banks, we
have planned to cope with such situation by continuously changing our product line with
innovation.The other thing which is threat for our organization is services comparison, old bank
or multinational bank having huge experiences usually took lead by providing better services.
The competition in an industry will be the higher; the easier it is for other companies to enter this
industry. In such a situation, new entrants could change major determinants of the market
environment (e.g. market shares, prices, customer loyalty) at any time. There is always a latent
pressure for reaction and adjustment for existing players in this industry. The threat of new
entries will depend on the extent to which there are barriers to entry. These are typically

       Economies of scale (minimum size requirements for profitable operations),

       High initial investments and fixed costs,
       Cost advantages of existing players due to experience curve effects of operation with fully
depreciated assets,
       Brand loyalty of customers
       Protected intellectual property like patents, licenses etc,
       Scarcity of important resources, e.g. qualified expert staff
       Distribution channels are controlled by existing players,
       Existing players have close customer relations, e.g. from long-term service contracts,
       High switching costs for customers
       Legislation and government action
  The average person can't come along and start up a bank, but there are services, such as internet
bill payment, on which entrepreneurs can capitalize. Banks are fearful of being squeezed out of
the payments business, because it is a good source of fee-based revenue. Another trend that
poses a threat is companies offering other financial services. What would it take for an insurance
company to start offering mortgage and loan services? Not much. Also, when analyzing a
regional bank, remember that the possibility of a mega bank entering into the market poses a real
threat.

4       Threat of Substitutes

A threat from substitutes exists if there are alternative products with lower prices of better
performance parameters for the same purpose. They could potentially attract a significant
proportion of market volume and hence reduce the potential sales volume for existing players.
This category also relates to complementary products.

Similarly to the threat of new entrants, the treat of substitutes is determined by factors like

       Brand loyalty of customers,

       Close customer relationships,
       Switching costs for customers,
       The relative price for performance of substitutes,
       Current trends

As you can probably imagine, there are plenty of substitutes in the banking industry. Banks offer
a suite of services over and above taking deposits and lending money, but whether it is insurance,
mutual funds or fixed income securities, chances are there is a non-banking financial services
company that can offer similar services. On the lending side of the business, banks are seeing
competition rise from unconventional companies. Sony, General Motors and Microsoft  all offer
preferred financing to customers who buy big ticket items. If car companies are offering 0%
financing, why would anyone want to get a car loan from the bank and pay 5-10% interest?
Subsitute goods and service affect on this industry if the intrest rete is low against banking.

5          Competitive Rivalry between Existing Players

This force describes the intensity of competition between existing players (companies) in an
industry. High competitive pressure results in pressure on prices, margins, and hence, on
profitability for every single company in the industry.

Competition between existing players is likely to be high when

       There are many players of about the same size,

       Players have similar strategies
       There is not much differentiation between players and their products, hence, there is much
competition
       Low market growth rates (growth of a particular company is possible only at the expense
of a competitor),
       Barriers for exit are high (e.g. expensive and highly specialized equipment).
 

The banking industry is highly competitive. The financial services industry has been around for
hundreds of years and just about everyone who needs banking services already has them.
Because of this, banks must attempt to lure clients away from competitor banks. They do this by
offering lower financing, preferred rates and investment services. The banking sector is in a race
to see who can offer both the best and fastest services, but this also causes banks to experience a
lower ROA. They then have an incentive to take on high-risk projects. In the long run, we're
likely to see more consolidation in the banking industry. Larger banks would prefer to take over
or merge with another bank rather than spend the money to market and advertise to people.
PRODUCT & SERVICES

The central bank (SBP) showed some leniency for Islamic banks of state. This is the opportunity
for the newly reformed banks before grabbing the market shares get some benefits which are
offered by sate bank. In view of above we will introduce few Islamic products.

1) Islamic loan against some fix asset mortgage in light of Islamic Financing.
2) Other Cash loan with who value will be adjusted against price of Gold or Inflation
indexes.
3) Islamic Munafa Scheme which do not have fix return, such deposit will be reinvested in
profit generating projects, and return will be paid as in Islamic munafa Scheme.

Other buyers for product is targeted to gain maximum returns and hence to increase the liquidity
of bank. Our Conventional saving accounts will be giving 4% less than KIBOR. This saving
account is different than other Products of bank. This return will increase the amount of deposit.

We will also introduce cash finance scheme for small entrepreneur they can avail running
finance loan facility for their general purpose.