31

Customers are Banks may provide Since a great Bank transfers

advised on the its customers with number of people funds from one
matter where they long period loans get loans, the party to another
should invest their like mortgages for banks may take (payer and
funds, on other ways buying a house risks from a certain receiver) with not
to get funding, on (usually the period number of relying on cash.
direct funds with the may be more than customers because
highest return. Also, 20 years) because the losses will be
experts ensure that of taking a huge covered by earning
the savings will earn number of small on other loans.
a good interest of deposits that are
rate. unlikely to be
withdrawn
Service helps to
simultaneously.
stimulate savings
flow and efficiently
use savings.

However, the modern banks do not only play the role of intermediary and issue
deposits, but also create money. Needless to say, they do not print banknotes but by
having deposit and loan transactions, banks expand the money supply. (Dilley 2008,
5.) In other words, McLeay, Radia and Thomas (2014) explain that whenever a loan
has been made, at the same time bank matches a deposit that leads to creating new
money. Important to mention that this activity may be done by commercial banks
and, obviously, this commercial bank created money cannot be considered the same
as money from central banks. The money by commercial banks are limited in supply
and may be used only in transactions among other banks. This created money are
not as effective as from central banks because when a customer comes to take away
their money from the bank, the bank needs central bank reserves – the cash. (Botos
2016).
 32
Commercial banks may be considered as companies because the balance sheet
reflects their financial position (Somashekar 2009, 10). Banks balance sheet consists
of assets and liabilities that allows the bank to have a stable financial condition as
well as to ensure monetary stability (Cross, Fisher and Weeken 2010, 34).
Somashekar (2009, 12) explains assets of banks as “what others owe the bank” and
banks’ liabilities as “what the bank owes others”.

2.4 Changing role of banks

Nowadays, the traditional role of banks as business units is changing and evolving,
because of the entry of new players, the introduction of new business models and
participation of innovative start-ups (PwC 2016b). The banking industry is being
redefined and banks are at the forefront of digital transformation, involving in a
highly competitive environment both internally, within the financial sector, and
externally, with FinTech companies, venture capital corporations and non-financial
players making more ambitious attempts to capture financial services’ market share.
Considering this tense competition, digitalization and FinTech anticipation is a key for
the survival and growth of current and future business models on the banking
market. (Kotarba 2017, 134.)

FinTech plays a vital role in the banking industry transformation and impacts the
entire ecosystem by redefining the mode of interactions (PwC 2016b). Accenture
(2014) sees openness, collaboration and investment as the most essential themes
that emerge for existing banking players, which are willing to benefit from the
improvement driven by new services and productivity. There are also two other
fundamental steps, which banks have to recognise to crate a competitive advantage
from digital disruption: successfully handling the issue of obsolete technologies and
talent management. (3.)

Open innovation is at the core of the digital revolution. For large organisations,
openness means the engagement with external technology solutions, knowledge
capital and resources during the first steps of an innovation process. It usually
involves opening up the organisation’s own intellectual property (IP), assets and
expertise to a third party, bringing outside innovators, which can help to generate
 33
new ideas, change organisational culture, identify and attract new skills, and discover
new areas for improvement. (ibid., 8)

Collaboration is also becoming a crucial element of FinTech era within the financial
services and technology industries. The importance of collaboration is confirmed by
the survey, which reveals that six out of ten respondents support the “Digitally
Reimagined” future scenario, successful alliances between different players benefit
the growth of the addressable market. Moreover, collaboration should go beyond
financial industry and established players should seek to collaborate more closely
with the companies in different industries and with different outlooks. In that way,
the traditional players will be able to maintain and grow value in these times of
change. Cross-industry collaboration is vital for future value generation as well.
Digital technologies flourish by enabling interesting products and services to be
created when combining the assets of two industries. Still, it remains to be the
biggest challenge for established players is to adapt their organisational culture’s
ability for partnerships with new innovators and start-ups. (ibid., 9)

The start-up innovation model has always included venture investing in its core.
However, nowadays established financial services firms are also taking this route to
try and generate innovation for their business. (ibid., 10.) Based on the above
discussion, the reader can study which technologies, highlighted in Figure 5, ensure
openness, collaboration and investment in banks.

Figure 5. Openness, Collaboration and Investment. (Compiled by the author.)

 34
2.5 Performance measurement
The selection of performance measurements is one of the most critical challenges for
organizations. Performance measurement systems play a vital role in the
improvement of strategic plans, the achievement of organizational targets
estimation and compensation. The final choice of performance measurement system
mostly depends on the perception of the most essential factors of successful
performance. Fitzgerald and colleagues (1991) argue that performance is a key factor
in ensuring the successful implementation of a company's strategy and proficiency in
pursuit of its goals, and in ensuring the success of a stage business organization in
both the short- and the long term. In the banking sector, the quality of
administration data, installation of modern technologies, the innovation of banking
products and services, competitive cost structure, risk management, extensive
information system, prominence of strategic planning and equity endowment are the
most critical determinants for productive and successful performance. (Ittner, &
Lacker 1998, 205-206; Zéman, Lukács, & Hajós 2013, 15.)

Performance measurement and accounting systems are used to understand past

behaviour, as well as for accurate decision-making regarding current issues and
planning and forecasting the future. Both the metrics design and the use of
performance measurement must be executed carefully to be beneficial. Since banks
are for-profit organizations, their performance measured mostly with financial
indicators. To enhance the internal processes, to conduct the decided strategy and to
achieve the mission and vision statement companies need to see a big picture and
have a complete understanding of the whole performance of the company. It is also
worth noting that in the modern world, with the technology development enabling a
collection of all sort of data, the quality and relevance of the performance metrics
play a more important role than the quantity of them. (Palosaari, Pakarinen,
Kostamo, & Takkunen, N.d.)

2.5.1 Financial performance measures

Financial ratio analysis is considered as a decent method to obtain the description of

a company’s overall financial condition. For the company’s management, the
financial ratio analysis is beneficial as an internal analysis in order to check the
 35
obtained financial achievement that it can be used for the forthcoming company
planning. (Husna, & Desiyanti 2016, 106.) Orajaka (2017, 717) generally argues that
the financial performance of a firm provides an insight into the asset utilization and
the company’s ability to generate revenue from its operations. In other words,
financial performance is a determination of the degree of the financial health of an
organization over a certain period of time.

Operating performance for a concrete time period is measured by profitability ratios.

Profitability ratios are used to determine an organization’s capability in gaining
profits.

Profitability

Positive profitability is one of the principal financial aims for the banks, as for all
other for-profit organizations. Meniccuci and Paolucci (2016, 87) define profitability
to be the one of key indicators in attracting investors because it shows the degree of
the bank’s management success and demonstrates the level of potential profitability
over years.

Gross Profit Margin (GPM)

The GPM ratio is an indicator of how a company’s productions are controlled, as

opposed to costs on distribution and costs on administration (Watson, & Head 2010,
49). The key factors affecting change in GPM percentage include volume of sales,
costs and prices because they constitute gross profit that is an indicator used in the
formula of GPM (Khan, & Jain 2008). According to Berk and DeMarzo (2013, 35) GPM
is calculated the following way:

𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
𝐺𝑃𝑀 =
𝑆𝑎𝑙𝑒𝑠

However, in accordance with Jagelavicius (2013, 8), a company may plan its GPM
because the price, various promotions, offers are planned by itself and the costs are
known.
 36
Net Profit Margin (NPM)

NPM is an efficiency indicator, which reveals the proficiency level of cost control
when revenue is generated from sales (Watson, & Head 2010, 48). A high NPM
allows a company to sustain and provide owners with sufficient return in case of
rising costs in production, fall in product or service demand or decline of price, (Khan,
& Jain 2008). To put it simply, the ratio shows the reflection of the profitability of the
company in the form of net sales percentage. Berk and DeMarzo (2013, 36) use the
following formula for ratio calculation:

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝑁𝑃𝑀 =
𝑆𝑎𝑙𝑒𝑠

Return on Assets (ROA)

ROA displays the overall profitability of total assets of a company (Khan, & Jain
2008). This metric is one of the most efficient tools of company’s performance
measurement, as it broadly and holistically assesses key indicators (Hagel, Brown,
Samoylova, Lui, Damani, & Grames 2013, 7). ROA reflects the results of the decision-
making process as it increases only when it is used in value-bringing activities
meaning that any artificial improvement of net profit will not lead to considerable
changes because net profit is only a proportion of assets (ibid., 16). Khan and Jain
(2010) claim that ROA is calculated as follows:

𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥𝑒𝑠

𝑅𝑂𝐴 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Return on Equity (ROE)

ROE is used to measure earnings from past investments (Berk, & DeMarzo 2013, 42).
It is an important indicator for shareholders as it makes the profitability of their
investments more transparent (Hagel et al., 16). Similarly, the ratio reflects a
company’s ability to find profitable opportunities to invest in (Berk, & DeMarzo 2013,
42). According to Damodaran (2007), the formula for ROE calculation is the following:

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝑅𝑂𝐸 =
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
 37
Earnings per Share (EPS)

Earnings per share (hereafter EPS) is a market prospect ratio that is used to measure
the amount of net income earned per share of stock outstanding. To put it simply,
this is the amount of money each share of stock would receive if all of the profits
were allocated to the outstanding shares at the end of the year. The calculation of
EPS shows how profitable a company is on a shareholder basis. According to Earnings
Per Share Guide (2019), EPS is calculated by subtracting preferred dividends from
profit and dividing by the weighted average common shares outstanding:

𝑃𝑟𝑜𝑓𝑖𝑡 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠

𝐸𝑃𝑆 =
𝑊𝑒𝑖𝑔ℎ𝑡𝑒𝑑 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠ℎ𝑎𝑟𝑒𝑠

Asset Utilization Ratio

Asset utilization ratio determines the total revenue earned for every dollar of assets
a company owns (Asset utilization N.d.). It shows the loss in revenue per unit of
investment that may be attributable to inefficient use of assets in companies (Aydin,
& Kulali 2018). This ratio is frequently used to compare a company's efficiency over
time (Asset utilization N.d.). The Glossary (N.d.), which provides the ratio formulas
proposes the following way of Asset utilization ratio calculation:

𝑁𝑒𝑡 𝑟𝑒𝑣𝑒𝑛𝑢𝑒
𝐴𝑠𝑠𝑒𝑡 𝑢𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Liquidity

Liquidity ratios measure the ability of a company to reimburse its expenses and
meet short term obligations (Hundal 2019, 22). Liquidity ratios also play the role
of metrics of the company’s ability to meet cash needs appearing unexpectedly
and in a short period of time (Ho 2008,2).

Current ratio

The current ratio measures how liquid the company is, also demonstrating the
financial stability of the company (Mayilmurugan, & Krishnan 2013, 119). The ratio
reveals a company’s ability to pay its obligations on time or not (Berk, & DeMarzo
2013, 37). Usually, the higher ratio is preferred, although, it should not exceed the
proportion of 2:1. The ratio which exceeds 2:1 proportion discloses inefficient use of