Following the principles of the
Game theory, knowingly or unknowingly, investors seek definite and safe returns when the
financial markets are turbulent. This is exactly what has been observed during the
recent economic recession and financial crisis faced by the world economy,
including the European banking sector.
Typically, investors opt for assets yielding higher returns even if such
investment implies greater risk, provided that the growth prospects for
the economy are positive. However, in the recent times, when the financial
sector slowdown was led by the default on part of the debtors and failure of the
financial risk management practices as well as inability to reduce the costs, investors
in the financial markets became doubly conscious. Financial institutions
like private banks, around the world, including the major players in the
European markets felt a significant impact of this behavior. It is also certain that the
recovery of these banks will primarily depend on how they react to the ensuing
changes in customer behavior.
Traditionally, banks are known to accept deposits and create credit on
the basis of these deposits. While deposits (liabilities) are at a cost (interest
paid on deposits and administrative charges), credit (assets) brings in
revenue (interest earned on loans). For many decades, banks were quite
conservative in their operations, which resulted in lower profitability.
However, with the expansion of the financial markets, increase in competition and
emergence of various financial instruments, bank became bolder. They gradually
offered higher returns to attract more and more deposits and attempted to
provide credit for even high risk-low return economic activities. Banks also
ventured into structured products such as insurance and customized mutual
and hedge funds to optimize their risk-return balance and increase their
profitability.
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