Chapter 1-2-3-4 An Overview of the Changing Financial- Services Sector Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

Chapter 1-2-3-4An Overview of the Changing Financial-Services Sector

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

McGraw-Hill/IrwinBank Management and Financial Services, 7/e

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The Different Kinds of Financial Service Firms Calling Themselves Banks• Commercial Banks• Savings Banks• Cooperative Banks• Mortgage Banks• Community Banks• Money Center Banks• Investment Banks• Merchant Banks• International Banks• Wholesale Banks• Retail Banks

• Limited Purpose Banks• Bankers’ Banks• Minority Banks• National Banks• State Banks• Insured Banks• Member Banks• Affiliated Banks• Virtual Banks• Fringe Banks• Universal Banks

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The Financial Service Competitors of Banks

• Savings Associations• Credit Unions• Money Market Funds• Mutual Funds (Investment Companies)• Hedge Funds• Security Brokers and Dealers• Investment Banks• Finance Companies• Financial Holding Companies• Life and Property-Casualty Insurance Companies

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Quick Quiz

•What is a bank? How does a bank differ from most other financial-service providers?

•Under current U.S. federal law what must a corporation do to qualify and be regulated as a commercial bank?

•What is happening to banking’s share of the financial marketplace and why?

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Traditional Services Offered By Banks

•Carrying Out Currency Exchange•Discounting Commercial Notes and Making

Business Loans•Offering Savings Deposits•Safekeeping of Valuables•Supporting Government Activities with

Credit•Offering Checking Accounts•Offering Trust Services

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More Recent Services Offered by Banks

•Granting Consumer Loans•Providing Financial Advice•Managing Cash•Offering Equipment Leasing•Making Venture Capital Loans•Selling Insurance Policies•Selling Retirement Plans

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Offering Security Brokerage and Investment Banking Services

•Underwriting Securities•Offering Mutual Funds and Annuities•Offering Merchant Banking Services•Offering Risk Management and Hedging

Services

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Trends Affecting Banks and Other Financial Service Firms Today

•Service Proliferation•Rising Competition•Government Deregulation• Increased Interest Rate Sensitivity•Technological Change and Automation•Consolidation and Geographic Expansion•E-Banking and E-Commerce•Convergence•Globalization

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Quick Quiz

•Why do banks and other financial intermediaries exist in modern society, according to the theory of finance?

•How have banking and the financial services market changed in recent years?

•What powerful forces are shaping financial markets and institutions today? Which of these forces do you think will continue into the future?

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Reasons for the Regulation of Banks

• Protection of the Safety of the Public’s Savings

•Control of the Supply of Money and Credit•Ensure Equal Opportunity and Fairness in

Access to Credit• Promote Public Confidence in the Financial

System•Avoid Concentration of Power•Support of Government Activities•Help for Special Segments of the Economy

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Principal Regulatory Agencies Under the Dual Banking System

•Federal Reserve System•Comptroller of the Currency•Federal Deposit Insurance Corporation•Department of Justice•Securities and Exchange Commission•State Banking Boards or Commissions

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Goals and Functions of Bank Regulations

• Laws Limiting Bank Lending and Risk• Laws Restricting and Expanding Services

Banks and Other Depository Institutions Can Offer

• Laws Prohibiting Discrimination in Offering Services

• Laws Mandating Increased Information Transparency and More Accurate Financial Reporting

• Laws Regulating Branch Banking• Laws Assisting Federal Agencies in Dealing

with Failing Depository Institutions

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Unresolved Regulatory Issues

•Does the regulatory safety net set up to protect small depositors encourage financial firms to take on added risk?

•Does deregulation exacerbate the too-big-to-fail problem?

•As firms become larger and more complex, can the government regulators effectively oversee what these firms are doing? Can we simplify the current regulatory structure?

•What is functional regulation and will it really work under the current structure?

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Quick Quiz•Briefly describe various types of banking

regulations and try to match each major law with the main goals/functions of regulations (use slide 5).

•How have bank failures influenced recent legislation?

•What changes in regulation did the GLBA bring about?

•What regulatory issues remain to be resolved?

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The Federal Reserve System

•Fundamental Functions Conduct monetary policy Provide and maintain the payments system Supervise and regulate banking operations

•Organization▫Board of Governors▫Federal Open Market Committee▫12 Federal Reserve Banks▫Member Banks

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The Federal Reserve Policy Tools▫Monetary Policy Tools

Open Market Operations (OMO)

Discount Rate

Reserve Requirements

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European Central Bank

•Central Policy is to Maintain Price Stability

•Structure is Similar to the Federal Reserve

•Eleven Member Nations

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Assets Held by U.S. FDIC-Insured Commercial Banks, 2007

87%

11%

2%

Assets Held By Large BanksAssets Held By Medium BanksAssets Held By Small Banks

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Number of U.S. FDIC-insured Commercial Banks, 2007

43%

50%

7%

Small ≤ $100 Million

Medium $100 Million -$1 Billion

Large > $1 Billion

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Community Banks or Retail Banks

• ‘Typical’ Size is $300 Million•Organizational Chart is Not Complicated•Significantly Affected by Health of Local

Economy•Generally Know their Customers Well –

Relationship Lending

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Money Center or Wholesale Banks

•Generally Multi-Billion Dollar Company•Organizational Chart is Much More

Complex•Serve Many Different Markets with Many

Different Services so are Better Diversified Geographically and by Product

•Able to Raise Large Amounts of Capital at Relatively Low Costs

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Quick Quiz

•What are the general trends in the size distribution and asset concentration of American banking industry?

•Describe differences between a typical organizational structure of smaller community bank and a larger money-center bank.

•What trends are affecting the way banks and their competitors are organized today?

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Unit Banks

•Offer All Services From One Office•One of the Oldest Kinds of Banks•New Banks are Generally Unit Banks Until

Can Grow and Attract More Resources

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Branch Banks

•Offer Full Range of Services from Several Locations

•Senior Management at the Home Office•Each Branch has its Own Management

Team with Limited Decision Making Ability•Some Functions are Highly Centralized,

While Others are Decentralized

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Reasons for Growth of Branching

•Exodus of Population to Suburban Communities

• Increased Bank Failures in Recent Years•Business Growth

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What Trend in Branch Banking Has Been Prominent in the U.S. in Recent Years?

Year # of Bank Main Offices

# of Branch Offices

Total of U.S. Bank Offices

Ave # of Branches/U.S. Bank

1934 14,146 2,985 17,131 0.21

1970 13,511 21,810 35,321 1.61

1982 14,451 39,784 54,235 1.75

2007 7,241 77,947 85,188 10.76

From Table 3-2; Source: FDIC

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Electronic Branches

• Internet Banking Services•Automated Teller Machines (ATMs)•Point of Sale (POS) Terminals

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Virtual Banks

•Provide their Services Exclusively Through the Web

•Can Generate Cost Savings Over Traditional Brick-and-Mortar Banks

•Have Not Yet Demonstrated They Can Be Consistently Profitable

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Bank Holding Companies (BHC)

•A Corporation Chartered for the Purpose of Holding the Stock of One or More Banks

•Control of a bank is Assumed When 25% or More of the Stock is Owned

•Must Get Approval from Federal Reserve Board to Control a Bank

•One-Bank Holding Companies vs. Multibank Holding Companies

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Board of Directors

Parent Company

Bank Subsidiary Nonbank Subsidiaries

Bank Branches

Each subsidiary has apresident and line officers

The bottom four levels have the same organizational form as the independent bank.

Single Bank Holding Company

Multibank Holding Company

Board of Directors

Parent Company

Bank Subsidiary Nonbank Subsidiaries Bank Subsidiary

Bank Branches Bank Branches

Organizational Structure of a BHC

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Nonbank Businesses of BHCs• Finance Companies•Mortgage Companies•Data Processing

Companies• Factoring Companies• Security Brokerage

Firms• Financial Advising• Credit Insurance

Underwriters•Merchant Banking

• Investment Banking Firms

• Trust Companies• Credit Card

Companies• Leasing Companies• Insurance Companies

and Agencies• Real Estate Services• Savings Associations

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Reasons for the Growth of BHCs

•Geographic Diversification•Product Line Diversification•Tax Sheltering•Double Leveraging•Source of Strength•A Way Around Regulatory Restrictions

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Bank

Holding

Company

SecuritiesSubsidiaries Insurance

Subsidiary

Thrift HoldingCompany

Real

Estate

Subsidiary

Financial HoldingCompany

Subsidiariesand ServiceCompanies

Thrift CompanyNonbankSubsidiaries

Commercial Banking Company

Sample Organizational Structure of FHC

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Bank Subsidiaries

•Bank Controls One or More Subsidiaries•Subsidiaries Offer Other Services Such as

Insurance and Security Brokerage Services•Profits and Losses of Each Subsidiary

Impact Parent Bank

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The Changing Organization and Structure

•Rise in Branching, BHCs, and FHCs•Consolidation among Banks and Nonbanks•Convergence •Other forces of change:▫Deregulation/Reregulation▫Financial Innovation▫Securitization▫Globalization▫Advances in Technology

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Do Bigger Firms Operate at Lower Cost?•Economies of Scale•Exhibit 3-10

•Economies of Scope•Banking and Financial Firm Goals and

Motivations•Expense-Preference Behavior•Agency Theory•Corporate Governance

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Structure and Organization of Banks in Asia•China – Large Dominating Government

Sector, Although Private Banks are Expanding

• Japan – Dominated by the Big Four Financial Group with More than One Hundred Smaller Domestic Banks and Seventy Foreign Banks

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Quick Quiz•Which type of corporations chartered for the

simple purpose of holding the stock of at least one bank?

•What were the reasons for the Riegle Neal Act of1994?

•When the banking industry moves toward larger but fewer organizations, what is it known as?

•What relationship appears to exist between bank size, efficiency, and operating costs per unit of service produced and delivered?

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Expected Rate of Return

The Decision of Whether to Establish a Branch Office is a Capital Budgeting Decision. The Present Value of the Net Future Cash Flows Should Be Larger Than the Initial Outlay

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Geographic Diversification

Reducing a Bank’s Overall Risk Exposure to its Total Return By Establishing Service Facilities in Different Market Areas Whose Individual Returns are Not Highly Correlated with the Returns from a Bank’s Existing Market Locations

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Branch Regulation

•FDIC Improvement Act Requires Institutions to Notify Their Regulatory Agency and Customers 90 Days Prior to Closing a Branch

•Community Reinvestment Act of 1977 Requires Them to Make an Effort to Reach All Segments of Their Communities With Services

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The Changing Role of Financial-Service Branch Offices•Sales Oriented•Offer Cross-Selling Opportunities•In-Store Branching▫Offices Set Up Inside Retail Stores or in

Malls in Order to Reduce Construction Costs

▫What are the Advantages and Disadvantages? (next slide)

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Advantages and Disadvantages of In-Store Branches

Advantages• Lest Costly to Build and

Maintain• Experience More Traffic

Flow than Normal Branches

• Deposit Volume May be Heavier Because they Attract Store’s Own Deposits

Disadvantages• May Need More

Aggressive Marketing• Many Financial

Transactions Need More Financial Expertise

• No Drive-in Window

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Limited-Service Facilities

•Point of Sale (POS)Terminals•Automated Teller Machines (ATMs)•Home and Office Banking•Telephone Banking and Call Centers• Internet-Banking

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ATMs

• Less Costly to Set Up ($70,000-$80,000) and Operate (about 36% compared to a human teller per transaction)

•But Less Effective at Cross Selling, Less Personal Service, and More Vulnerable to Criminal Activity

•Decision to Install ATM: The Bank Examines the Present Value of the Stream of Cash Savings from the New ATM Machine

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Common Call Center Services

•Current Balance of Loan, Deposit or Investment Account

•Verification of Transactions Through Customer’s Account

•Amount of Interest Paid or Earned on Accounts

•How to Move Funds Among Accounts• Fax or Downloadable Copies of Applications

and Account Statements•Details on Different Services Currently

Available

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Services Provided Through the Internet•Verify Real-Time Account Balance•Move Funds Instantly Among Accounts•Confirm Deposits Made, Checks Cleared

and Online Transactions Have Taken Place•View and Print Images of Checks•Place Orders for New Checks•Submit Applications for Loans and Credit

Cards•Carry Out On-Line Bill Paying

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The Internet and Customer Safety

•Especially Vulnerable to Fraud and Identity Theft

•Authentication Factors▫Something a Customer Knows▫Something a Customer Has▫Something a Customer is

•Move to Multi-Factor Authentication From Single Factor Authentication Today

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Quick Quiz•What factors are often considered in

evaluating possible sites for new branch offices?

•What laws and regulations affect the creation of new bank and thrift branches and the closing of existing branches?

•What services do ATMs provide? What are the main advantages and disadvantages of ATMs as a service provider? Should ATMs carry fees?

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