Chap 1
Content
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
C H A P T E R
O N E
An Overview of Banks and the FinancialServices Sector Key Topics in This Chapter • •
Powerful Forc Powerful Forces es Resh Reshapin aping g the the Indu Industry stry What Is Is a Ba Ban nk?
•
The Financi Financial al System System and Competing Competing Financia Financial-Ser l-Service vice Institu Institution tionss
•
Old and New Serv Services ices Offe Offered red to the the Publi Public c
•
Key Trend Trendss Affectin Affecting g All Finan Financial cial-Serv -Service ice Firms Firms
•
Appendi App endix: x: Career Career Opportu Opportuniti nities es in Financ Financial ial Service Servicess
1–1 Introduction There is an old joke attributed to comedian Bob Hope that says “a bank is a financial institution where you can borrow money only if you can prove you don’t need it.” Although many of a bank’s borrowing borrowing customers may get the impression that old joke is more truth than fiction, the real story is that banks today readily provide hundreds of different services to millions of people, businesses, and governments all over the world. And many of these financial services are vital to our personal well-being and the well-being of the communities and nations where we live. Banks are the principal source of credit (loanable funds) for millions of individuals and families and for many units of government (school districts, cities, counties, etc.). Moreover, for small businesses ranging from grocery stores to automobile dealers, banks are often the major source of credit to stock shelves with merchandise or to fill a dealer’ dealer’ss lot with new cars. When businesses and consumers must make payments for purchases of goods and services, more often than not they use bank-supplied checks, credit or debit cards, or electronic accounts accessible through a Web site. And when they need financial information and financial advice, it is the banker to whom they turn most frequently for advice and counsel. More than any other financial-service firm, banks have a reputation for public trust. Worldwide, banks grant more installment loans to consumers (individuals and families) than any other financial-service provider. provider. In most years, they are among the leading buyers of bonds and notes governments issue to finance public facilities, ranging from auditoriums and football stadiums to airports and highways. Banks are among the most important sources of short-term working capital for businesses and have become increasingly active 3
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
4 Part One Introduction to the Business of Banking and Financial-Services Management
in recent years in making long-term business loans to fund the purchase of new plant and equipment. The assets held by U.S. banks represent about one-fifth of the total assets and an even larger proportion of the earnings of all U.S.-based financial-service institutions. In other nations—for example, in Japan—banks hold half or more of all assets in the financial system. The difference is because in the United States, many important nonbank financial-service providers can and do compete to meet the needs of businesses, consumers, and governments.
Powerful Forces Are Reshaping Banking and Financial Services Today
Factoid What nation has the greatest number of commercial banks? Answer: The United States with about 7,800 commercial banks, followed by Germany with close to 2,500.
As we begin our study of this important industry, we should keep in mind the great forces reshaping the whole financial-services sector. sector. For example, most banks today are profitable— and, in fact, in several recent quarters they have posted record earnings—but their market share of the financial-services marketplace is falling significantly. As the former chairman of the Federal Deposit Insurance Corporation (FDIC) noted recently, in 1980 insured commercial banks and other depository financial institutions held more than 90 percent of Americans’ money—a share that had dropped to only about 45 percent as the 21st century opened. Over the same time span, banks’ and other depositories’ share of U.S. credit market liabilities fell from about 45 percent of the grand total to only about 25 percent (as reported by Powell [6]). The industry is also consolidating rapidly with substantially fewer, but much larger, banks and other financial firms. For example, the number of U.S. commercial banks fell from about 14,000 to fewer than 8,000 between 1980 and 2005. The number of separately incorporated commercial banks in the United States has now reached the lowest level in more than a century century,, and much the same pattern of industry consolidation appears around the globe in most financial-service industries. Moreover,, banking and the financial-servi Moreover financial-services ces industry are rapidly globalizing and experiencing intense competition in marketplace after marketplace around the planet, not just between banks, but also involving security dealers, insurance companies, credit unions, finance companies, and thousands of other financial-servi financial-service ce competitors. These financial heavyweights are all converging toward each other, offering parallel services and slugging it out for the public’s attention. If consolidation, globalization, convergence, and competition were are notalso enough to keepaan industry in turmoil,asbanking and its financial-service technological revolution neighbors undergoing the management of information and the production and distribution of financial services become increasingly electronic. For example, thanks to the Check 21 Act passed in the United States in 2004, even the familiar “paper check” is gradually being replaced with electronic images. People increasingly are managing their deposit accounts through the use of personal computers, cell phones, and debit cards, and there are virtual banks around the world that offer their services exclusively through the Internet. Clearly, if we are to understand banks and their financial-service competitors and see where they all are headed, we have our work cut out for us. But, then, you always wanted to tackle a big challenge, right?
1–2 What Is a Bank? As important as banks are to the economy as a whole and to the local communities they call home, there is still much confusion about what exactly a bank is. A bank can be defined in terms of (1) the economic functions it serves, (2) the services it offers its customers, or (3) the legal basis for its existence.
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 5
Certainly banks can be identified by the functions they perform in the economy. They are involved in transferring funds from savers to borrowers (financial intermediation) intermediation) and in paying for goods and services. Historically, banks have been recognized for the great range of financial services they offer—from checking accounts and savings plans to loans for businesses, consumers, and governments. However, bank service menus are expanding rapidly today to include investment banking (security underwriting), insurance protection, financial planning, advice for merging companies, the sale of risk-management services to businesses and consumers, and numerous other innovative services. Banks no longer limit their service offerings to traditional services but have increasingly become general financial-service providers. Unfortunately in our quest to identify what a bank is, we will soon discover that not only are the functions and services of banks changing within the global financial system, but their principal competitors are going through great changes as well. Indeed, many financialfinan cialservice institutions—including institutions—including leading security dealers, investment bankers, brokerage firms, credit unions, thrift institutions, mutual funds, and insurance companies—are trying to be as similar to banks as possible in the services they offer. Examples include Merrill Lynch, Dreyfus Corporation, and Prudential Insurance—all of which own banks or banklike firms. Moreover, if this were noteffort confusing enough, several industrial have stepped forward in recent decades in an to control a bank and offer loans,companies credit cards, savings plans, and other tra traditional banking services. Examples of these giant banking-market invaders include General Motors Acceptance Corporation (GMAC), GE Capital, and Ford Motor Credit, to name only a few. Even Wal-Mart, the world’s largest retailer, recently has explored the possibility of acquiring an industrial bank in Utah in an effort to expand its financial-service offerings! American Express and Target already control banklike institutions. Bankers have not taken this invasion of their turf lying down. They are demanding relief from traditional rules and lobbying for expanded authority to reach into new markets all around the globe. For example, with large U.S. banks lobbying heavily, the United States Congress passed the Financial Services Modernization Act of 1999 (known more popularly as the Gramm-Leach-Bliley or GLB Act after its Congressional sponsors), allowing U.S. banks to enter the securities and insurance industries and permitting nonbank financial holding companies to acquire and control banking firms. To add to the prevailing uncertainty about what a bank is, over the years literally dozens of organizations have emerged from the competitive financial marketplace proudly bearing the label of bank. As Exhibit 1–1 shows, for example, there are savings banks, investment banks, mortgage banks, merchant banks, universal banks, and so on. In this text we will spend most of our time focused upon the most important of all banking institutions— the commercial bank—which serves both business and household customers all over the world. However, However, the management principles and concepts we will explore in the chapters that follow apply to many different kinds of “banks” as well as to other financial-service institutions that provide similar services. While we are discussing the many different kinds of banks, we should mention an important distinction between banking types that will surface over and an d over again as we make our way through this text—community banks versus money-center banks. Money-center banks are giant industry leaders, spanning whole regions, nations, and continents, offering the widest possible menu of financial services, gobbling up smaller businesses, and facing tough competition from other giant financial firms around the globe. Community banks, on the other hand, are usuallynarrower, much smaller andmore service local communities, towns, and cities, offering a significantly but often personalized, menu of financial services to the public. As we will see, community banks are declining in numbers, but they also are proving to be tough competitors in the local areas they choose to serve.
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
6 Part One Introduction to the Business of Banking and Financial-Services Management
EXHIBIT 1–1 The Different Kinds of Financial-Servic Financial-Servicee Firms Calling Themselves Banks
Name Na me of Ba Bank nkin ingg-TTyp ypee Fir Firm m
Defi De fini niti tion on or De Desc scri ript ptio ionn
Commercial banks:
Sell deposits and make loans to businesses and individuals
Money center banks: Community banks: Savings banks: Cooperative banks: Mortgage banks: Investment banks: Merchant banks: Industrial banks:
Are large commercial banks based in leading financial centers Are smaller, locally focused commercial and savings banks Attract savings deposits and make loans to individuals and families Help farmers, ranchers, and consumers acquire goods and services Provide mortgage loans on new homes but do not sell deposits Underwrite issues of new securities by their corporate customers Supply both debt and equity capital to businesses State-chartered State-charte red loan companies owned by financial or nonfinancial corporations Are commercial banks present in more than one nation Are larger commercial banks serving corporations and governments Are smaller banks serving primarily households and small businesses Offer a narrow menu of services, such as credit card companies and subprime lenders Supply services (e.g., check clearing and security trading) to banks Focus primarily on customers belonging to minority groups Function under a federal charter through the Comptroller of the Currency Function under charters issued by banking commissions in the various states Maintain deposits backed by federal deposit insurance plans (e.g., the FDIC) Belong to the Federal Reserve System Are wholly or partially owned by a holding company Offer their services only over the Internet. Offer payday and title loans, cash checks, or operate as pawn shops and rent-to-own firms Offer virtually all financial s ervices available in today’s marketplace.
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:
One final note in our search for the definition of banks concerns the legal basis for their existence. When the federal government of the United States decided that it would regulate and supervise banks more than a century ago, it had to define what was and what was
Key URLs The Federal Deposit Insurance Corporation not only insures deposits, but provides large amounts of data on individual banks. See especially www.fdic.gov and www.fdic.gov/bank/ index.html.
not a bank for purposes of enforcing its rules. After all, if you plan to regulate banks you have to write down a specific description of what they are—otherwise, the regulated firms can easily escape their regulators, claiming they aren’t really banks at all! The government finally settled on the definition still used by many nations today: A bank is any business offering deposits subject to withdrawal on demand (such as by writing a check or making an electronic transfer of funds) and making loans of a commercial or business business nat nature ure (such as granting credit to private businesses seeking to expand the inventory of goods on their shelves or purchase new equipment). Over a century later, during the 1980s, when hundreds of financial and nonfinancial institutions (such as J. C. Penney and Sears) were offering either, but not both, of these two key services and, therefore, were claiming exemption from being regulated as a bank, the U.S. Congress decided to take another swing at the challenge of defining banking. Congress then defined a bank as any institution that could qualify for deposit insurance administered by the Federal Deposit Insurance Corporation (FDIC). A clever move indeed! Under federal law in the United States a bank had come to be defined, not so much by its array of service offerings, but by the government agency insuring its deposits! Please stay tuned—this convoluted and complicated story undoubtedly will develop even more bizarre twists as the 21st century unfolds.
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Insights and Issues A BRIEF HISTORY OF BANKING AND OTHER FINANCIAL-SERVICE FIRMS As best we can tell from historical records, banking is the oldest of all financial-service professions. Where did these powerful financial institutions come from? Linguistics (the science of language) and etymology (the study of word origins) tell us that the French word banque and the Italian banca were used centuries ago to refer to a “bench” or “money changer’s table.” This describes quite well what historians have observed about the first bankers offering their services more than 2,000 years ago. They were money changers, situated usually at a table in the commercial district, aiding travelers by exchanging foreign coins for local money or discounting commercial notes for a fee. The earliest bankers pledged a lot of their own money to support these early ventures, but it wasn’t long before the idea of attracting deposits and loaning out those same funds emerged. Loans were granted to shippers, landowners, and others at interest rates as low as 6 percent to as high as 48 percent a month for the riskiest ventures! ventures! Most of the early banks were Greek in origin. The banking industry gradually spread from the classical civilizations of Greece and Rome into Europe. It encountered religious opposition during the Middle Ages primarily because loans to the poor often carried high interest rates. However, as the Middle Ages drew to a close and the Renaissance began in Europe, the bulk of loans and deposits involved wealthy customers, which helped to reduce religious objections. The development of overland trade routes and improvements in navigation in the 15th, 16th, and 17th centuries gradually shifted the center of world commerce from the Mediterranea Mediterranean n toward Europe and the British Isles. During this period, the seeds of the Industrial Revolution, which demanded a well-developed financial system, were planted. The adoption of mass production required an expansion in global trade to absorb industrial output, which in turn required new methods for making payments and obtaining credit. Banks that could deliver on these needs grew rapidly, led by such institutions as the Medici Bank in Italy and the Hochstet ter Bank in Germany. The early banks in Europe were places for the safekeeping of wealth (such as gold and silver) for a fee as people came to fear loss of their assets due to war, theft, or expropriation by government. Merchants shipping goods found it safer to place their payments of gold and silver in the nearest bank rather than risking loss to pirates or storms at sea. In England government efforts to seize private holdings resulted in people depositing their valuables valua bles in goldsmiths’ goldsm iths’ shops, which wh ich issued tokens to kens or cer tifica tes indic indicating ating the custo customer mer had made a depos it. Soon,
goldsmith certificates began to circulate as money because they were more convenient and less risky to carry around than gold or other valuables. The goldsmiths also offered certification of value services—what we today call property appraisal. Cus tomer s wo uld bring in their valua valuables bles to have an expert certi fy these items it ems were real and not fakes. fa kes. When colonies were established in North and South America, Old World banking practices entered the New World. At first the colonists dealt primarily with established banks in the countries from which they had come. Later, state governments in the United States began chartering banking companies. The U.S. federal government became a major force in banking during the Civil War.. The Office of the Comptroller of the Currency War Currency (OCC) was established in 1864, created by the U.S. Congress to charter national banks. This divided bank regulatory system, in which both the federal government and the states play key roles in the supervision of banking activity, has persisted in the United States to the present prese nt day. Despite banking’s long history and success, tough financialservice competitors competitors have emerged over the past century or two, mostly from Europe, to challenge bankers at every turn. Among the oldest were life insurance companies—the companies—the first American company was chartered in Philadelphia in 1759. Property-casualty insurers emerged at roughly the same time, led by Lloyds of London in 1688, underwriting a wide range of risks to persons and property. The 19th century ushered in a rash of new financial competi tors, led by savings saving s banks in Scotland Scotla nd in 1810. These institution institutionss offered small savings deposits to individuals at a time when most commercial banks largely ignored this market segment. A similar firm, the savings and loan association, appeared in the midwestern United States during the 1830s, encouraging household saving and financing the construction of new homes. Credit unions were first chartered in Germany during the same era, providing savings accounts and low-cost credit to industrial workers. Mutual funds—one of banking’s most successful competitors— appeared in Belgium in 1822. These investment firms entered the United U nited State Statess in s ignifi cant numbe numbers rs dur ing the t he 192 0s, were we re devastated by the Great Depression of the 1930s, and rose again to grow r apidly. A cl osely rel ated institut in stitution—th ion—the e money market fund—surfaced in the 1970s to offer professional cash management services to households and institutions. These aggressive competitors attracted a huge volume of deposits away from banks and ultimately helped to bring about government deregulation of the banking industry. Finally, hedge funds appeared to offer investors a less regulated, more risky alternative to mutual funds. They grew explosively into the new century.
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
8 Part One Introduction to the Business of Banking and Financial-Services Management
1–3 The Financial System and Competing Financial-Service Financial-Service Institutions Roles of the Financial System
Factoid Did you know that the number of banks operating in the U.S. today represents less than a third of the number operating 100 years ago? Why do you think this is so?
Key URLs Want to know more about savings associations? See especially the Office of Thrift Supervision at www.ots.treas.gov and the Federal Deposit Insurance Corporation at www.fdic.gov.
As we noted at the opening of this chapter chapter,, bankers face challenges from all sides today as they reach out to their financial-service customers. Banks are only one part of a vast financial system of markets and institutions that circles the globe. The primary purpose of this ever-changing financial system is to encourage individuals and institutions to save and to trans fer those savings to those individuals and institutions planning to invest i nvest in i n new projects. This process of encouraging savings and transforming savings into investment spending causes the economy to grow, new jobs to be created, and living standards to rise. But the financial system does more than simply transform savings into investment. It also provides a variety of supporting services essential to modern living. These include payment services that make commerce and markets possible (such as checks, credit cards, and interactive Web sites), risk protection services for those who save and venture to invest (including insurance policies and derivative contracts), liquidity services (making it possible to convert property into immediately available spending power), and credit services for those who need loans to supplement their income.
The Competitive Challenge for Banks For many centuries banks were way out in front of other financial-service institutions in supplying savings and investment services, payment and risk protection services, liquidity, liquidity, and loans. They dominated the financial system of decades past. But this is no longer as true today. Banking’s Banking’s financial market share generally has fallen as other financial institutions have moved in to fight for the same turf. In the United States of a century ago, for example, banks accounted for more than two-thirds of the assets of all financial-service providers. However, However, as Exhibit 1–2 illustrates, that share has fallen to only about one-fifth of the assets of the U.S. financial marketplace. Some authorities in the financial-services field suggest this apparent loss of market share may imply that traditional banking is dying. (See, for example, Beim [2] and the counterargument by Kaufman and Mote [3].) Certainly as financial markets become more efficient andborrowing the largestincustomers find waystraditional around banks to may obtain the funds need (such as by the open market), banks become less they necessary. Some experts argue that the reason we still have thousands of banks scattered around the globe—perhaps many more than we need—is that governments often subsidize the industry through cheap deposit insurance and low-cost loans. Still others argue that banking’s market share is falling due to excessive government regulation, restricting the industry’s ability to compete. Perhaps banking is being “regulated to death,” which may hurt those customers who most heavily depend on banks for critical services—individuals and small businesses. Other experts counter that banking is not dying, but only changing —offering —offering new services and changing its form—to reflect what today’s market demands. Perhaps the traditional measures of the industry’s importance (like total assets) no longer reflect how truly diverse and competitive bankers have become in the modern world.
Leading Competitors with Banks Among the leading competitors with banks in wrestling for the loyalty of financial-service customers are such nonbank financial-service institutions institutions as: Savings associations: Specialize in selling savings deposits and granting home mortgage loans and other forms of credit to individuals and families, illustrated by such financial firms as Atlas Savings and Loan Association (www.atlasbank.com ),
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 9
EXHIBIT 1–2 Comparative Size by Industry of Commercial Banks and Their Principal Financial-Service Competitors Source: Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United States. First Quarter 2005, June 2005.
Financial-Service Institutions Depository Institutions: Commercial banks** Savings institutions*** Credit unions
Total Financial Assets Held in 2005 (bill.)*
Percent of All Financial Assets Held in 2005
8,713 1,693 670
20.1% 3. 9 1. 5
Nondeposit Financial Institutions: Life insurance companies Property/casualty and other insurers Private pension funds State and local government retirement funds Federal government retirement funds Money market funds Investment companies (mutual funds) Finance companies Mortgage companies Real estate investment trusts Security brokers and dealers
4,166 1,197 4,286
9.6 2. 8 9. 9
2,040 71 1,841 5,443 1,424 32 259 1,941
4. 7 0.2 4. 2 12.5 3.3 **** 0. 6 4. 5
Other financial service providers (including government-spon government-sponsored sored enterprises, mortgage pools, payday lenders, etc.)
9,670
22. 3
43,446
100.0%
Totals
Notes: Columns may not add to totals due to rounding error. *Figures are for the first quarter of 2005. **Commercial banking as recorded here includes U.S. chartered commercial banks, foreign banking offices in the United States, bank holding companies, and banks operating in United States affiliated areas. ***Savings institutions include savings and loan associations, mutual and federal savings banks, and cooperative banks. ****Figure is less than one-tenth of one percent.
Key URLs To explore the character of the credit union industry see www.cuna.org and www.occu.org.
Key URLs The nature and characteristics of money market funds and other mutual funds are explained at length in such sources as www.smartmoney.com, www.ici.org, www. morningstar.com, and www.marketwatch.com.
Key URLs
To learn more about security brokers and dealers see www.sec.gov or www.investorguide. com.
Flatbush Savings and Loan Association (www.flatbush.com ) of Brooklyn, New York, Washington Mutual (www.wamu.com), and American Federal Savings Bank (www.americanfsb.com ). Credit unions: Collect deposits from and make loans to their members as nonprofit associations of individuals sharing a common bond (such as the same employer), including such firms as American Credit Union of Milwaukee (www.americancu.org ) and Chicago Post Office Employees Credit Union (www.my-creditunion.com ). Money market funds: Collect short-term, liquid funds from individuals and institutions and invest these monies in quality securities of short duration, including such firms as Franklin Templeton Tax-Free Money Fund (www.franklintempleton. com) and Scudder Tax-Free Money Fund (www.scudder.com). Mutual funds (investment companies): Sell shares to the public representing an interest in a professionally managed pool of stocks, bonds, and other securities, including such financial firms as Fidelity (www.fidelity.com) and The Vanguard Group (www.vanguard.com ). Hedge funds: Sell shares mainly to upscale investors in a broad group of different kinds of assets (including nontraditional investments in commodities, real estate, loans to new and ailing companies, and other risky assets); for additional information see such firms as Magnum Group ( www.magnum.com) and Turn Key Hedge Funds (www.turnkeyhedgefunds.com ). Security brokers and dealers: Buy and sell securities on behalf of their customers and for their own accounts, such as Merrill Lynch (www.ml.com) and Charles Schwab (www.Schwab.com ).
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
10 Part One Introduction to the Business of Banking and Financial-Services Management
Key URL You can explore the world of investment banking more fully at www.wallstreetprep. com.
Key URL To discover more about hedge funds see the Security and Exchange Commission’s Web site at www.sec.gov/ answers/hedge.htm.
Key URLs To explore the life insurance and property/casualty insurance industries see especially www.acli.com and www.iii.org.
Key URLs To learn more about finance companies see www.nacm.org, www.hsbcusa.com, and www.capitalone.com.
Investment banks: Provide professional advice to corporations and governments raising funds in the financial marketplace or seeking to make business acquisitions, including such prominent investment banking houses as Bear Stearns (www.bearstearns.com ) and Morgan Stanley (www.morganstanley.com). Finance companies: Offer loans to commercial enterprises (such as auto and appliance dealers) and to individuals and families using funds borrowed in the open market or from other financial institutions, including such well-known financial firms as Household Finance (www.household.com ) and GMAC Financial Services (www.gmacfs.com). Financial holding companies: (FHCs) Often include credit card companies, insurance and finance companies, and security broker/dealer firms under one corporate umbrella as highly diversified financial-service providers, including such leading financial conglomerates as GE Capital (www.gecapital.com ) and UBS Warburg AG (www.ubswarburg.com ). Life and property/casualty insurance companies: Protect against risks to persons or property and manage the pension plans of businesses and the retirement funds of individuals, including such industry leaders as Prudential Insurance (www.prudential. com) and State Farm Insurance Companies ( www.statefarm.com ). As suggested by Exhibit 1–3, all of these financial-service providers are converging in terms of the services they offer—rushing toward each other like colliding trains—and embracing each other’s innovations. Moreover, recent changes in government rules, such as the U.S. Financial Services Modernization (Gramm-Leach-Bliley) Act of 1999, have allowed many of the financial firms listed above to offer the public one-stop shopping for financial services. To To bankers the financial-services marketplace appears to be closing in from all sides as the list of aggressive competitors grows. Thanks to more liberal government regulations, banks with quality management and adequate capital can now truly become conglomerate financial-service providers. The same is true for security firms, insurers, and other financially oriented companies that wish to acquire bank affiliates. Thus, the historic legal barriers in the United States separating banking from other financialservice businesses have, like the walls of ancient Jericho, “come tumbling down.” The challenge of differentiating banks from other financial-service providers is greater than ever before. However, inside the United States, Congress (like the governments of many other nations around the globe) has chosen to limit severely banks’ association with industrial and manufacturing firms, fearing that allowing banking–industrial combinations of companies might snuff out competition, threaten bankers with new risks, and possibly weaken the safety net that protects depositors from loss when the banking system gets into trouble.
Concept Check 1–1.
What is a bank? How does a bank differ from most other financial-service providers?
1–2.
Under U.S. Under U.S. law what must a corpor corporatio ation n do to qualqualify and be regulated as a commercial bank?
1–3.. 1–3
Why are some some bank bankss reachi reaching ng out out to beco become me one-stop financial-service conglomerates? Is this a good idea, in your opinion?
1–4.
Which busines Which businesses ses are are bankin banking’ g’ss closest closest and toug toughhest competitors? What services do they offer that compete directly with banks’ services?
1–5.
What is happen happening ing to to banking banking’’s share share of the finan finan-cial marketplace and why? What kind of banking and financial system do you foresee for the future if present trends continue?
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 11
EXHIBIT 1–3 The Most Important Nonbank Competitors for Banks Bankers feel the impact of their fiercest nonbank competitors coming in from all directions
Offering customers credit, payments, and savings deposit services often fully comparable to what banks offer
Credit Unions and Other Thrift Institutions
de r rn
M o
B a n k
Insurance Companies and Pension Plans
Providing customers with long-term savings plans, risk protection, and credit
Supplying customers with Providing investment and savings planning, executing security purchases and sales, and providing credit cards to their customers
Supplying professional cash management and investing services for longer-term savers
Security Brokers and Dealers
Mutual Funds
Advising corporations and governments on raising funds, entering new markets, and planning acquisitions and mergers
Finance Companies
Financial Conglomerates
access to cash (liquidity) and short- to medium-term loans for everything from daily household and operating expenses to the purchase of appliances and equipment
Highly diversified financial-service providers
that control multiple financial firms
offering many different services
Investment Banks
The result of all these recent legal maneuverings is a state of confusion in the public’ public’ss mind today over what is or is not a bank. The safest approach is probably to view these historic financial institutions in terms of the many key services—especially credit, savings, payments, financial advising, and risk protection services—they offer to the public. This multiplicity of services and functions has led to banks and their nearest competitors being labeled “financial department stores” and to such familiar advertising slogans as “Your Bank—a Full-Service Financial Institution.”
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
12 Part One Introduction to the Business of Banking and Financial-Services Management
TABLE 1–1 The Many Different Roles Banks and Their Closest Competitors Play in the Economy
The modern bank has had to adopt many roles to remain competitive and responsive to public needs. Banking’ss principal roles (and the roles performed by many of its competitors) today include: Banking’ The Th e int inter erme medi diat atio ion n rol role e
The pa payments ro role
The gu guarantor ro role The Th e ris riskk man manag agem emen entt rol role e The Th e inve investm stment ent ban bankin king g role role The savings/investment advisor role The safekeeping/ce safekeeping/certification rtification of value role The agency ro role The policy role
Tra rans nsfo form rmin ing g sav savin ings gs re rece ceiv ived ed pr prim imar aril ilyy fro from m hou house seho hold ldss int into o cre credi ditt (loans) for business firms and others in order to make investments in new buildings, equipment, and other goods. Carryi ng ng ou out payments fo for go goods an and s er ervices on on behalf of of cu cus to tomers (such as by issuing and clearing checks and providing a conduit for electronic payments). Standing be behind th their cu customers to to pa pay of off cu cus to tomer de debts wh when th those customers are unable to pay (such as by issuing letters of credit). Assi As sist stin ing g cus custo tome mers rs in pr prep epar arin ing g fin finan anci cial ally ly fo forr the the ri risk sk of lo loss ss to property,, persons, and financial assets. property Assist Ass isting ing cor corpor porati ations ons and gov govern ernmen ments ts in mar market keting ing sec securi uritie tiess and and raising new funds. Aiding customers in fulfilling their long-range goals for a better life by building and investing savings. Safeguarding a customer’s valuables and certifying their true value. Acting on behalf of customers to manage and protect their property. Serving as a conduit for government policy in attempting to regulate the growth of the economy and pursue social goals.
1–4 Services Banks and Many of Their Closest Competitors Offer the Public Banks, like their neighboring competitors, are financial-service providers. As such, they play a number of important roles in the economy. (See Table 1–1.) Their success hinges on their ability to identify the financial services the public demands, produce those services efficiently, and sell them at a competitive price. What services does the public demand from banks and their financial-service competitors today? In this section, we present an overview of both banking’s traditional and its modern service menu.
Services Banks Have Offered throughout History Carrying Out Currency Exchanges History reveals that one of the first services banks offered was currency exchange. A banker stood ready to trade one form of coin or currency (such as dollars) for another (such as francs or pesos) in return for a service fee. Such exchanges have been important to travelers over the centuries, because the traveler’s survival and comfort may depend on gaining access to local funds. In today’s financial marketplace, trading in foreign currency is conducted primarily by the largest financial-service firms due to the risks involved and the expense required to carry out these transactions. Discounting Commercial Notes and Making Business Loans Early in history history,, bankers began discounting commercial notes—in notes—in effect, making loans to local merchants who sold the debts (accounts receivable) they held against their customers to a bank to raise cash quickly. It was a short step from discounting commercial notes to making direct loans for purchasing inventories of goods or for constructing new facilities—a service that today is provided by banks, finance companies, insurance firms, and other financial-service competitors. Offering Savings Deposits Making loans proved so profitable that banks began searching for ways to raise additional loanable funds. One of the earliest sources of these funds consisted of offering
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I. Introduction to the
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and the Financial−Services Sector
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Management
Insights and Issues THE ROLE OF BANKS AND OTHER FINANCIAL INTERMEDIARIES IN THEORY
cial services to surplus-spending units in order to attract funds and then allocating those t hose funds to deficit spenders. In so doing, intermediaries accelerate economic growth by expanding the available pool of savings, lowering the risk of investments through diversification, and increasing the productivity of savings and investment. Intermediation activities will take place (1) if there is a positive spread between the expected yields on loans that financial intermediaries make to deficit spenders and the expected cost of the funds intermediaries attract from surplus spenders; and (2) if there is a positive correlation between the yields on loans and other assets and the cost of attracting funds. If an intermediary’s asset yields and its fund-raising costs are positively correlated, this will reduce uncertainty about its expected profits and allow it to expand. An ongoing debate in finance concerns why financial intermediaries exist at all. What services do they provide that other businesses and individuals cannot provide for themselves?
many small savers and investors. Financial intermediaries provide a valuable service in dividing up such instruments into smaller units that are readily affordable for millions millions of people. Another contribution that intermediaries make is their willingness to accept risky loans from borrowers, while issuing low-risk securities to their depositors and other funds providers. These service providers engage in risky arbitrage across the financial markets and sell risk-management services as well. Financial intermediaries satisfy the need for liquidity. Financial instruments are liquid if they can be sold quickly in a ready market with little risk of loss to the seller. Many households and businesses, for example, demand large precautionary balances of liquid funds to cover future cash needs. Intermediaries satisfy this customer need by offering high liquidity in the financial assets they provide, giving customers access to liquid funds precisely when they are needed. Still another reason intermediaries have prospered is their superior ability to evaluate information. Pertinent data on financial investments is limited and costly. Some institutions know more than others or possess inside information that allows them to choose profitable investments while avoiding the losers. This uneven distribution of information and the talent to analyze it is known as informational asymmetry. Asymmetries reduce the efficiency of markets, but provide a profitable role for intermediaries that have the expertise to evaluate evalua te potential investments. Yet another view of why financial institutions exist in modern society is called delegated monitoring. Most borrowers prefer to keep their financial records confidential. Lending institutions are able to attract borrowing customers because they pledge confidentiality. For example, a bank’s depositors are not privileged to review the records of its borrowing customers. Depositors often
This question has proven difficult to answer. Research evidence showing that our financial markets are reasonably efficient has accumulated in recent years. Funds and information flow readily to market participants, and the prices of assets seem to be determined in highly competitive markets. In a perfectly competi tive and efficient financial system, in which all participan participants ts have equal and open access to the financial marketplace, no one par ticipant can exercise control over prices, all pertinent information info rmation affecting the value of various assets is available to all, transac tions costs are not significant impediments to trading, and all assets are available in denominations anyone can afford, why would banks and other financial-service firms be needed at all? Most current theories explain the existence of financial intermediaries by pointing to imperfections in our financial system. For example, all assets are not perfectly divisible into small denomina tions that everyone can afford. To illustrate, marketable U.S. Trea-
have time norprocess the skill over to choose good loans over bad. They neither turn thethe monitoring to a financial intermediary. Thus a depository institution serves as an agent on behalf of its depositors, monitoring the financial condition of those customers who do receive loans to ensure that depositors will recover their funds. In return for monitoring, depositors pay a fee to the lender that is probably less le ss than the cost co st they would incur inc ur if they t hey moni tored borrowers themselves. By making a large volume of loans, lending institutions acting as delegated monitors can diversify and reduce their risk exposure, resulting in increased safety for savers’ funds. Moreover, when a borrowing customer has received the stamp of approval of a lending institution it is easier and less costly for that cus tomer to raise funds elsewhere. This signal s the financial marketplace that the borrower is likely to repay his or her loans. This signaling effect seems to be strongest, not when a lending insti-
sury bonds—one of the most popular securities in the world—have minimum denominations of $1,000, which is beyond the reach of
tution makes maturing loan.the first loan to a borrower, but when it renews a
Banks, along with insurance companies, mutual funds, finance companies, and similar financial-service providers, are financial intermediaries. The term financial intermediary simply means a business that interacts with two types of individuals and institu tions in the economy: econo my: (1) deficit-spend deficit-spending ing individuals and institu- tions, whose current expenditures for consumption and investment exceed their current receipts of income and who, therefore, need to raise funds externally externally through through borrowing borrowing or issuing issuing stock; stock; and (2) (2) surplus-spending individuals and institutions whose current receipts of income exceed their current expenditures on goods and services so they have surplus funds that can be saved and invested. Intermediaries perform the indispensable task of acting as a bridge between these two groups, offering convenient finan-
Rose−Hudgins: Bank
I. Introduction to the
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Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
14 Part One Introduction to the Business of Banking and Financial-Services Management
savings deposits deposits—interest-bearing —interest-bearing funds left with depository institutions for a period of time. According to some historical records, banks in ancient Greece paid as high as 16 percent in annual interest to attract savings deposits from wealthy patrons and then made loans to ship owners sailing the Mediterranean Sea at loan rates double or triple the rate bankers were paying to their savings deposit customers. How’s How’s that for a nice profit spread?
Safekeeping of Valuables and Certification C ertification of Value During the Middle Ages, banks and other merchants (often called “goldsmiths”) began the practice of holding gold and other valuables owned by their customers inside secure vaults, thus reassuring customers of their safekeeping. These financial firms would assay the market value of their customers’ valuables, especially gold and jewelry, and certify whether or not these “valuables” were worth what others had claimed. Supporting Government Activities with Credit During the Middle Ages and the early years of the Industrial Revolution, governments in Europe noted bankers’ ability to mobilize large amounts of funds. Frequently banks were chartered under the proviso that they would purchase government bonds with a portion of the deposits they received.War. This. The lesson was of notNorth lost on the fledgling American during the Revolutionary War Bank America, chartered by thegovernment Continental Congress in 1781, was set up to help fund the struggle to throw off British rule and make the United States a sovereign nation. Similarly, Similarly, during the Civil War the U.S. Congress created a whole new federal banking system, agreeing to charter national banks provided these institutions purchased government bonds to help fund the war.
Factoid What region of the United States contains the largest number of banks? The Midwest. The smallest number of banks? The Northeast. Why do you think this is so?
Offering Checking Accounts (Demand Deposits) The Industrial Revolution ushered in new financial services and new service providers. Probably the most important of the new services developed during this period was the demand deposit—a checking account that permitted the depositor to write drafts in payment for goods and services that the bank or other service provider had to honor immediately. Demand deposit services proved to be one of the financial-service industry’s most important offerings because it significantly improved the efficiency of the payments process, making transactions easier, faster, and safer. Today the checking account concept has been extended to the Internet, to the use of plastic debit cards that tap your checking account electronically, and to “smart cards” that electronically store spending power. Today payment-on-demand accounts are offered not only by banks, but also by savings associations, credit unions, securities firms, and other financial-service providers.
Offering Trust Services For many years banks and a few of their competitors (such as insurance and trust companies) have managed the financial affairs and property of individuals and business firms in return for a fee. This property management function is known as trust as trust services. Providers of this service typically act as trustees for wills, managing a deceased customer’s customer’s estate by paying claims against that estate, keeping valuable assets safe, and seeing to it that legal heirs receive their rightful inheritance. In commercial trust departments, trust-service providers manage security portfolios and pension plans for businesses and act as agents for corporations issuing stocks and bonds.
Services Banks and Many of Their Financial-Service Competitors Have Offered More Recently Granting Consumer Loans Historically, banks did not actively pursue loan accounts from individuals and families, believing that the relatively small size of most consumer loans and their relatively high
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I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 15
default rate would make such lending unprofitable. Accordingly, other financial-service providers—especially credit unions, savings and loans, and finance companies—soon moved in to focus on the consumer. Early in this century, however, bankers began to rely more heavily on consumers for deposits to help fund their large corporate loans. In addition, heavy competition for business deposits and loans caused bankers increasingly to turn to the consumer as a potentially more loyal customer. By the 1920s and 1930s several major banks, led by one of the forerunners of New York’s Citibank and by the Bank of America, had established strong consumer loan departments. Following World War II, consumer loans were among the fastest-growi fastest-growing ng forms of bank credit. Their rate of growth has slowed recently, though, as bankers have run into stiff competition for consumer credit accounts from nonbank service providers.
Filmtoid What 2001 documentary recounts the creation of an Internet company, GovWorks.com, using more than $50 million in funds provided by venture capitalists? Answer: Startup.com.
Financial Advising Customers have long asked financial institutions for advice, particularly when it comes to the use of credit and the saving or investing of funds. Many service providers today offer a wide range of financial advisory services, from helping to prepare tax returns and financial plans for individuals to consulting about marketing opportunities at home and abroad for business customers. Managing Cash Over the years, financial institutions have found that some of the services they provide for themselves are also valuable for their customers. One of the most prominent is cash management services, in which a financial intermediary agrees to handle cash collections and disbursements for a business firm and to invest any temporary cash surpluses in interestbearing assets until cash is needed to pay bills. Although banks tend to specialize mainly in business cash management services, many financial institutions are offering similar services to consumers.
Offering Equipment Leasing Many banks and finance companies have moved aggressively to offer their business customers the option to purchase equipment through a lease arrangement in which the lending institution buys the equipment and rents it to the customer. These equipment leasing services benefit leasing institutions as depreciate well as their because, as the real owner of the leased equipment, the lessor can it customers for additional tax benefits. Key URL For more information on the venture capital industry see www.nvca.org.
Making Venture Venture Capital Loans Increasingly, banks, security dealers, and other financial conglomerates have become active in financing the start-up costs of new companies. Because of the added risk involved in such loans, this is generally done through a separate venture capital firm that raises money from investors to support young businesses in the hope of turning a profit when those firms are sold or go public. Selling Insurance Policies For many years bankers have sold credit life insurance to their customers receiving loans, guaranteeing repayment if borrowers die or become disabled. Moreover, during the 19th and early 20th centuries, many bankers sold insurance and provided financial advice to their customers, literally serving as the local community’s all-around financial-service store. However, However, beginning with the Great Depression of the 1930s, U.S. banks were prohibited from acting as insurance agents or underwriting insurance policies. For example, banks in most cases couldn’t provide automobile or homeowners’ coverage or general life and health insurance protection. Congress acted out of fear that selling insurance would increase bank risk and lead to conflicts of interest in which customers asking for one service would be compelled to buy other services as well.
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I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Leading Nonbank Financial Firms That Have Reached into Traditional Bank Service Markets For several decades now bankers have watched as some of the world’s most aggressive nonbank institutions have invaded banking’s traditional marketplace. Among the most successful and aggressive of such companies are these: Merrill Lynch & Co. (www. (www.ml.com). ml.com).* Merrill is one of the largest security trading and underwriting firms on the planet and serves as an adviser to corporations and governments on every continent. Beginning as an investment firm in 1885, Merrill now competes directly with banks in offering money market accounts and online banking services to both businesses and households. It was one of the first nonbank firms to adopt the holding company form and acquire or establish affiliates dealing in government securities, securities, asset management, and the management of mutual funds. During the 1970s Merrill Lynch organized one of the largest of all money market funds and today also controls an industrial bank. American Express Company (http://home.americanexp ress.com).* American Express was one of the first f irst credit c redit card compan c ompanies ies in the United U nited State Statess and now serves se rves million m illionss of househ h ouseholds olds and a nd business firms. It also owns an FDIC-insured industrial bank (American Express Centurion Bank) through throu gh which wh ich it offer s home mortga ge and home e quity loans, saving savingss depo sits, checki c hecki ng and retirement accounts, and online bill paying. AEX is registered with the Federal Reserve Board as a financial holding company. Household Internat Household International ional (www (www.househ .household.com) old.com)..* Household is the largest finance company in the world, offering personal loans as well as financial assistance to businesses requiring inventory financing. Reaching over 50 million customers in Canada, the United States, and Great Britain, Household competes directly with banks in offering credit cards, auto financing, home mortgages, and credit life insurance. It also operates a joint venture with an insurance company to offer term life and auto insurance coverage. During 2002, Household International announced its acquisition by HSBC of London, one of the world’s largest banks. Countrywide Financial Corp. (www.countrywide.com). Countrywide is the largest home mortgage lender in the United States. Founded in New York in 1969, the company pioneered banklike branches (known as “country stores”), based initially in California and then spreading nationwide, subsequently forming a broker–dealer subsidiary, an insurance agency, and an online lending unit. Subsequently Countrywide bought Treasury Bank, NA, in Alexandria, Virginia. *Indicates this financial firm is included in the Educational Version of S&P’s Market Insight.
Many bankers arranged to have insurance companies sell policies to customers by renting space in bank lobbies. This picture of extreme separation between banking and insurance changed dramatically in 1999 when the U.S. Congress passed the Gramm-Leach-Bliley (GLB) Act and tore down the legal barriers between the two industries, allowing bank holding companies to acquire control of insurance companies and, conversely, permitting insurance companies to acquire banks. Today, these two industries are competing aggressively with each other, pursuing cross-industry mergers and acquisitions.
Selling Retirement Plans Banks, trust departments, mutual funds, and insurance companies are active in managing the retirement plans that most businesses make available to their employees, investing incoming funds and dispensing payments to qualified recipients who have reached retirement or become disabled. Banks and other depository institutions sell retirement plans (such as IRAs and Keoghs) to individuals holding these deposits until the funds are needed for income after retirement.
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I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 17
Dealing in Securities: Offering Security Brokerage and Investment Banking Services One of the biggest of all banking service targets in recent years, particularly in the United States, has been dealing in securities, executing buy and sell orders for security trading customers (referred to as security brokerage services) services) and marketing new securities to raise funds for corporations and other institutions (referred to as security underwriting or investment banking services). However, much of this security brokerage and security underwriting activity was prohibited in the United States due to the separation of commercial and investment banking by the Glass-Steagall Act, passed in 1933. With the passage of the Gramm-Leach-Bliley Act in the fall of 1999, however, banks are now permitted to affiliate with securities firms and security firms can acquire banks. Two venerable old industries, long separated by law, especially in the United States and Japan, are now like two out-of-control locomotives rushing toward each other, pursuing many of the same customers.
Offering Mutual Funds and Annuities Many customers have come to demand investment products from their financial-service providers. Mutual fund investments and annuities that offer the prospect of higher yields than the returns often available on conventional bank deposits are among the most sought-after investment products. However, these product lines also tend to carry more risk than do bank deposits. Annuities consist of long-term savings plans that promise the payment of a stream of income to the annuity holder beginning on a designated future date (e.g., at retirement). In contrast, mutual funds are professionally managed investment programs that acquire stocks, bonds, and other assets that appear to “fit” the funds’ announced goals (such as to maximize current income or to achieve long-term capital appreciation). Recently many banking firms have organized special subsidiary organizations to market these services or entered into joint ventures with security brokers and insurance companies. In turn, many of bankers’ key competitors, including insurance companies and security firms, have moved aggressively to expand their public offerings of fixed and variable annuity plans and broaden their menu of investment services in order to attract customers away from banks. Offering Merchant Banking Services U.S. financial-service providers are following in the footsteps of leading financial institutions all over the globe (for example, Barclays Bank of Great Britain and Deutsche Bank of Germany) in offering merchant banking services to larger corporations. These consist of the temporary purchase of corporate stock to aid the launching of a new business venture or to support the expansion of an existing company. Hence, a merchant banker becomes a temporary stockholder and bears the risk that the stock purchased may decline in value. In practice, merchant banking services often encompass the identification of possible merger targets for a corporate customer, providing that customer with strategic marketing advice. Offering Risk Management and Hedging Services Many observers see fundamental changes going on in the banking sector with larger banks (such as J. P. P. Morgan Chase and Citibank) moving away from a traditionally heavy emphasis on deposit-taking and loan-making toward risk intermediation—providing their customers with financial tools to combat risk exposure in return for substantial fees. The largest banks around the globe now dominate the risk-hedging field, either acting as dealers (i.e., serving as “market makers”) in arranging for risk protection for the banks’ customers from third parties or directly selling their customers the bank’s own
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I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
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Management
Some Leading Retailing and Industrial Firms Reaching into the Banking and Financial-Services Sector Banks and other financial-service firms have experienced a rising tide of competition from leading manufacturing, retailing, and other businesses in recent decades. These companies based outside the financial sector nevertheless have often been successful in capturing financial-service cus tomers. Among Among the best best known of such nonfinancial-b nonfinancial-based ased entities entities are these: these: GE Capital (www (www.gecapit .gecapital.com). al.com).* The predecessor of GE Capital was set up during the 1930s as a captive finance company of its parent, General Electric, to provide financing so that consumers and appliance and equipment dealers could afford GE products. The firm branched out as it grew to finance more than just GE products. Today it offers such diverse services as leasing airplanes, autos, and oil tankers; credit cards; equity investments; and insurance. If GE Capital were a bank it would rank in the top 10 of all U.S. banks. In 2002 GE announced that GE Capital would become four separate businesses—GE Commercial Finance, GE Consumer Finance, GE Equipment Management, and GE Insurance. General Electric also owns Monogram Credit Card Bank. GMAC Financial Services (www.gmacfs.com). GMAC began in 1919 as a captive finance company, financing the vehicles produced by General Motors by lending to both dealers and consumers. Today GMAC Financial Services is a family of financial-service companies that not only finance purchases of motor vehicles, but extend home mortgage loans, provide real estate brokerage services, make commercial loans, sell insurance on homes and autos, and provide banking services through GMAC bank and a thrift institution. Wal-Mart (www.wal-mart.com/financial-services). * The largest consumer retailer on the planet today, offering several financial services through its more than th an 3,500 stores, is Wal-Mart. Working largely through cooperative ventures with such companies as MoneyGram, Discover Card, and SunTrust, Wal-Mart cashes payroll checks, sells money orders, and provides wire transfers of funds to Mexico. It has allocated space to allow some banks to set up bank branch offices in nearly 1,000 of its superstores and applied for an industrial bank charter. *Indicates this firm is included in the Educational Version of S&P’s S&P’s Market Insight.
risk-protection contracts (i.e., acting as “matched traders”) in which bankers take on their customers’ risk exposure and find creative ways to protect their own institutions from that exposure. As we will see later on, this popular financial service has led to phenomenal growth in such risk-hedging tools as swaps, options, and futures contracts.
Convenience: The Sum Total of All Banking and Financial Services It should be clear from the list of services we have described that not only are banks and their financial-service competitors offering a wide array of comparable services today, but that service menu is growing rapidly. New service delivery methods like the Internet, cell phones, and smart cards with digital cash are expanding and whole new service lines are being launched every year. Viewed as a whole, the impressive array of services offered and the service delivery channels used by modern financial institutions add up to greater convenience for their customers, who can satisfy virtually all their financial-service needs at one location. Banks and some of their competitors have become the financial department stores of the modern era, working to unify banking, ban king, fiduciary, fiduciary, insurance, and security brokerage services under one roof—a trend often referred to as universal banking in the
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 19
TABLE 1–2 Some of the Leading Financial-Servicee Financial-Servic Firms around the Globe Sources: Bank for International Settlements, Bank of England, Bank of Japan, and Board of Governors of the Federal Reserve System.
Leading Banking-Oriented Firms around th t he Globe
Leading Global Nonbank Service Providers, Security Dealers, Brokers, and Investment Bankers
Mizuho Fi Financial Gr Group Lt Ltd., Ja Japan* Mitsubishi Ba Banking Co Corp., Ja Japan* Deutsche Bank AG, Germany UBS AG, Switzerland Citigroup, Inc., USA* HSBC Holdings PLC, Great Britain* Lloyds TSB, Great Britain Indu In dust stri rial al an and d Com Comme merc rcia iall Ban Bankk of of Chi China na BNP Paribus Group, France Barc Ba rcla lays ys PL PLC, C, Lo Lond ndon on,, Gre Great at Br Brit itai ain* n* Bank of Montreal, Canada Canadian Imperial Bank of Commerce J. P. Morgan Chase & Company, USA* Bank of America Corp., USA* Agricultural Bank of China Australian & N.Z. Banking Group
Merrill Ly Lynch, US USA* Goldman Sa Sachs, US USA* Nomura Securities, Japan Daiwa Securities, Japan
Insurance Companies Nippon Nipp on Lif Life e Ins Insur uran ance ce Axa/Equitable, Paris, France Metr Me trop opol olit itan an Li Life fe In Insu sura ranc nce, e, US USA* A* Prudential Insurance, USA
Finance Companies Household International, USA* GE Capital, USA*
*This financial firm appears in the Educational Version of S&P’s Market Insight.
United States and Great Britain, as allfinanz in Germany, and as bancassurance in France. Table 1–2 lists some of these financial department stores, including some of the very largest banks and competing nonbank financial firms in the world, while Table 1–3 lists the largest banks operating in the United States. TABLE 1–3 The Largest Banks Operating in the United States (Total assets as reported for March 31, 2005) Source: National Information Center, Federal Reserve System, Washington, D.C.
Bank Ba nk Nam amee
Loca Lo cattio ionn of He Head adqu quar artter erss
J. P. Morgan Chase Bank, N.A. Bank of America, NA Citibank, N.A. Wachovia Bank, N.A. Wells Fargo Bank, N.A. Fleet National Bank
Columbus, Ohio Charlotte, North Carolina New York City, New York Charlotte, North Carolina Sioux Falls, South Dakota Providence, Rhode Island
U.S. Bank, N.A. HSBC Bank USA, N.A. SunTrust Bank Chase Bank USA, N.A. State Street Bank and Trust Company KeyBank, N.A.
Cincinnati, Ohio Wilmington, Delaware Atlanta, Georgia Newark, Delaware Boston, Massachusetts Cleveland, Ohio
Tot otal al As Assset etss ($ bi bill ll.) .) $ 983 838 685 455 367 213 198 139 136 89 88 85
Notes: The designation N.A. means National Association, indicating that the bank carrying this designation is a national bank chartered by the Office of the Comptroller of the Currency in Washington, D.C. as opposed to most other banks, which are chartered by their home states.
Concept Check 1–6.
1–7.
What diff different erent kind kindss of servi services ces do banks banks offe offerr the the public today? What services do their closest competitors offer? What is a financial department store? A universal bank? Why do you think these institutions have
become so important in the modern financial system? 1–8.. 1–8
Why do banks Why banks and and other other financ financial ial inter intermed mediar iaries ies exist in modern society, according to the theory of finance?
Rose−Hudgins: Bank
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Management and Financial Services, Seventh Edition
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Management
20 Part One Introduction to the Business of Banking and Financial-Services Management
1–5 Key Trends Affecting All Financial-Service Firms The foregoing survey of financial services suggests that banks and many of their financialservice competitors are currently undergoing sweeping changes in function and form. In fact, the changes affecting the financial-services business today are so important that many industry analysts refer to these trends as a revolution, one that may well leave financial institutions of the next generation almost unrecognizable. What are the key trends reshaping banking and financial services today?
Service Proliferation Leading financial firms have been rapidly expanding the menu of services they offer to their customers. This trend toward service proliferation has accelerated in recent years under the pressure of increasing competition from other financial firms, more knowledgeable and demanding customers, and shifting technology. The new services have opened up new sources of revenue—service fees (called fee income), which are likely to continue to grow relative to more traditional sources of financial-servi financial-service ce revenue (such as the interest earned on loans). Rising Competition The level and intensity of competition in the financial-services field have grown as financial institutions have proliferated their service offerings. For example, the local bank offering business and consumer credit, savings and retirement plans, and financial counseling faces direct competition for all of these services today from other banks, thrift institutions like Washington Mutual, securities firms like Merrill Lynch, finance companies like GE Capital, and insurance companies and agencies like Prudential. This trend toward rising competition has acted as a spur to develop still more services for the future and to reduce operating costs. Government Deregulation Rising competition and the proliferation of financial services have been spurred on by government deregulation—a loosening of government control—of the financial services industry that began more two decades ago and has spreadbegan around the the globe. As we will see more fully in thethan chapters ahead, U.S. deregulation with lifting of government-imposed interest rate ceilings on savings deposits in an effort to give the public a fairer return on their savings. Almost simultaneously, simultaneously, the services many of banking’s key competitors, competitors, such as savings and loans and credit unions, could offer were sharply expanded by legislation so they could remain competitive with banks. Such leading nations as Australia, Canada, Great Britain, and Japan have recently joined the deregulation movement, broadening the legal playing field for banks, security dealers, and other financial-service companies operating in a freer and more competitive marketplace.
An Increasingly Interest-Sensitive Interest-Sensitive Mix of Funds Government deregulation of the financial sector has made it possible for customers to earn higher and more flexible rates of return on their savings and payments accounts. Massive amounts of funds have flowed from older, low-yielding savings instruments and noninterestbearing checking accounts into newer high-yielding accounts whose rates of return could be changed with market conditions. Thus, bankers and their closest competitors found themselves with an increasingly interest-sensitive mix of funds. Financial-service managers have discovered that they are facing a better-educated, as well as more interest-sensitive, customer today, whose loyalty can more easily be lured away by aggressive competitors. Financial-service providers must now strive to be more
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 21
competitive in the returns they offer on the public’s money and more sensitive to changing public preferences with regard to how savings are allocated.
Technological Change and Automation Banks and many of their most serious competitors (for example, insurance companies) have been faced with higher operating costs in recent years and, therefore, have turned increasingly to automation and the installation of sophisticated electronic systems to replace older, labor-based production and delivery systems. This move toward greater technological change is especially evident in the delivery of such services as dispensing payments and making credit available to qualified customers. The most prominent examples of major technological innovations in financial services include automated teller machines (A (ATMs), TMs), cell phones, point of sale (POS) terminals, and debit cards. There are well over 300,000 ATMs in the United States today and a comparable number in Europe, giving customers 24-hour access to their accounts for cash withdrawals and deposits and to a widening menu of other services. Also accessible well beyond “bankers’ hours” are POS terminals in stores and shopping centers that replace paper-based means of paying for goods and services with rapid computer entries. Even more rapidly growing are encoded debit cards that permit a customer to pay for purchases of goods and services with the swipe of a card through an electronic card reader, while in some parts of the world customers can pay for purchases simply by waving their cell phones, which contain embedded chips, over an electronic sensor at some merchants’ cash registers. Thus, banking and financial services now comprise a more capital-intensive, fixed-cost industry and a less labor-intensive, variable-cost industry than in the past. Some experts believe that traditional brick-and-mortar buildings and face-to-face meetings with customers eventually will become relics of the past, replaced almost entirely by electronic communication. Service production and delivery would then be fully automated. TechnoTechnological advances such as these will significantly lower the per-unit costs associated with high-volume transactions, but they will tend to depersonalize financial services and result in further loss of jobs as capital equipment is substituted for labor. Recent experience suggests, however, that fully automated financial services for all customers may be a long time coming. A substantial proportion of customers still prefer personalized service and the opportunity to consult personally, one to one, with their financial advisor.
Consolidation and Geographic Expansion Making efficient use of automation and other technological innovations requires a high volume of sales. So financial-service providers have had to expand their customer base by reaching into new and more distant markets and by increasing the number of service units sold. The result has been a dramatic increase in branching activity in order to provide multiple offices (i.e., points of contact) for customers, the formation of financial holding companies that bring smaller institutions into larger conglomerates offering multiple services in multiple markets, and mergers between some of the largest bank and nonbank financial firms, such as J. P. Morgan Chase with Bank One, Bank of America with Fleet Boston Financial Group and MBNA, and Deutsche Bank of Germany with Bankers Trust Company of New York. The number of small, independently owned financial institutions is declining and the average size of individual banks, as well as securities firms, credit unions, finance companies, and insurance firms, has risen significantly. This consolidation of financial institutions has resulted in a decline in employment in the financial-services sector. sector. Convergence Service proliferation and greater competitive rivalry among financial firms have led to a powerful trend, toward convergence, particularly on the part of the largest financial
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
22 Part One Introduction to the Business of Banking and Financial-Services Management
institutions. Convergence refers to the movement of businesses across industry lines so that a firm formerly offering only one product line ventures into other product lines to broaden itscompanies, sales base. and Thissecurity phenomenon has been most evident among larger banks, insurance broker/dealer firms that have eagerly climbed into each other’s backyard. Clearly, competition intensifies in the wake of convergence as businesses previously separated into different industries now find their former industry boundaries no longer discourage new competitors. Under these more intense competitive pressures, weaker firms will fail or be merged into companies that are ever larger and offer more diverse services.
Factoid When in American history did the greatest number of banks fail? Between 1929 and 1933 when about one-third (approximatelyy 9,000) (approximatel of all U.S. banks failed or were merged out of existence.
Globalization The geographic expansion and consolidation of financial-service units have reached well beyond the boundaries of a single nation to encompass the whole planet—a trend called globalization. The largest financial firms in the world compete with each other for business on every continent. For example, huge banks headquartered in France (led by BNP Paribus), Germany (led by Deutsche Bank), Great Britain (led by HSBC), and the United States (led by Citigroup and J. P. P. Morgan Chase) have become heavyweight competitors in the global market for corporate and government loans. Deregulation has helped all these institutions compete more effectively and capture growing shares of the global market for financial services.
1–6 The Plan of This Book The primary goal of this book is to provide the reader with a comprehensive understanding of the financial-services industry and the role of o f banking in that industry. Through its seven major parts we pursue this goal both by presenting an overview of the financial-services industry as a whole and by pointing the reader toward specific questions and issues that bankers and their principal competitors must resolve every day. Part One, consisting of Chapters 1 through 4, provides an introduction to the world of banking and financial services and their functions in the global economy. economy. We explore the principal services offered by banks and many of their closest competitors, and we examine the many financial firms organized to bringtheir together human equipment, andways natural resources toare produce and deliver services. Partskill, Onecapital also explains how and why banks and other financial-service providers are regulated and who their principal regulators are. Part One concludes with an analysis of the different ways financial institutions deliver their services to the public, including the chartering of new financial firms, constructing branches, installing ATMs ATMs and point-of-sale terminals, expansion of call centers, and use of the Internet. Part Two Two introduces readers to the financial statements of banks and their closest competitors. Chapter 5 explores the content of balance sheets and income/expense statements, while Chapter 6 examines measures of performance often used to gauge how well banks and their closest competitors are doing in serving their stockholders and the public. Among the most important performance indicators discussed are numerous measures of financial firm profitability and risk. Part Three opens up the dynamic area of asset-liabili asset-liability ty management (ALM). Chapters 7, 8, and 9 describe how financial-service managers managers have changed their views about managing assets, liabilities, and capital and controlling risk in recent years. These chapters take a detailed look at the most important techniques for hedging against changing market interest rates, including financial futures, options, and swaps. Part Three also explores some of the newer tools to deal with credit risk and the use of off-balance-sheet financing techniques, including securitizations, loan sales, and credit derivatives.
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I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Real Banks, Real Decisions CONVERGENCE AND CONSOLIDATION CONSOLIDATION IN FINANCIAL SERVICES SLOWS DOWN Although financial institutions have continued to move closer to each other, heating up competition in the financial-services sector sector,, the pace of convergence and consolidation in financial services appears to have slowed somewhat. As the 21st century opened, mergers were proceeding at about half the pace of the hectic 1990s. The formation of new financial holding companies, combining banking, insurance, and security services under one roof, paused and leveled out. Perhaps most dramatic of all, the leading financial firm in the world—Citigroup—divested itself of Travelers Property and Casualty Insurance in 2001 (after acquiring the latter in 1998) and then subsequently announced its intention to sell to MetLife Insurance its Travelers Life and Annuity Insurance unit and to sell to GE its CitiCapital Transportation Financial Services affiliate. This was a big surprise because Citigroup, perhaps more than any other financial institution, has epitomized the expansion of “one-stop financial services shopping” around the world. And Citigroup is not alone. American Express recently announced plans to sell its Financial Advisers unit and move closer to being a pure credit card company, while J. P. Morgan Chase sold its life insurance and annuity underwriting business to Protective Life Corporation. Why did these leading financial-service conglomerates take an apparent step backward from their highly publicized “one-stop” financial services strategies? Is the drive toward consolidation and convergence now reversing itself and returning to more traditional lines? After all, the financial-service giants named above had argued long and loud that one-stop shopping was the “wave of the future.” They had contended that multiple-service firms would achieve greater efficiency in generating revenues and capture ample cost savings, while their customers would not only experience greater convenience, but also lower service fees. What customer wouldn’t relish being able to go to one location and open a savings account, sign up for a new auto insurance policy, and purchase stocks and bonds for their retirement plan? Was this one-stop, financial-conglomerate strategy now falling apart? Not likely, but the pace of financial-services diversification appears to have slowed. One reason: the economies economies of Europe Europe and America America have been growing growing more slowly slowly in the current current decade. decade. Moreover, efforts to further deregulate financial-service firms slowed in the new century. Then, too, the cost savings from one-stop financial shopping have been much less than many financial firms anticipated. Moreover, many firms that tried to combine managing the public’s assets and selling in-house investment products ran into conflict-of-interest problems. And new electronic shopping channels (especially the Internet) have encouraged more customers to “shop around” in search of the best deal rather than making all their purchases from one place. One thing is clear: Change in the financial-services industry often proceeds by fits and starts, due principally to the continual interaction between economic conditions, changing technology, and government regulation.
Part Four addresses two age-old problem areas for depository institutions and their closest competitors: managing a portfolio of investment securities and maintaining enough liquidity to meet daily cash needs. We examine the different types of investment securities typically acquired and review the factors that an investment officer must weigh in choosing what investment securities to buy or sell. This part of the book also takes a critical look at why depository institutions and their closest competitors must constantly struggle to ensure that they have access to cash precisely when and where they need it. Part Five directs our attention to the funding side of the balance sheet—raising money to support the acquisition of assets and to meet operating expenses. We present the principal types of deposits and nondeposit investment products and review recent trends in the mix and pricing of deposits for their implications for managing banks and other financial firms today and tomorrow. Next, we explore all the important nondeposit sources of shortterm funds—federal funds, security repurchase agreements, Eurodollars, and the like—and assess their impact on profitability and risk for banks and other financial firms. This part of the book also examines the increasing union of commercial banking, investment banking, and
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
24 Part One Introduction to the Business of Banking and Financial-Services Management
insurance industries in the United States and selected other areas of the world and the rise of bank sales of nondeposit investment products, including sales of securities, annuities, and insurance. the implications the newer product lines forsource financial-firm return and risk.We Theexplore final source of funds we of review is equity capital—the of funding provided by a financial firm’s owners. Part Six takes up what many bankers and other financial-service managers regard as the essence of their business—granting credit to customers through the making of loans. The types of loans made by banks and their closest competitors, regulations applicable to the lending process, and procedures for evaluating and granting loans are all discussed. This portion of the text includes expanded information about credit card services—one of the most successful, but challenging, service areas for financial institutions today. Finally, Part Seven tackles two of the most important strategic decisions that many financial firms have to make—acquiring or merging with other financial-servi financial-service ce providers and following their customers into international markets. As the financial-servi financial-services ces industry continues to consolidate and converge into larger units, managerial decisions about acquisitions, mergers, and global expansion become crucial to the long-run survival of many financial institutions. This final part of the book concludes with an overview of the future of the financial-servic financial-services es marketplace in the 21st century.
Concept Check 1–9.
1–10. 1– 10.
How have bank banking ing and and the the finan financial cial-ser -service vicess marmarket changed in recent years? What powerful forces are shaping financial markets and institu tions today? Which of these forces do you think will continue into the future? Can you you expl explain ain why why many many of of the forc forces es you you named in the answer to the previous question
Summary
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have led to significant problems for the management of banks and other financial firms and for their stockholders? stockhol ders? 1–11. 1–1 1.
What do you thin What thinkk the finan financia cial-se l-servic rvices es indus industry try will look like 20 years from now? What are the implications of your projections for its management today?
In this opening chapter we have explored many of the roles played by modern banks and their financial-service competitors. We have examined how and why the financial-services marketplace is rapidly changing, becoming something new and different as we move forward into the future. Among the most important points presented in this chapter were these: • Banks—the Banks—the oldest and most most familiar of all all financial instituti institutions—have ons—have changed changed greatly since their origins centuries ago, evolving from moneychangers and money issuers to become the most important gatherers and dispensers of financial information in the economy. • Bankin Bankingg is being pressured on all sides by key financial-se financial-service rvice competitors competitors—savi —savings ngs and loan associations and savings banks, credit unions, money market funds, investment banks, security brokers and dealers, investment companies (mutual funds), hedge funds, finance companies, insurance companies, and financial-servic financial-servicee conglomerates. • The leading nonbank nonbank businesses that compete with with banks today in the financial financial sector offer many of the same services and, therefore, make it increasingly difficult to separate banks from other financial-service providers. Nevertheless, larger banks tend to offer the widest range of services of any financial-service firm today.
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 25
• The principal principal functions (and (and services) offered offered by banks and and many of their financial-s financial-service ervice competitors today include: (1) lending and investing money (the credit function); (2) making onfunction); behalf of customers to facilitate their purchases of goods services (thepayments payments (3) managing and protecting customers’ cash and and other forms of customer property (the cash management, risk management, and trust functions); and (4) assisting customers in raising new funds and investing those funds profitably (through the brokerage, investment banking, and savings functions). • Major trends affecting the performance of financial firms today include: (1) widening service menus (i.e., greater product-line diversification); (2) the globalization of the financial marketplace and the spread of services worldwide (i.e., geographic diversification); (3) the easing or elimination of government rules affecting banks and other financial firms (i.e., deregulation); (4) the growing rivalry among banks themselves and with their closest financial-service competitors (i.e., intense competition); (5) the tendency for all financial firms increasingly to look alike, offering similar services (i.e., convergence); (6) the declining numbers and larger size of financial-service providers (i.e., consolidation); and (7) the increasing automation of financial-service production and delivery (i.e., technological change) in order to offer greater convenience for customers, reach wider markets, and promote cost savings.
Key Terms
Problems and Projects
bank, 4 savings associations, 8 credit unions, 9 money market funds, 9 mutual funds, 9 hedge funds, 9 security brokers and dealers, 9 investment banks, 10 finance companies, 10 financial holding
life and property/casualty insurance companies, 10 currency exchange, 12 discounting commercial notes, 12 savings deposits, 14 demand deposit services, 14 trust services, 14 financial advisory services, 15 cash management
companies, 10
services, 15
equipment leasing services, 15 insurance policies, 15 retirement plans, 16 security brokerage services, 17 security underwriting, 17 investment banking, 17 merchant banking services, 17
1. You have just been hired as the marketing officer for the new First National Bank of Vincent, Vinc ent, a suburban banking institution that will soon be serving a local community of 120,000 people. The town is adjacent to a major metropolitan area with a total population of well over 1 million. Opening day for the newly chartered bank is just two months away, away, and the president and the board of directors are concerned that the new bank may not be able to attract enough depositors and good-quality loan customers to meet its growth and profit projections. (There are 18 other financial-service competitors in town, including two credit unions, three finance companies, four insurance agencies, and two security broker offices.) Your task is to recommend the various services the bank should offer initially to build an adequate customer base. You are asked to do the following: a. Make a list of the services services the new bank could offer, offer, according according to current current regulations. regulations. b. decide List thewhich types of ofmany information will need abouttothe local community community to help you possibleyou services are likely have sufficient demand to make them profitable. c. Divid Dividee the possible services services into into two groups: those those you think are essential essential to customers (which should be offered opening day) and those you believe can be offered later as the bank grows.
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Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
26 Part One Introduction to the Business of Banking and Financial-Services Management
d. Briefly describe describe the kind of advertising campaign campaign you would like to run run to help the public see how your bank is different from all the other financial-service providers in
2.
3.
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5. 6.
7.
the area.toWhich services byent? nonbank service providers would be of mostlocal concern the new bank’s offered managem management? Leading money money center banks in the United United States have have accelerated accelerated their investment banking activities all over the globe in recent years, purchasing corporate debt securities and stock from their business customers and reselling those securities to investors in the open market. Is this a desirable move by banking organizations from a profit standpoint? From a risk standpoint? From the public interest point of view? How would you research these questions? If you were managing a corporation that had placed large deposits with a bank engaged in such activities, would you be concerned about the risk to your company’s funds? Why or why not? Thee te Th term rm bank has been applied broadly over the years to include a diverse set of financialservice institutions, which offer different financial-service packages. Identify as many of the different kinds of banks as you can. How do the banks you have identified compare to the largest banking group of all—the commercial banks? Why do you think so many different financial firms have been called banks? How might this terminology confusion affect financial-service customers? What advantages advantages can you see to banks affiliating affiliating with insurance insurance companies? companies? How might such an affiliation benefit a bank? An insurer? Can you identify any possible disadvantages to such an affiliation? Can you cite any real-world examples of bank–insurer affiliations? How well do they appear to have worked out in practice? Explain Expl ain the differ difference ence between between consolidation and convergence. Are these trends in banking and financial services related? Do they influence each other? How? financial ial interme intermediary? diary? What are its key characteristics? Is a bank a type of finanWhat Wh at is a financ cial intermediary? What other financial-services companies are financial intermediaries? What important roles within the financial system do financial intermediaries play? Four main types of financial-service financial-service firms—depository firms—depository institutions, investment banks, insurance companies, and finance/credit card companies—are in intense competition with one another today. Using Standard & Poor’s Market Insight, Educational Version, available to users of this McGraw-Hill book, describe the principal similarities and differences thesethe fourfiles types companies. may find it helpful in answering this question among to examine on of Market InsightYou devoted to such financial firms as Bank of America (BAC), Bear Stearns Companies (BSC), American International Group (AIG), and Capital One Financial Corp (COF).
Internet Exercises 1. The beginning beginning of this chapter addresses addresses the question, question, “What “What is a bank?” (That is a tough question!) A number of Web sites also try to answer the very same question. Explore the following Web sites and try to develop an answer from two different perspectives: http://money.howstuffworks. http://money .howstuffworks.com/bank1.htm com/bank1.htm http://law.freeadvice.com/ http://law .freeadvice.com/financial_law/banki financial_law/banking_law/bank.htm ng_law/bank.htm http://www.pacb.org/banks_and_banki http://www .pacb.org/banks_and_banking/ ng/ a. In the broadest broadest sense, sense, what what constitute constitutess a bank? b. In the narrowest sense, what what constitutes constitutes a bank? 2. What services does does the bank you use offer? Check Check out its Web Web site, either by surfing surfing the Web using the bank’s name and location or by checking the Federal Deposit Insurance Corporation’s Web site for the bank’s name, city, and state. How does your current bank seem to compare with neighboring banks in the range of services it offers? In the quality of its Web site? (See especially www.fdic.gov.)
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 27
3. In this chapter we discuss the the changing character character of the financial-services financial-services industry industry and the role of consolidation. Visit the Web site http://www.financialservicesfacts.org/ financial/ andus?look consolidation for changed the financial-services numbers tell Howathave the numbers since 2000? industry. What do the a. Specifically Specifically,, which sectors of the financial-services financial-services industry industry have increased the dollar amount of assets they control? b. In terms of market share based on the volume of assets held, which sectors have increased their shares (percentagewise) and which have decreased their shares? 4. As college students, we often often want to know: How big is the job market? Visit Visit the Web Web http://www.financialservicesfacts.org/financial/ .financialservicesfacts.org/financial/ and look at employment for the site http://www financial-services financial-servi ces industry. Answer the following questions using the most recent data on this site. a. How many employees employees work at depository institutions? What is the share (percentage) of total financial-servi financial-services ces employees? b. How many employees employees work in insurance? insurance? What is the share (percentage) (percentage) of total financial-services financial-servic es employees?
c. How many employees employees work in securities securities and commodities? commodities? What is the share (per(percentage) of total financial-services employees? 5. What kinds of jobs seem most plentiful plentiful in the banking industry today? today? Make a brief list of the most common job openings you find at various bank Web sites. Do any of these jobs interest you? (See, for example, www.bankjobs.com .) 6. Accordi According ng to the sources mentioned earlier on the World World Wide Wide Web, how did banking get its start and why do you think it has ha s survived for so long? What major event occurred in 1934 that has affected banking, not only in the United States, but in many countries around the world ever since then? (See www.factmonster.com/ipka/A080/059.html and www.fdic.gov.) 7. In what ways do the following corporations resemble banks? How are they different from banks of about the same asset size? Charles Schwab Corporation (www.schwab.com) Household International (www.hsbcusa.com ) GMAC Financial Services (www.gmacfs.com) S&P Market Insight Challenge (www.mhhe.com/edumarketinsight). (www.mhhe.com/edumarketinsight). 1. GE Capital is a financial-services financial-services affiliate affiliate of General Electric. Electric. Reread the description description of GE Capital in this chapter. Then, using the Educational Version of S&P’s Market Insight, read and print the “Long Business Description” for GE. Describe any new developments concerning the company’s financial-service affiliates. What is the most recent contribution of the financial-services affiliates to the total revenue received by the entire company? (This would be expressed as a percentage of total revenue.) 2. Table 1–2 in this chapter provides a list list of the leading banking and nonbanking financial-service providers around the globe. The left-hand column lists banks and the right-hand column lists several nonbank financial-service firms. (Those firms found in the Educational Version of S&P’s Market Insight are noted in the table.) Choose one banking-oriented firm from the left-hand column and one nonbank financialservice firm from the right-hand column. Using Market Insight, print out the “Long Business Description” for your two selected financial firms. Compare and contrast the business descriptions of the two financial-service firms. What are the implications for these firms of any differences you detect in their business descriptions?
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I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
28 Part One Introduction to the Business of Banking and Financial-Services Management
REAL NUMBERS
The Very First Assignment
FOR REAL BANKS Identification of a bank to follow throughout the semester (or perhaps for the rest of your life): A. Choose a bank bank holding holding company company (BHC) that that is both among among the 25 largest U.S. banking companies and in S&P’s Market Insight. Do not choose National City Corporation because that BHC is used for examples throughout the text. (Your instructor may impose constraints to ensure that your class examines a significant number of institutions, rather than just a few.) The list of the 50 largest U.S. BHCs is found at www.ffiec. gov/nic. Click on the link “Top 50 BHCs/Banks” and choose ch oose from the top 25. B. Having chosen chosen a BHC, BHC, check to make make sure that your bankbank-
Insight, Educational Version. (At last count, 21 of the 25 largest U.S. banking companies were included in Market Insight.) Using Market Insight, read and print the “Long Business Description” for your firm. Also, print and read the most recent S&P stock report. In Chapter 1 we discussed the traditional financial services that have been associated with commercial banking for decades and then the services that have recently been added to banks’ financial-service offerings. What do the Market Insight descrip tions for your chos en banking firm reveal regarding types of services? C. In conclusion, conclusion, write write approximately approximately one page on your chosen banking company and the focus of its operations.
ing company is covered by Standard & Poor’s Market
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Selected References
For a review of the history of banking and nonbank financial firms, see especially:
1. Kindleberger, Charles P. P. A Financial History of Western Europe. Boston: Allen and Unwin, 1984. For a discussion of the changing role and market share of banking and its competitors, see, for example:
2. Beim, David David U. “Why Are Banks Banks Dying?” Dying?” The Columbia Journal of World Business, Spring 1992, pp. 1–12. 3. Kaufman, George G., and Larry Larry R. Mote. “Is Banking a Declining Industry? Industry? A Historical Perspective.” Economic Perspectives, Federal Reserve Bank of Chicago, May/June 1994, pp. 2–12. 4. Kwan, Simon. Simon. “Banking Consolidation. Consolidation.”” FRBSF Economic Letter, Federal Reserve Bank of San Francisco, no. 2004-15 (June 2004), pp. 1–3. 5. Poposka, Klimantina, Mark D. Vaughan, and Timothy Timothy J. Yeager. Yeager. “The Two Two Faces of Banking.” The Regional Economist, Federal Reserve Bank of St. Louis, October 2004, pp. 10–11. 6. Powell, Donald E., Former Chairman of the Federal Deposit Insurance Corporation. “South America and Emerging Risks in Banking.” Speech to the Florida Bankers Association, Orlando, Florida, October 23, 2002. 7. Rose, Peter Peter S., and Milton Milton H. Marquis. Marquis. Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace. 9th ed. Burr Ridge, IL: McGrawHill/Irwin Hill/Irwi n Press, 2006. See especially Chapters 4, 14, and 17. For a review of the theory of banking and financial intermediation, see especially:
8. Rose, John T. T. “Commercial Banks as Financial Intermediaries and Current Trends Trends in Banking: A Pedagogical Framework.” Financial Practice and Education 3, no. 2 (Fall 1993), pp. 113–118.
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1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
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Chapter 1 An Overview of Banks and the Financial-Services Financial-Services Sector 29
Appendix Career Opportunities in Financial Services In this chapter, we have focused on the great importance of banks and nonbank financial-service firms in the functioning of the economy and financial system and on the many roles played by financial firms in dealing with the public. But Key URLs To see what kinds of banks and their financial comjobs are available in the petitors are more than just financial services field financial-servicee providers. They financial-servic see www.careers-incan also be the place for a satisfinance.com/cb.htm fying professional career. What and www.bankjob different kinds of professionals search.com. work inside most financial firms?
managers lead each branch’s Key URL effort to attract new accounts, For opportunities in branch management, calling on business firms and operations, and systems households in their local area. management see, They also approve loan requests for example, and resolve customer complaints. www.bankstaffers. Branch managers must know com. how to motivate employees and how to represent their institution in the local community.
Loa n Offaccepting icers ice rs Many managers begin their careers andfinancial analyzing loan applications
language. The systems analyst provides a vital link between managers and computer programmers in making the computer an effective problem-solving tool and an efficient channel for delivering customer services. Systems analysts need in-depth training in computer programming as well as courses emphasizing business problem solving.
submitted by business and household customers. Loan officers make initial contact with potential new customers and assist them in filing loan requests and in developing a service relationship with a lending institution. Loan officers are needed in such important financial institutions as banks, credit unions, finance companies, and savings associations. The credit For jobs in lending analyst backstops the work of the and credit analysis loan officer by preparing detailed see, for example, written assessments of each loan www.bankjobs.com and applicant’s financial position and www.scottwatson.com. advises management on the wisdom of granting any particular loan. Credit analysts and loan officers need professional training in accounting, financial statement analysis, and business finance.
Key URLs
Credit Analysts
Managers in the operations division are responsible for processing checks and clearing other cash items on behalf of their customers, for maintaining the institution’s computer facilities and electronic networks, for supervising the activities of tellers, for handling customer problems with services, for maintaining security systems to protect property, and for overseeing the operation of the personnel (human resources) department. Managers in the operations division need sound training in the principles of business management and in computers and management information systems, and they must have the ability to interact with large groups of people.
Manag ers of Oper Operatio ations ns
When financial service providers operate large branch systems, many of these functions are supervised by the manager of each branch office. Branch
Bran ch Man Manager ager s
These computer specialists work with officers and staff in all departments, translating their production and information needs into programming Systems Analysts
Keeping abreast of the inflow of revenues and the outflow of expenses and tracking changes in the service provider’s financial position are the responsibilities of auditors and accountants. These are some of the most important tasks within a financial institution because they help guard against losses from criminal activity and waste. Jobs as important as these require considerable training in accounting and auditing.
Auditing and Control Personnel
Trust Department Specialists
Key URL
For jobs in trust Specialists in a trust department departments see, for aid companies in managing example, www.ihire their employee retirement banking.com. programs, issuing securities, maintaining business records, and investing funds. Consumers also receive help in managing their property and in building an estate for retirement. Men and women employed in trust departments usually possess a wide range of backgrounds in commercial and property law, real estate appraisal, securities investment strategies, and marketing.
One employee that many customers see and talk with at virtually all depository institutions is the teller—the Tellers
Key URL For information about teller jobs see www.bankjobs.com.
individual who aoccupies fixed or at a drive-in window, station within branchaoffice receiving deposits and dispensing cash and information. Tellers must sort and file deposit receipts and withdrawal
Rose−Hudgins: Bank
I. Introduction to the
1. An Overview of Banks
Management and Financial Services, Seventh Edition
Business of Banking and Financial−Services
and the Financial−Services Sector
© The McGraw−Hill Companies, 2008
Management
30 Part One Introduction to the Business of Banking and Financial-Services Management
slips, verify customer signatures, check account balances, and balance their own cash position posi tion at least once each day. Because of their pivotal role in communicating with customers, tellers must be friendly, accurate, and knowledgeable about other departments and the services they sell. Security analysts and traders are usually found in a financial firm’s bond department and in its trust department. All financial institutions have a pressing need for individuals skilled in evaluating the businesses and governments issuing securities that the institution might buy and in assessing financial market conditions. Such courses as economics, money and capital markets, and investment analysis are usually the best fields of study for a person interested in becoming a security analyst or security trader. Security Analysts and Traders
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Mar ket ing Per son nel
With
greater competition today, financial-service providers have an urgent need to develop new services and to more aggressively sell existing services—tasks that usually fall primarily to the marketing department. This important function requires an understanding of the problems involved in producing and selling services and a familiarity with service advertising techniques. Course work in economics, services marketing, statistics, and business management is especially helpful in this field. For opportunities marketing see, for in example, www.ritesite. com.
A financial firm’s performance in serving the public and its owners depends, more than anything else, on the talent, training, and dedication of its management and staff. The job of human resources managers is to find and hire people with superior skills and to train them to fill the roles needed by the institution. Many institutions provide internal management training programs directed by the human resources division or outsource this function to other providers. Human resources managers keep records on employee performance and counsel employees on ways to improve their performance and opportunities for promotion. Human Resources Managers
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Investment Banking Specialists
Investment banking career opportunities are often found at www.efinancial careers.com and www.bankjobs.com.
Banks are becoming increasingly involved in assisting their business customers with the issue of bonds and stock to raise new capital, and they frequently render advice on
financial market opportunities and on business mergers and acquisitions. This is the dynamic, fast-paced field of investment banking, one of the highest-paid and most challenging areas in the financial marketplace. Investment banking personnel must have intensive training in accounting, economics, strategic planning, investments, and international finance. Bank Ban k Exami Examiners ners and Regu Regulato lators rs
Key URLs Information about Because banks are among the possible employment at most heavily regulated of all key bank regulatory business firms, there is an agencies may be found, ongoing need for men and for example, at women to examine the financial www.federal.reserve. condition and operating gov/careers or at www. procedures of banks and their fdic.gov/about/jobs . closest competitors and to prepare and enforce regulations. Regulatory agencies hire examiners from time to time, often by visiting college campuses or as a result of phone calls and letters from applicants. Examiners and regulators must have knowledge of accounting, business management, economics, and financial laws and regulations. Compliance personnel must make sure the regulated financial firm is in compliance with state, national, and international rules. Training in business law, economics, and accounting is most useful. Regulatory Compliance Officers
These professionals monitor each financial firm’s exposure to a variety of risks (especially market, credit, and operational risks) and develop strategies to deal with that exposure. Training in economics, statistics, and accounting is especially important in this rapidly developing field. Risk Management Specialists
In summary, with recent changes in services offered, technology, and regulation, the financial-services field can be an exciting and challenging career. However, finding a good job in this industry will not be easy. Hundreds of smaller financial institutions are being absorbed by larger ones, with subsequent reductions in staff. Nevertheless Nevertheless,, if such a career path sounds interesting to you, there is no substitute for further study of the industry and its history, services, and problems. It is also important to visit with current personnel working in financially oriented businesses to learn more about the daily work environment. Only then can you be sure that financial services is really a good career path for you.
