Product diversification chapter 21
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Product Diversification Chapter 21. Financial Institutions Management, 3/e By Anthony Saunders. Introduction. Universal FI structure in Germany, Switzerland and UK. Recent Citicorp/Travelers merger. Risks of product segmentation lack of diversification exposure to nonbank competition

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Product Diversification Chapter 21

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Product diversification chapter 21

Product DiversificationChapter 21

Financial Institutions Management, 3/e

By Anthony Saunders



  • Universal FI structure in Germany, Switzerland and UK.

  • Recent Citicorp/Travelers merger.

  • Risks of product segmentation

    • lack of diversification

    • exposure to nonbank competition

      • especially MMMFs

Segmentation in u s financial services industry

Segmentation in U.S. Financial Services Industry

  • Commercial and investment banking

    • Glass-Steagall Act 1933 exemptions

      • Underwriting Treasuries and municipal general obligation bonds;

      • Engage in private placements.

    • 1987 Federal Reserve Board allowed BHCs to establish Section 20 affiliates.

      • Firewalls between banks and Section 20 affiliates.

Erosion of glass steagall

Erosion of Glass-Steagall

  • 20 states allow state-chartered banks to engage in securities activities beyond those permitted by Glass-Steagall for national banks.

  • OCC ruling in 1996:

    • permit national banks on a case-by-case basis to establish direct subsidiaries to undertake non-banking activities such as underwriting.

Further challenges to glass steagall

Further Challenges to Glass-Steagall

  • International Banking Act 1978

    • Foreign banks securities activities grandfathered.

  • Investment banks increasing efforts to offer banking products.

    • Cash management accounts

    • Deposit brokering

Banking and insurance

Banking and Insurance

  • 1986: banks began selling annuities but traditionally banks prevented from entering insurance.

    • Restricted to agency activities, offering credit-related products in small towns.

    • Garn-St. Germain Act specifies restrictions on BHCs establishing insurance affiliates.

Banking and insurance continued

Banking and Insurance (continued)

  • Delaware: liberal laws allowing state-chartered banks to engage in P&C and life insurance.

  • Nonbank banks as a route for insurance companies and commercial firms to engage in banking.

  • Current challenge to Bank Holding Company Act’s restrictions

    • Citicorp and Travelers

Commercial banking and commerce

Commercial Banking and Commerce

  • Banks can only engage in commercial activities “incidental to banking”

  • Restrictions on BHCs are a more recent phenomenon.

  • 1956 Bank Holding Company Act.

Issues involved in expansion of product powers

Issues Involved in Expansion of Product Powers

  • Overview

    • Safety and soundness issues

    • Economy of scale and scope issues

    • Conflict of interest issues

    • Deposit insurance issues

    • Regulatory oversight issues

    • Competition issues

Safety and soundness

Safety and Soundness

  • Risk of securities underwriting

    • Firm Commitment

    • British Petroleum

    • Firewalls as protection from securities affiliate

      • Risks from upstreaming or affiliate loans

      • Risks from contagious confidence problem

    • Benefits from product diversification and geographic diversification

Economies of scale and scope

Economies of Scale and Scope

  • Economies of scale opportunities for firms up to $25 billion in asset size.

    • Revenue-based for largest FIs

  • Economies of scope

    • May be limited by firewalls between banks and Section 20 subsidiaries.

    • Greater gains possible with universal banking structure as in Germany.

Conflicts of interest

Conflicts of Interest

  • Six potential conflicts

    • Salesperson’s stake

      • NationsBank example.

    • Stuffing fiduciary accounts

    • Bankruptcy risk transference

    • Third-party loans

    • Tie-ins

    • Information transfer

Deposit insurance

Deposit Insurance

  • Deposit insurance

    • may provide competitive advantage to banks over other FIs.

    • Banks may also gain an advantage from being too big to fail.

Regulatory oversight

Regulatory Oversight

  • Large bank holding companies with extensive nonbank subsidiaries face a complex structure of regulators.

  • If further integration of financial services then there may be argument for a single regulatory body.



  • Procompetitive

    • Increased capital access for small firms

    • Lower commissions and fees

    • Reduce degree of underpricing of new issues

  • Anticompetitive

    • Long-run outcome could be oligopoly with higher prices for investment banking services.

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