Part 1 banking and the forces of change in the financial services industry
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Part 1: Banking and the Forces of Change in the Financial-Services Industry. Chapter 1: Overview of Banking and the Financial-Services Industry Chapter 2: Drivers of Change, Innovation, and Consolidation in the Financial-Services Industry Chapter 3: Technology in Banking:

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Part 1 banking and the forces of change in the financial services industry
Part 1:Banking and the Forces of Change in the Financial-Services Industry

  • Chapter 1: Overview of Banking and the Financial-Services Industry

  • Chapter 2: Drivers of Change, Innovation, and Consolidation in the Financial-Services Industry

  • Chapter 3: Technology in Banking:

    E-Money, E-Banking, and E-Commerce

Chapter 1


Chapter 1

CHAPTER 1

OVERVIEW OF BANKING AND THE FINANCIAL-SERVICES INDUSTRY

Chapter 1


Learning objectives
LEARNING OBJECTIVES

TO UNDERSTAND....

  • The functions of a financial system and that “Banks do it”

  • How to judge the efficiency of a financial system and how it interacts with the real economy

  • Who the major players in the FSI are and how they are organized

  • The role of the federal safety net and the difference between regulatory discipline and market discipline

  • The dimensions of bank competition and how regulation shapes them

Chapter 1


The functions of a financial system do banks do it
THE FUNCTIONS OF A FINANCIAL SYSTEM: Do Banks Do It?

  • Clear and settle payments to facilitate trade and commerce

  • Aggregate and disaggregate wealth and flows of funds so that both large-scale and small-scale projects can be financed

  • Transfer economic resources over time, space, and industries

  • Accumulate, process, and disseminate information for decision-making purposes

  • Provide ways for managing uncertainty and controlling risk

  • Provide ways for dealing with incentive and asymmetric-information problems that arise in financial contracting

Chapter 1


Judging the efficiency of a financial system
JUDGING THE EFFICIENCY OF A FINANCIAL SYSTEM

  • Allocative Efficiency

  • Operational or Cost Efficiency

  • Informational or Price Efficiency

Chapter 1


How the financial sector affects the real sector
HOW THE FINANCIAL SECTOR AFFECTS THE REAL SECTOR

  • Credit Screening Activities

  • Credit Rationing

  • Creating Liquidity

  • Facilitate Trade and Investment Activities

  • Debt Restructurings

  • Feedback Role

Chapter 1


Players in the financial services industry
PLAYERS IN THE FINANCIAL- SERVICES INDUSTRY

  • Financial Holding Companies

    Ex: Citigroup, American Express, Capital One Financial

  • Bank Holding Companies

    Ex: Bank of America, Wells Fargo, SunTrust

  • Community Banks

  • Securities Firms

    Ex: Merrill Lynch, MSDW, Charles Schwab

  • Thrift Institutions

    Ex: Washington Mutual, Charter One Financial, Dime Bancorp

Chapter 1


Players in the financial services industry continued
PLAYERS IN THE FINANCIAL SERVICES INDUSTRY (Continued)

  • Insurance Companies

    Ex: Aetna, AFLAC, Allstate

  • Pension Funds

  • Finance Companies

  • Investment Funds

  • Nonfinancial Corporations

  • Venture Capitalists

Chapter 1


The ization of the fsi
THE “-IZATION” OF THE FSI

  • Institutionalization

  • Securitization

  • Globalization

  • Privatization

  • Modernization

Chapter 1


Types and classes of commercial banks
TYPES AND CLASSES OF COMMERCIAL BANKS

  • National Banks -- Charters are issued by the Office of the Comptroller of the Currency (OCC)

  • State Banks -- chartered by states and D.C.

  • Fed-Member Bank -- Must be insured by the Federal Deposit Insurance Corporation

  • Bankers’ Banks

  • Pawnshops (“shadow banks”)

Chapter 1


Bank holding companies bhcs
BANK HOLDING COMPANIES (BHCs)

  • Dominant Organizational Form in US is the BHC

    • One-Bank Holding Company

    • Multi-Bank Holding Company

  • Evolution to LCBOs and FHCs

Chapter 1


Market capitalization of large bhcs
MARKET CAPITALIZATION OF LARGE BHCs

  • Citigroup = $285 Billion

  • J.P. Morgan Chase Co = $96 Billion

  • Bank of New York = $37 Billion

  • These data are as of September 13, 2000 – update them. Have they recovered from the financial aftermath of the “Attack on America”?

Chapter 1


The federal safety net two basic components
THE FEDERAL SAFETY NET:Two Basic Components

  • Discount Window -- The lender of last resort for banks that encounter liquidity crises

  • Deposit Insurance -- Provided by the FDIC, provides public confidence to the banking system

  • The TBTF policy is implemented through these two components

  • Moral Hazard -- refers to behavior that is altered by the existence of insurance

Chapter 1


How does the safety net work
HOW DOES THE SAFETY NET WORK?

When banks experience financial difficulty, they...

1.Borrow funds from the lender of last resort, the Fed

2.The FDIC has time, called “forbearance”, to arrange a permanent solution to the bank’s problems, usually a merger with another viable bank in a purchase-and-assumption transaction

3.FDICIA (1991), however, calls for “prompt corrective action” or PCA

Chapter 1


Principal agent relations regulatory discipline and market discipline
Principal-Agent Relations, Regulatory, Discipline, and Market Discipline

  • The key players in regulatory discipline are:

    • Taxpayers as principals

    • President/Congress as agents and then as principals

    • Regulators as agents and then as principals

    • Managers of insured depositories as agents and then as principals

    • See Figure 1-2 (p. 16) for additional details

Chapter 1


Techniques for managing the safety net
TECHNIQUES FOR MANAGING THE SAFETY NET Market Discipline

  • Monitoring the value of the collateral

  • Restricting the kinds of assets acceptable as collateral, and

  • Charging risk-based premiums

Chapter 1


The camel model
THE “CAMEL” MODEL Market Discipline

C = Capital Adequacy

A = Asset Quality

M = Management

E = Earnings

L = Liquidity

(S = systemic risk, CAMELS)

Chapter 1


Regulatory dialectic or struggle model
Regulatory Dialectic or Struggle Model Market Discipline

  • Thesis

  • Antithesis

  • Synthesis

Chapter 1


The risks of banking
THE RISKS OF BANKING Market Discipline

  • Credit Risk

  • Interest-Rate Risk

  • Liquidity Risk

  • Foreign-Exchange Risk

Chapter 1


Strength in banking equation
Strength-in-Banking Equation Market Discipline

  • Strength = New powers + Firm supervision

  • New powers: GLB Act of 1999 (Modernization)

  • Firm supervision: Risk-based capital requirements (regulatory discipline) and market discipline

Chapter 1


The dimensions of fsi competition
The Dimensions of FSI Competition Market Discipline

  • Price

  • User convenience/service

  • Public confidence

  • Both market forces and regulations shape these dimensions

Chapter 1


Chapter summary
Chapter Summary Market Discipline

  • Banks do it when it comes to the functions of a financial system

  • We judge financial systems in terms of their efficiency – allocative, operating (cost), and price

  • Banks are heavily regulated firms (e.g., risk-based capital requirements, CAMEL, etc.) and structured as holding companies – BHCs, LCBOs, and FHCs

Chapter 1


Summary continued
Summary (continued) Market Discipline

  • Customers pick financial-services providers based on price, convenience, and confidence as shaped by market forces and regulators

  • As banks gain new powers (GLB Act of 1999) firm supervision by markets and regulators is required to maintain strength in banking

Chapter 1


Summary continued1
Summary (continued) Market Discipline

  • Principal-agent relations play a key role in understanding how regulatory and market disciplines work

  • The regulatory dialectic or struggle model captures the ongoing battle between regulated FSFs and their regulators – thesis, antithesis, and synthesis

Chapter 1


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