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FIN 653: Seminar in Bank Management Lecture 1.1: Recent Bank Developments Yea-Mow Chen Department of Finance San Francisco State University I. Recent Bank Developments I. Recent Bank Developments I. Recent Bank Performance I. Recent Bank Performance I. Recent Bank Performance

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fin 653 seminar in bank management
FIN 653: Seminar in Bank Management

Lecture 1.1:

Recent Bank Developments

Yea-Mow Chen

Department of Finance

San Francisco State University

i recent bank performance6
I. Recent Bank Performance
  • Bank Profitability Stabilized in the 90s
  • ROA of Different Size Banks, 1990-2000
  • All $0m- $100m $1b- $10b
  • Year Banks $100m -$1b -$10b and above
  • ____________________________________________________
  • 1990 0.49% 0.79% 0.78 0.76% 0.38%
  • 1991 0.54 0.83 0.83 0.54 0.44
  • 1992 0.95 1.08 1.05 0.95 0.92
  • 1993 1.22 1.16 1.19 1.33 1.24
  • 1994 1.17 1.16 1.22 1.19 1.17
  • 1995 1.17 1.18 1.25 1.28 1.10
  • 1996 1.19 1.23 1.29 1.31 1.10
  • 1997 1.24 1.25 1.39 1.30 1.18
  • 1998 1.19 1.14 1.31 1.52 1.08
  • 1999 1.31 1.01 1.34 1.48 1.28
  • 2000 1.19 1.01 1.28 1.29 1.16
  • 2001 1.15
  • 2002
  • 2003 1.40
  • 2004________1.31________________________________________________
i recent bank performance7
I. Recent Bank Performance
  • Bank Profitability Stabilized in the 90s
  • ROE of Different Size Banks, 1990-2000
  • All $0m- $100m $1b- $10b
  • Year Banks $100m -$1b -$10b and above
  • ____________________________________________________
  • 1990 7.64% 9.02% 9.95 10.25% 6.68%
  • 1991 8.05 9.40 10.51 7.50 7.35
  • 1992 13.24 11.93 12.60 12.52 13.86
  • 1993 15.67 12.29 13.61 14.02 16.81
  • 1994 14.90 12.01 13.49 14.19 15.73
  • 1995 14.68 11.37 13.48 15.04 15.60
  • 1996 14.40 11.69 13.63 14.82 14.93
  • 1997 14.71 11.57 14.50 14.30 15.32
  • 1998 13.95 10.15 13.57 15.96 13.82
  • 1999 15.34 9.07 14.24 16.02 15.97
  • 2000 14.07 9.09 13.56 14.57 14.42
  • ________________________________________________________
i recent bank performance21
I. Recent Bank Performance

The Increased Concentration in U.S. Banking ( trillions of 1999 dollars)

  • 1990 1993 1996 1999
  • _________________________________________________________
  • Number of banks 12,370 11,001 9,576 8,698
  • Total assets $4.22 $4.23 $4.80 $5.47
  • % held by fifty largest BHCs 55.3 % 59.7 % 66.6 % 68.1%
  • %held by ten largest BHCs 25.6 % 31.6 % 38.5 % 44.8 %
  • Total domestic deposits $2.93 $2.76 $2.85 $3.08
  • % held by fifty largest BHCs 48.0% 51.4% 56.9% 58.2%
  • % held by ten largest BHCs 17.3 % 22.0 % 26.2 % 33.6 %
  • _________________________________________________________
  • Source: Consolidated Reports of Condition and Income, 1990-99.
ii recent banking trends
II. Recent Banking Trends
  • 1. Deregulation/Re-regulation
  • Regulations took many forms including:
    • Maximum interest rates that could be paid on deposits or charged on loans;
    • Minimum capital-to-asset ratios;
    • Minimum legal reserve requirements;
    • Limited geographic markets for full-service banking;
    • Constraints on the type of investments permitted, and restrictions on the range of products and services offered.
ii recent banking trends23
II. Recent Banking Trends
  • 1. Deregulation/Re-regulation
  • CAMELS System:
  • Capital
  • Asset Quality
  • Management Quality
  • Earning Quality
  • Liquidity
  • Sensitivity to Market Risk
ii recent banking trends24
II. Recent Banking Trends
  • 1. Deregulation/Re-regulation
  • Banks and other market participants have consistently restructured their operations to circumvent regulation and meet perceived customer need.
  • In response, regulators or lawmakers would impose new restrictions, which market participants circumvented again.
  • This process of regulation and market response (financial innovation) and imposition of new regulations (re-regulation) is the regulatory dialectic.
ii recent banking trends25
II. Recent Banking Trends
  • 1. Deregulation/Re-regulation
  • Today banks are accessing the formerly forbidden areas of investment banking, by the repeal of the Glass-Steagall Act via the Financial Services Modernization Act (Gramm-Leach-Bliley Act of 1999).
ii recent banking trends26
II. Recent Banking Trends
  • 1. Deregulation/Re-regulation
  • Efforts at deregulation and re-regulation generally address:
    • Pricing issues: removing price controls on the maximum interest rates paid to depositories and the rate charged to borrowers (usury ceilings).
    • Allowable geographic market penetration: The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 has eliminated branching restrictions.
    • New Products and services: Gramm-Leach-Bliley Act of 1999 has dramatically expanded the banks’ product choices; i.e., insurance, brokerage services, and securities underwriting.
ii recent banking trends27
II. Recent Banking Trends
  • Shortcomings of Current Banking Regulations:
    • Does not prevent bank failures
    • Cannot eliminate economic risk
    • Does not guarantee that bank management will make good decisions
ii recent banking trends28
II. Recent Banking Trends
  • 2. Rising Competition from other Financial Services Companies:
    • Non-bank financial institutions especially finance companies, foreign institutions, and the public capital markets, have increased their market share in commercial lending at the expense of domestic commercial banks.
    • Non-financial institutions, such as Sears, AT&T, and General Motors, have increased their market share in consumer lending at the expense of the banks.
ii recent banking trends29
II. Recent Banking Trends
  • 2. Rising Competition from other Financial Services Companies:
    • Competition for deposits
    • Competition for loans
    • Competition for payment services
    • Competition for other financial services
ii recent banking trends30
II. Recent Banking Trends
  • Competition for deposits
    • MMMFs were created by investment banks in 1973 and grew from $10.4 b in 1978 to almost $189 b in 1981.
    • Congress passed legislation enabling banks and thrifts to offer similar accounts including money market deposit accounts (MMDAs) and Super NOWS.
  • Competition for loans comes in many forms:
    • Commercial paper
    • Captive automobile finance companies
    • Other finance companies
    • Junk bonds
ii recent banking trends31
II. Recent Banking Trends
  • Competition for payment services is coming from emerging electronic payment systems, such as:
    • Smart and stored-value cards
    • Automatic bill payment
    • Bill presentment processing
    • Cash money can be acquired at any teller machine
    • Open a checking account, apply for a loan and receive funds electronically
ii recent banking trends32
II. Recent Banking Trends
  • Competition for investment banking services:
    • National Full-Line Firms
    • Investment Banking Firms
    • Underwriter
      • Underwriter syndicate
    • Broker versus Dealer
ii recent banking trends33
II. Recent Banking Trends
  • Competition for other financial services:
    • Trust services
    • Brokerage
    • Data Processing
    • Securities underwriting
    • Real estate appraisal
    • Credit life insurance
    • Personal financial consulting
ii recent banking trends34
II. Recent Banking Trends
  • 3. Financial Innovation
  • Innovations take the form of new securities and financial markets, new products and services, new organizational forms, and new delivery systems.
    • Regulation Q brought about financial innovation as depository institutions tried to slow disintermediation.
    • Banks developed new vehicles to compete with Treasury bills, money market mutual funds, and cash management accounts.
    • Recent innovations take the form of new futures, options, options-on-futures, and the development of markets for a wide range of securitized assets.
ii recent banking trends35
II. Recent Banking Trends
  • 3. Financial Innovation
  • One competitive response to asset quality problems and earnings pressure has been to substitute fee income for interest income by offering more fee-based services.
  • Banks also lower their capital requirements and reduce credit risk by selling assets and servicing the payments between borrower and lender rather than holding the same assets to earn interest.
  • This process of converting assets into marketable securities is called securitization.
ii recent banking trends36
II. Recent Banking Trends
  • 4. Off-Balance-Sheet Activities
  • Loan Commitments
  • Loan guarantees
  • Standby Letters of Credit
  • Interest Rate Swaps
  • Futures, Forwards & Options
  • Leases
ii recent banking trends39
II. Recent Banking Trends
  • Securitization
  • Securitization is the process of converting assets into marketable securities.
  • It enables banks to move assets off-balance-sheet and increase fee income.
  • It increases competition for standardized produces such as mortgages and other cerdit-scored loans.
ii recent banking trends40
II. Recent Banking Trends
  • Securitization
  • Benefits to financial institutions:
    • Free capital for other uses
    • Improve ROE via servicing income
    • Diversify credit risk
    • Obtain new sources of liquidity
    • Reduce interest rate risk
ii recent banking trends41
II. Recent Banking Trends
  • 5. Information Technology and Banking
  • (1). New technology had made offering new products available:
    • Securitization would not be possible without the servicing software that controls and monitors cash flows.
    • Investors trade pools of credit card loans because they can assess default risk without knowing the creditworthiness of each borrower.
    • Swaps, swaptions, collars and caps are feasible and easier to use because computer pricing models narrow the bounds of mispricing and other errors.
ii recent banking trends42
II. Recent Banking Trends
  • (2). Derivative products for risk management: Banks' risk management has been improved with the striking advances in information technology:
    • Artificial intelligence software can narrow the role of human judgment in the management of credit risk.
  • (3). Internet banking had reduced costs substantially;
  • (4). New technology had relaxed the geographical market and product constraints, which led to a greater market consolidation.
ii recent banking trends43
II. Recent Banking Trends
  • (5). But low-cost information is a double-edged sword:
    • 1. If loans are more liquid, then banks' private information about these loans and their role in monitoring the loans are both diminished.
    • 2. If loans are securitized, any broker should be able to pool loans, issue traded claims against the pool, collecting interest and principal, and disbursing it to claim-holders.
    • 3. If the bank's clients can manage interest risk with derivatives, why should they pay the bank for such protection?
ii recent banking trends44
II. Recent Banking Trends
  • 6. Globalization
  • The gradual evolution of markets and institutions so that geographic boundaries do not restrict financial transactions.
  • Firms must recognize that businesses in other countries as well as their own are competitors, and that international events affect domestic operations.
ii recent banking trends45
II. Recent Banking Trends
  • The 20 largest banks in the world, July 1, 2004
ii recent banking trends46
II. Recent Banking Trends
  • The 20 largest banks in the world, July 1, 2004