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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

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.