Irwin/McGraw-Hill 1 Product Diversification Chapter 21 Financial Institutions Management, 3/e By Anthony Saunders

Irwin/McGraw-Hill 2 Introduction n Universal FI structure in Germany, Switzerland and UK. n Recent Citicorp/Travelers merger. n Risks of product segmentation lack of diversification exposure to nonbank competition »especially MMMFs

Irwin/McGraw-Hill 3 Segmentation in U.S. Financial Services Industry n Commercial and investment banking Glass-Steagall Act 1933 exemptions » Underwriting Treasuries and municipal general obligation bonds; »Engage in private placements Federal Reserve Board allowed BHCs to establish Section 20 affiliates. »Firewalls between banks and Section 20 affiliates.

Irwin/McGraw-Hill 4 Erosion of Glass-Steagall n 20 states allow state-chartered banks to engage in securities activities beyond those permitted by Glass-Steagall for national banks. n 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.

Irwin/McGraw-Hill 5 Further Challenges to Glass-Steagall n International Banking Act 1978 Foreign banks securities activities grandfathered. n Investment banks increasing efforts to offer banking products. Cash management accounts Deposit brokering

Irwin/McGraw-Hill 6 Banking and Insurance n 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.

Irwin/McGraw-Hill 7 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

Irwin/McGraw-Hill 8 Commercial Banking and Commerce n Banks can only engage in commercial activities “incidental to banking” n Restrictions on BHCs are a more recent phenomenon. n 1956 Bank Holding Company Act.

Irwin/McGraw-Hill 9 Issues Involved in Expansion of Product Powers n Overview Safety and soundness issues Economy of scale and scope issues Conflict of interest issues Deposit insurance issues Regulatory oversight issues Competition issues

Irwin/McGraw-Hill 10 Safety and Soundness n 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

Irwin/McGraw-Hill 11 Economies of Scale and Scope n Economies of scale opportunities for firms up to $25 billion in asset size. Revenue-based for largest FIs n Economies of scope May be limited by firewalls between banks and Section 20 subsidiaries. Greater gains possible with universal banking structure as in Germany.

Irwin/McGraw-Hill 12 Conflicts of Interest n Six potential conflicts Salesperson’s stake »NationsBank example. Stuffing fiduciary accounts Bankruptcy risk transference Third-party loans Tie-ins Information transfer

Irwin/McGraw-Hill 13 Deposit Insurance n Deposit insurance may provide competitive advantage to banks over other FIs. Banks may also gain an advantage from being too big to fail.

Irwin/McGraw-Hill 14 Regulatory Oversight n Large bank holding companies with extensive nonbank subsidiaries face a complex structure of regulators. n If further integration of financial services then there may be argument for a single regulatory body.

Irwin/McGraw-Hill 15 Competition n Procompetitive Increased capital access for small firms Lower commissions and fees Reduce degree of underpricing of new issues n Anticompetitive Long-run outcome could be oligopoly with higher prices for investment banking services.