Chapter An Overview of the Changing Financial- Services Sector Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Different Kinds of Financial Service Firms Calling Themselves Banks Commercial Banks Savings Banks Cooperative Banks Mortgage Banks Community Banks Money Center Banks Investment Banks Merchant Banks International Banks Wholesale Banks Retail Banks Limited Purpose Banks Bankers’ Banks Minority Banks National Banks State Banks Insured Banks Member Banks Affiliated Banks Virtual Banks Fringe Banks Universal Banks 1-2

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Financial Service Competitors of Banks Savings Associations Credit Unions Money Market Funds Mutual Funds (Investment Companies) Hedge Funds Security Brokers and Dealers Investment Banks Finance Companies Financial Holding Companies Life and Property-Casualty Insurance Companies 1-3

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz What is a bank? How does a bank differ from most other financial-service providers? Under current U.S. federal law what must a corporation do to qualify and be regulated as a commercial bank? What is happening to banking’s share of the financial marketplace and why? 1-4

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Traditional Services Offered By Banks Carrying Out Currency Exchange Discounting Commercial Notes and Making Business Loans Offering Savings Deposits Safekeeping of Valuables Supporting Government Activities with Credit Offering Checking Accounts Offering Trust Services 1-5

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. More Recent Services Offered by Banks Granting Consumer Loans Providing Financial Advice Managing Cash Offering Equipment Leasing Making Venture Capital Loans Selling Insurance Policies Selling Retirement Plans 1-6

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Offering Security Brokerage and Investment Banking Services Underwriting Securities Offering Mutual Funds and Annuities Offering Merchant Banking Services Offering Risk Management and Hedging Services 1-7

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Trends Affecting Banks and Other Financial Service Firms Today Service Proliferation Rising Competition Government Deregulation Increased Interest Rate Sensitivity Technological Change and Automation Consolidation and Geographic Expansion E-Banking and E-Commerce Convergence Globalization 1-8

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz Why do banks and other financial intermediaries exist in modern society, according to the theory of finance? How have banking and the financial services market changed in recent years? What powerful forces are shaping financial markets and institutions today? Which of these forces do you think will continue into the future? 1-9

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Reasons for the Regulation of Banks Protection of the Safety of the Public’s Savings Control of the Supply of Money and Credit Ensure Equal Opportunity and Fairness in Access to Credit Promote Public Confidence in the Financial System Avoid Concentration of Power Support of Government Activities Help for Special Segments of the Economy 2-10

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Principal Regulatory Agencies Under the Dual Banking System Federal Reserve System Comptroller of the Currency Federal Deposit Insurance Corporation Department of Justice Securities and Exchange Commission State Banking Boards or Commissions 2-11

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Goals and Functions of Bank Regulations Laws Limiting Bank Lending and Risk Laws Restricting and Expanding Services Banks and Other Depository Institutions Can Offer Laws Prohibiting Discrimination in Offering Services Laws Mandating Increased Information Transparency and More Accurate Financial Reporting Laws Regulating Branch Banking Laws Assisting Federal Agencies in Dealing with Failing Depository Institutions 2-12

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Unresolved Regulatory Issues Does the regulatory safety net set up to protect small depositors encourage financial firms to take on added risk? Does deregulation exacerbate the too-big-to- fail problem? As firms become larger and more complex, can the government regulators effectively oversee what these firms are doing? Can we simplify the current regulatory structure? What is functional regulation and will it really work under the current structure? 2-13

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz Briefly describe various types of banking regulations and try to match each major law with the main goals/functions of regulations (use slide 5). How have bank failures influenced recent legislation? What changes in regulation did the GLBA bring about? What regulatory issues remain to be resolved? 2-14

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Federal Reserve System Fundamental Functions  Conduct monetary policy  Provide and maintain the payments system  Supervise and regulate banking operations Organization ▫ Board of Governors ▫ Federal Open Market Committee ▫ 12 Federal Reserve Banks ▫ Member Banks 2-15

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Federal Reserve Policy Tools ▫ Monetary Policy Tools  Open Market Operations (OMO)  Discount Rate  Reserve Requirements 2-16

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. European Central Bank Central Policy is to Maintain Price Stability Structure is Similar to the Federal Reserve Eleven Member Nations 2-17

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Assets Held by U.S. FDIC-Insured Commercial Banks,

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Number of U.S. FDIC-insured Commercial Banks,

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Community Banks or Retail Banks ‘Typical’ Size is $300 Million Organizational Chart is Not Complicated Significantly Affected by Health of Local Economy Generally Know their Customers Well – Relationship Lending 3-20

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Money Center or Wholesale Banks Generally Multi-Billion Dollar Company Organizational Chart is Much More Complex Serve Many Different Markets with Many Different Services so are Better Diversified Geographically and by Product Able to Raise Large Amounts of Capital at Relatively Low Costs 3-21

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz What are the general trends in the size distribution and asset concentration of American banking industry? Describe differences between a typical organizational structure of smaller community bank and a larger money-center bank. What trends are affecting the way banks and their competitors are organized today? 3-22

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Unit Banks Offer All Services From One Office One of the Oldest Kinds of Banks New Banks are Generally Unit Banks Until Can Grow and Attract More Resources 3-23

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Branch Banks Offer Full Range of Services from Several Locations Senior Management at the Home Office Each Branch has its Own Management Team with Limited Decision Making Ability Some Functions are Highly Centralized, While Others are Decentralized 3-24

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Reasons for Growth of Branching Exodus of Population to Suburban Communities Increased Bank Failures in Recent Years Business Growth 3-25

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. What Trend in Branch Banking Has Been Prominent in the U.S. in Recent Years? Year# of Bank Main Offices # of Branch Offices Total of U.S. Bank Offices Ave # of Branches/ U.S. Bank ,1462,98517, ,51121,81035, ,45139,78454, ,24177,94785, From Table 3-2; Source: FDIC 3-26

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Electronic Branches Internet Banking Services Automated Teller Machines (ATMs) Point of Sale (POS) Terminals 3-27

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Virtual Banks Provide their Services Exclusively Through the Web Can Generate Cost Savings Over Traditional Brick-and-Mortar Banks Have Not Yet Demonstrated They Can Be Consistently Profitable 3-28

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Holding Companies (BHC) A Corporation Chartered for the Purpose of Holding the Stock of One or More Banks Control of a bank is Assumed When 25% or More of the Stock is Owned Must Get Approval from Federal Reserve Board to Control a Bank One-Bank Holding Companies vs. Multibank Holding Companies 3-29

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Organizational Structure of a BHC 3-30

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Nonbank Businesses of BHCs Finance Companies Mortgage Companies Data Processing Companies Factoring Companies Security Brokerage Firms Financial Advising Credit Insurance Underwriters Merchant Banking Investment Banking Firms Trust Companies Credit Card Companies Leasing Companies Insurance Companies and Agencies Real Estate Services Savings Associations 3-31

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Reasons for the Growth of BHCs Geographic Diversification Product Line Diversification Tax Sheltering Double Leveraging Source of Strength A Way Around Regulatory Restrictions 3-32

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Holding Company Securities Subsidiaries Insurance Subsidiary Thrift Holding Company Real Estate Subsidiary Financial Holding Company Subsidiaries and Service Companies Thrift Company Nonbank Subsidiaries Commercial Banking Company Sample Organizational Structure of FHC 3-33

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Subsidiaries Bank Controls One or More Subsidiaries Subsidiaries Offer Other Services Such as Insurance and Security Brokerage Services Profits and Losses of Each Subsidiary Impact Parent Bank 3-34

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Changing Organization and Structure Rise in Branching, BHCs, and FHCs Consolidation among Banks and Nonbanks Convergence Other forces of change: ▫ Deregulation/Reregulation ▫ Financial Innovation ▫ Securitization ▫ Globalization ▫ Advances in Technology 3-35

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Do Bigger Firms Operate at Lower Cost? Economies of Scale Exhibit 3-10 Economies of Scope Banking and Financial Firm Goals and Motivations Expense-Preference Behavior Agency Theory Corporate Governance 3-36

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Structure and Organization of Banks in Asia China – Large Dominating Government Sector, Although Private Banks are Expanding Japan – Dominated by the Big Four Financial Group with More than One Hundred Smaller Domestic Banks and Seventy Foreign Banks 3-37

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz Which type of corporations chartered for the simple purpose of holding the stock of at least one bank? What were the reasons for the Riegle Neal Act of1994? When the banking industry moves toward larger but fewer organizations, what is it known as? What relationship appears to exist between bank size, efficiency, and operating costs per unit of service produced and delivered? 3-38

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Expected Rate of Return The Decision of Whether to Establish a Branch Office is a Capital Budgeting Decision. The Present Value of the Net Future Cash Flows Should Be Larger Than the Initial Outlay 4-39

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Geographic Diversification Reducing a Bank’s Overall Risk Exposure to its Total Return By Establishing Service Facilities in Different Market Areas Whose Individual Returns are Not Highly Correlated with the Returns from a Bank’s Existing Market Locations 4-40

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Branch Regulation FDIC Improvement Act Requires Institutions to Notify Their Regulatory Agency and Customers 90 Days Prior to Closing a Branch Community Reinvestment Act of 1977 Requires Them to Make an Effort to Reach All Segments of Their Communities With Services 4-41

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Changing Role of Financial- Service Branch Offices Sales Oriented Offer Cross-Selling Opportunities In-Store Branching ▫ Offices Set Up Inside Retail Stores or in Malls in Order to Reduce Construction Costs ▫ What are the Advantages and Disadvantages? (next slide) 4-42

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Advantages and Disadvantages of In-Store Branches Advantages Lest Costly to Build and Maintain Experience More Traffic Flow than Normal Branches Deposit Volume May be Heavier Because they Attract Store’s Own Deposits Disadvantages May Need More Aggressive Marketing Many Financial Transactions Need More Financial Expertise No Drive-in Window 4-43

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Limited-Service Facilities Point of Sale (POS)Terminals Automated Teller Machines (ATMs) Home and Office Banking Telephone Banking and Call Centers Internet-Banking 4-44

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. ATMs Less Costly to Set Up ($70,000-$80,000) and Operate (about 36% compared to a human teller per transaction) But Less Effective at Cross Selling, Less Personal Service, and More Vulnerable to Criminal Activity Decision to Install ATM: The Bank Examines the Present Value of the Stream of Cash Savings from the New ATM Machine 4-45

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Common Call Center Services Current Balance of Loan, Deposit or Investment Account Verification of Transactions Through Customer’s Account Amount of Interest Paid or Earned on Accounts How to Move Funds Among Accounts Fax or Downloadable Copies of Applications and Account Statements Details on Different Services Currently Available 4-46

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Provided Through the Internet Verify Real-Time Account Balance Move Funds Instantly Among Accounts Confirm Deposits Made, Checks Cleared and Online Transactions Have Taken Place View and Print Images of Checks Place Orders for New Checks Submit Applications for Loans and Credit Cards Carry Out On-Line Bill Paying 4-47

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Internet and Customer Safety Especially Vulnerable to Fraud and Identity Theft Authentication Factors ▫ Something a Customer Knows ▫ Something a Customer Has ▫ Something a Customer is Move to Multi-Factor Authentication From Single Factor Authentication Today 4-48

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz What factors are often considered in evaluating possible sites for new branch offices? What laws and regulations affect the creation of new bank and thrift branches and the closing of existing branches? What services do ATMs provide? What are the main advantages and disadvantages of ATMs as a service provider? Should ATMs carry fees? 4-49