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  • 1. What Do Banks Do? <ul><li>Intermediation </li></ul><ul><ul><li>Transforming savings received primarily from households into credit for business firms and others in order to make investments </li></ul></ul><ul><ul><li>Are there others who perform intermediation roles in the financial markets? </li></ul></ul>
  • 2. Why Is Intermediation Important? <ul><li>Liquidity </li></ul><ul><ul><li>Intermediaries provide liquid financial instruments </li></ul></ul><ul><ul><li>One of the oldest reasons for the existence of financial institutions </li></ul></ul><ul><ul><ul><li>Knights Templar </li></ul></ul></ul><ul><li>Delegated Monitoring </li></ul><ul><ul><li>Individuals do not have the ability to make informed investment decisions </li></ul></ul><ul><ul><li>Intermediaries act as agents </li></ul></ul>
  • 3. Why Is Intermediation Important? <ul><li>Information asymmetries </li></ul><ul><ul><li>Financial intermediaries have unique abilities to select investment opportunities </li></ul></ul><ul><ul><li>Work with clients one on one </li></ul></ul><ul><li>Transaction costs </li></ul><ul><ul><li>Intermediaries reduce transaction costs in markets </li></ul></ul><ul><ul><ul><li>Access to markets for individuals </li></ul></ul></ul><ul><ul><ul><li>Allow for smaller transaction sizes for individuals </li></ul></ul></ul>
  • 4. Are Banks Unique In Their Intermediation Role <ul><li>Yes… </li></ul><ul><ul><li>Bank loans contain information </li></ul></ul><ul><ul><ul><li>Markets respond positively to bank loan renewals </li></ul></ul></ul><ul><ul><li>Banks create relationships </li></ul></ul><ul><ul><ul><li>Relationship lending </li></ul></ul></ul><ul><ul><ul><li>Able to exploit profitable opportunities that others would avoid </li></ul></ul></ul><ul><ul><li>Banks are in a unique position to provide liquidity and serve as the best alternative </li></ul></ul><ul><ul><ul><li>Deposit insurance </li></ul></ul></ul>
  • 5. Are Banks Unique In Their Intermediation Role <ul><li>No… </li></ul><ul><ul><li>Any intermediary can provide liquidity </li></ul></ul><ul><ul><li>Many non-bank firms create relationships that create unique opportunities </li></ul></ul><ul><ul><ul><li>Venture capital </li></ul></ul></ul><ul><ul><li>Banking system is a product of regulation and is not efficient </li></ul></ul><ul><ul><ul><li>Un-regulated markets would have developed an efficient system </li></ul></ul></ul>
  • 6. The Other Roles of Commercial Banks Today <ul><li>Payment Role </li></ul><ul><ul><li>Checkable deposits, clear checks, transfer funds </li></ul></ul><ul><ul><ul><li>Again, not unique </li></ul></ul></ul><ul><li>Guarantor Role </li></ul><ul><ul><li>Provide standby letters of credit and other forms of guarantees </li></ul></ul><ul><li>Risk Management Role </li></ul><ul><ul><li>Essentially providing insurance services both traditional and non-traditional </li></ul></ul>
  • 7. The Other Roles of Commercial Banks Today <ul><li>The Investment Banking Role </li></ul><ul><ul><li>Financial service diversification has allowed banks to take a more active role </li></ul></ul><ul><ul><li>Underwriting Securities </li></ul></ul><ul><ul><ul><li>Big issuer of ABS </li></ul></ul></ul><ul><ul><li>Offering Mutual Funds and Annuities </li></ul></ul><ul><ul><li>Offering Merchant Banking Services </li></ul></ul><ul><ul><ul><li>Venture capital role </li></ul></ul></ul><ul><ul><li>Offering Risk Management and Hedging Services </li></ul></ul><ul><ul><ul><li>Exchange rate risk </li></ul></ul></ul><ul><ul><ul><li>Interest rate risk </li></ul></ul></ul><ul><ul><li>Essentially banks have become market makers for many financial products </li></ul></ul>
  • 8. The Roles of Commercial Banks Today <ul><li>Savings/Investment Advisor Role </li></ul><ul><ul><li>One stop shop concept </li></ul></ul><ul><ul><li>Again, financial service diversification has allowed this to happen </li></ul></ul><ul><li>Safekeeping/Certification of Value Role </li></ul><ul><ul><li>Safe deposit boxes, savings accounts, CD’s </li></ul></ul><ul><li>Agency Role </li></ul><ul><ul><li>Trust services </li></ul></ul><ul><li>Policy Role </li></ul><ul><ul><li>Banks are used by government to control the economy </li></ul></ul><ul><ul><ul><li>Federal Reserve Bank </li></ul></ul></ul>
  • 9. Traditional Services Offered By Banks <ul><li>Carrying Out Currency Exchange </li></ul><ul><li>Discounting Commercial Notes and Making Business Loans </li></ul><ul><li>Offering Savings Deposits </li></ul><ul><li>Safekeeping of Valuables </li></ul><ul><li>Supporting Government Activities with Credit </li></ul><ul><li>Offering Checking Accounts </li></ul><ul><li>Offering Trust Services </li></ul>
  • 10. More Recent Services Offered by Banks <ul><li>Granting Consumer Loans </li></ul><ul><li>Providing Financial Advice </li></ul><ul><li>Managing Cash </li></ul><ul><li>Offering Equipment Leasing </li></ul><ul><li>Making Venture Capital Loans </li></ul><ul><li>Selling Insurance Policies </li></ul><ul><li>Selling Retirement Plans </li></ul>
  • 11. The Financial Service Competitors of Banks <ul><li>Savings Associations </li></ul><ul><li>Savings Banks </li></ul><ul><li>Credit Unions </li></ul><ul><li>Money Market Funds </li></ul><ul><li>Mutual Funds (Investment Companies) </li></ul><ul><li>Hedge Funds </li></ul><ul><li>Security Brokers and Dealers </li></ul><ul><li>Investment Banks </li></ul><ul><li>Finance Companies </li></ul><ul><li>Financial Holding Companies </li></ul><ul><li>Life and Property-Casualty Insurance Companies </li></ul>
  • 12. Some Leading Non-Bank Competitors <ul><li>Merrill-Lynch </li></ul><ul><ul><li>Traditionally think of them as a stock broker </li></ul></ul><ul><ul><li>One of the first non-bank companies to form a holding company </li></ul></ul><ul><ul><li>Deals in gov’t securities, asset management, and mutual funds (especially money market funds) </li></ul></ul><ul><ul><li>Controls an industrial bank </li></ul></ul>
  • 13. Some Leading Non-Bank Competitors <ul><li>American Express </li></ul><ul><ul><li>Credit cards </li></ul></ul><ul><ul><li>Owns FDIC-insured industrial bank </li></ul></ul><ul><ul><ul><li>Provides mortgage, home equity, and consumer loans </li></ul></ul></ul><ul><ul><ul><li>Offers savings and deposits, on-line bill paying </li></ul></ul></ul><ul><li>Household International </li></ul><ul><ul><li>Largest finance company in the world </li></ul></ul><ul><ul><ul><li>Credit cards, auto loans, home loans, consumer loans </li></ul></ul></ul><ul><ul><li>Purchased HSCB of London in 2002 </li></ul></ul>
  • 14. Some Leading Non-Bank Competitors <ul><li>Countrywide </li></ul><ul><ul><li>Mortgages </li></ul></ul><ul><ul><ul><li>Set up branch-like offices </li></ul></ul></ul><ul><ul><li>Broker/dealer subsidiary and insurance subsidiary </li></ul></ul><ul><ul><li>Bought Treasury Bank, NA </li></ul></ul><ul><li>GE Capital </li></ul><ul><ul><li>Originally set up as a “captive” finance company to provide financing to customers </li></ul></ul><ul><ul><li>Today does a bunch of leasing, credit cards, insurance, etc. </li></ul></ul><ul><ul><li>Would be 10 th largest bank in the US </li></ul></ul>
  • 15. Common Thread <ul><li>What do all of these competitors have in common with banks? </li></ul><ul><ul><li>They all own banks or have industrial banks </li></ul></ul><ul><ul><li>Is this a potential problem? </li></ul></ul>
  • 16. $94,906,746   MCLEAN, VA CAPITAL ONE FINANCIAL CORPORATION (2277860) 20 $95,682,192   CLEVELAND, OH KEYCORP (1068025) 19 $98,464,925   PITTSBURGH, PA PNC FINANCIAL SERVICES GROUP, INC., THE (1069778) 18 $105,828,398   CINCINNATI, OH FIFTH THIRD BANCORP (1070345) 17 $106,730,000   NEW YORK, NY BANK OF NEW YORK COMPANY, INC., THE (1033470) 16 $112,341,939   BOSTON, MA STATE STREET CORPORATION (1111435) 15 $118,523,897   WINSTON-SALEM, NC BB&T CORPORATION (1074156) 14 $138,134,005   CLEVELAND, OH NATIONAL CITY CORPORATION (1069125) 13 $155,199,559   CHICAGO, IL ABN AMRO NORTH AMERICA HOLDING COMPANY (1379552) 12 $163,084,111   PROVIDENCE, RI CITIZENS FINANCIAL GROUP, INC. (1132449) 11 $183,104,553   ATLANTA, GA SUNTRUST BANKS, INC. (1131787) 10 $193,194,572   CALABASAS, CA COUNTRYWIDE FINANCIAL CORPORATION (2549857) 9 $216,855,000   MINNEAPOLIS, MN U.S. BANCORP (1119794) 8 $430,384,000   NEW YORK, NY TAUNUS CORPORATION (2816906) 7 $473,711,105   PROSPECT HEIGHTS, IL HSBC NORTH AMERICA HOLDINGS INC. (3232316) 6 $483,441,000   SAN FRANCISCO, CA WELLS FARGO & COMPANY (1120754) 5 $559,922,000   CHARLOTTE, NC WACHOVIA CORPORATION (1073551) 4 $1,338,029,000   NEW YORK, NY JPMORGAN CHASE & CO. (1039502) 3 $1,451,603,528   CHARLOTTE, NC BANK OF AMERICA CORPORATION (1073757) 2 $1,746,248,000   NEW YORK, NY CITIGROUP INC. (1951350) 1
  • 17. Bank Structure <ul><li>Unit Bank </li></ul><ul><ul><li>Offer All Services From One Office </li></ul></ul><ul><ul><li>One of the Oldest Kinds of Banks </li></ul></ul><ul><ul><li>New Banks are Generally Unit Banks </li></ul></ul>
  • 18. Bank Structure <ul><li>Branch banking </li></ul><ul><ul><li>Offer Full Range of Services from Several Locations </li></ul></ul><ul><ul><li>Senior Management at the Home Office </li></ul></ul><ul><ul><li>Each Branch has its Own Management Team with Limited Decision Making Ability </li></ul></ul><ul><ul><li>Some Functions are Highly Centralized, While Others are Decentralized </li></ul></ul>
  • 19. Bank Structure <ul><li>Bank Holding Company </li></ul><ul><ul><li>A Corporation Chartered for the Purpose of Holding the Stock of One or More Banks </li></ul></ul><ul><ul><li>Control of a bank is Assumed When 25% or More of the Stock is Owned </li></ul></ul><ul><ul><li>Must Get Approval from Federal Reserve Board to Control a Bank </li></ul></ul>
  • 20. Reasons for the Growth of BHCs <ul><li>A Way Around Regulatory Restrictions </li></ul><ul><li>Geographic Diversification </li></ul><ul><li>Product Line Diversification </li></ul><ul><li>Tax Sheltering </li></ul><ul><li>Double Leveraging </li></ul>
  • 21. Nonbank Businesses of BHCs <ul><li>Finance Companies </li></ul><ul><li>Mortgage Companies </li></ul><ul><li>Data Processing Companies </li></ul><ul><li>Factoring Companies </li></ul><ul><li>Security Brokerage Firms </li></ul><ul><li>Financial Advising </li></ul><ul><li>Credit Insurance Underwriters </li></ul><ul><li>Merchant Banking </li></ul><ul><li>Investment Banking Firms </li></ul><ul><li>Trust Companies </li></ul><ul><li>Credit Card Companies </li></ul><ul><li>Leasing Companies </li></ul><ul><li>Insurance Companies and Agencies </li></ul><ul><li>Real Estate Services </li></ul><ul><li>Savings Associations </li></ul>
  • 22. Bank Structure <ul><li>Financial Holding Company </li></ul><ul><ul><li>Special Type of Holding Company </li></ul></ul><ul><ul><li>Offers the Broadest Range of Services </li></ul></ul><ul><ul><li>List of Activities Offered May Expand as Regulators Decide What Services are ‘Compatible’ with Banking </li></ul></ul><ul><ul><li>Each Affiliated Financial Firm has its Own Capital and Management and its Own Profit or Loss </li></ul></ul>
  • 23. Bank Structure <ul><li>Bank Subsidiaries </li></ul><ul><ul><li>Bank Controls One or More Subsidiaries </li></ul></ul><ul><ul><li>Subsidiaries Offer Other Services Such as Insurance and Security Brokerage Services </li></ul></ul><ul><ul><li>Profits and Losses of Each Subsidiary Impact Parent Bank </li></ul></ul>
  • 24. Structure and Organization of Banks in Europe <ul><li>Germany – Largest European Banking Industry </li></ul><ul><ul><li>Private Sector Banks </li></ul></ul><ul><ul><li>Public Sector Banks </li></ul></ul><ul><li>France – Second in Number of Banks </li></ul><ul><li>Belgium – Dominated by Five Large Banks </li></ul><ul><li>Great Britain – Dominated by a Half Dozen Banking Firms </li></ul><ul><li>Switzerland – Credit Suisse and UBS and Many Smaller Firms </li></ul><ul><li>Italy Privatized Banking in the 1990’s </li></ul>
  • 25. Structure and Organization of Banks in Asia <ul><li>China – Large Dominating Government Sector, Although Private Banks are Expanding </li></ul><ul><li>Japan – Dominated by the Big Four Financial Group with More than One Hundred Smaller Domestic Banks and Seventy Foreign Banks </li></ul>
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  • 29. Consolidation in Banking <ul><li>Decreased # of banks </li></ul><ul><ul><li>Primarily smaller banks that have gone away </li></ul></ul><ul><li>Increased importance on asset size </li></ul><ul><ul><li>Larger banks have greater share of the market </li></ul></ul><ul><li>Will this trend continue? </li></ul>
  • 30. Bank Efficiency <ul><li>Economies of Scale </li></ul><ul><ul><li>As Output Doubles Economies of Scale Mean Less Than the Doubling of Production Costs </li></ul></ul><ul><ul><li>Producing Multiple Units of the Same Package Costs Less Because of Efficiencies </li></ul></ul><ul><li>Economies of Scope </li></ul><ul><ul><li>A Financial Services Provider can Save Operating Costs When it Expands the Mix of Products it Offers </li></ul></ul><ul><ul><li>Resources are Used More Efficiently in Jointly Producing Multiple Services </li></ul></ul>
  • 31. Bank Efficiency <ul><li>Are the largest banks the most cost efficient? </li></ul><ul><ul><li>Probably so </li></ul></ul><ul><li>Are the largest banks the most profit efficient? </li></ul><ul><ul><li>Not necessarily, not all bank operations shown to be particularly profitable </li></ul></ul><ul><ul><li>Asset specialization may play a role in overall profitability </li></ul></ul>
  • 32. Community Banks <ul><li>‘ Typical’ Size is $250 Million </li></ul><ul><li>Organizational Chart is Not Complicated </li></ul><ul><li>Significantly Affected by Health of Local Economy </li></ul><ul><li>Generally Know their Customers Well </li></ul>
  • 33. Money Center or Wholesale Banks <ul><li>Generally Multi-Billion Dollar Company </li></ul><ul><li>Organizational Chart is Much More Complex </li></ul><ul><li>Serve Many Different Markets with Many Different Services </li></ul><ul><li>Better Able to Withstand Risks of Fluctuating Economy </li></ul><ul><li>Able to Raise Large Amounts of Capital at Relatively Low Costs </li></ul>