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  • 1. INTRODUCTION During recent times, the United States banking industry has gone through a major restructuring by means of deregulation, technological advancement, and international competition and expansion. This trend has also allowed companies to cross into previously restricted arenas involving financial services thereby unifying much of the industry. BACKGROUND AND DEVELOPMENT The banking industry, one of America’s largest and oldest industries, had a major impact on the U.S. economy and the nation's money supply during the 1900’s. In 1913 the Federal Reserve Act was passed, creating the Federal Reserve Board (FRB). The Federal Reserve was the first central U.S. bank acting as the “lender of last resort” to banks that needed access to immediately spendable funds (Zebib, 1997, <http://cber.nlu. edu/DBR/Z1.htm>). The establishment of the Federal Reserve was to prevent bank panics and prevent depressions similar to those before its creation. For more detailed information on the Federal Reserve System, refer to Appendix A. The Fed began to adopt the attitude that “what’s good for banks is good for America,” and began setting interest rates below market level while keeping low reserve requirements. This resulted in a huge money supply increase of 60% leaving the big banks extremely content (America’s Great Depression: An Overview, 1998, <http://amatecon.com>). Although the stock market seemed to be flourishing, this period did not last for long. The Great Depression and the Stock Market Crash of 1929 By early 1929, the Fed started to realize that it couldn’t maintain it’s current policies and interest rates quickly began to rise. They began putting a hold on the money supply and for the next three years it declined by 30%. The stock market crashed and the bank runs began to start. The amount of bank failures skyrocketed between 1929 and 1933. The number of banks dropped from 25,000 to 14,000 . During the depression the prices of stock fell by 40% and while simultaneously 9 million savings accounts were wiped out (Gart, 1994). After the depression there was little faith left in the banking 1
  • 2. system and many described it as a holocaust. Depression brought cries of blame on the government from the public who was left feeling helpless and betrayed. The Banking Act of 1933 (The Glass-Steagall Act) This incident along with the unethical activities of commercial banks led Congress to the creation of the Banking Act of 1933, (or the Glass-Steagall Act). This act helped to restore confidence and safety in the American financial system. Its main objective was to separate investment banking from commercial banking, establishing them as separate lines of commerce (FDIC: Important Banking Legislation, 1999). Another important part of this legislation was the formation of the Federal Deposit Insurance Corporation (FDIC), which guaranteed deposits up to a certain limit. For more on the FDIC and its regulatory control, refer to Appendix B. After 1945 and the creation of the FDIC, banks began to change their structure and expand their operations to offer a wide variety of financial services to their customers. By 1960, banks began referring to themselves as “full-service banks,” giving an indication to the customer that they offered an extensive range of financial services (Gart, 1994). The Savings and Loan Failures During the 1970’s, the government’s method of financing the Vietnam War contributed to the failure of the Savings and Loan Industry. When faced with problems of financing the war, the U.S. government decided to print more currency. This rapid creation of money resulted in a period of inflation for the U.S. economy. The U.S. dollar depreciated, literally destroying the Savings and Loan industry by running them out of business. With interest rates flying and the value of the dollar falling, S&L’s disappeared at an alarming rate. The rate at which the S&L’s borrowed money from the Federal Reserve had increased to about 20% while the rate at which S&L’s were lending to customers was 6%. With such an unattractive outlook for the customer because of continual increases in market interest rates, consumers began withdrawing their deposits and looking to put their money in other areas with higher rates of return. With a spread 2
  • 3. this large, bankruptcy was inevitable for more than 5,000 S&L’s. In 1979, the number of S&L’s dropped from 6,000 to 1,000 (Rakes, 2000). New Legislation Later in the 1970’s after the devastating banking crisis, the need for new legislation became extremely evident to regain stability in the industry. However, this time it would have a reverse impact, deregulating former restrictions to facilitate industry survival and foster competition and adaptation (Bank Regulation, 1998, <http://c3po.cochise. cc.az.us/pratt/bank/mandb3.html>). Deregulation began to be the trend of the latter part of the twentieth century, and eventually banks began to expand into the foreign marketplace starting the globalization of the industry. DEREGULATION The concept of deregulation began in the 1980’s as an opposing force to strict regulatory developments within the banking industry. “The OCC (Office of the Comptroller of the Currency) was the first to lobby Congress for deregulation and did so most actively while the FDIC (Federal Depositor’s Insurance Corporation) and FRB (Federal Reserve Board) were less sanguine about some of the proposals”(White, 1991). By the mid 1980’s however, all three of these agencies were allowing banks to enter new product areas through their individual agency’s regulations. Further explanation about the powers and structure of these agencies can be found in Appendix B. Moreover, with the introduction of globalization during the late 1980’s, these regulatory agencies saw it necessary to repeal some of the laws passed earlier in the century. These laws hindered our financial industry from staying competitive in the global marketplace. With the advancement of globalization in the marketplace during the 1990’s, these agencies saw it even more necessary to further deregulate the banking industry. This goal was recently accomplished through the passing of the Gramm-Leach Bliley Act of 1999. Major Acts With the passing of the Riegle-Neal Act of 1994 and the Gramm-Leach Bliley Act of 1999, legislation had finally repealed the last remnants of the Glass-Steagall Act 3
  • 4. of 1933. This act was developed in light of the Great Depression and restricted our banking industry for more than half a century. “Although Glass-Steagall has been chipped away at over the last 20 years, it has until now survived almost annual onslaught by legislators. In the end, it became increasingly clear that the legal divisions in the financial services industry caused by Glass-Steagall were a hindrance to America’s retaining its leadership in global finance” (Banking Deregulation, 1999, <http://fool.com/news/1999/foth991027.htm>). In other words, the Glass-Steagall Act was finally done away with following the passage of the Gramm-Leach Bliley Act of 1999. The revisions made in the Riegle-Neal Act allowed “Bank Holding Companies to acquire banks in any state and interstate mergers between adequately capitalized and managed banks, subject to concentration limits, and state laws ” (FDIC, 1999). Moreover, the revisions under the Gramm Leach Bliley Act allowed affiliations between banks, insurance companies, and investment banks. More information on these and other acts that have affected the history of the banking industry and chipped away at the Glass Steagall Act can be found in Appendix C. Political Influence Much of the deregulation within the banking industry has occurred during the 1990’s. It is noted that one of the major driving forces behind deregulation, was the pressure and influence that the banking industry, securities, and insurance industries had on legislation. These three influential financial industries increased political contributions throughout the 1990’s, as compared with other industries such as the automotive, which has decreased donations. “In 1997, GMC stopped making such contributions because it said there was no way to know how they were being spent. Now, Ford Motor Company and Daimler-Chrysler AG have followed suit” (Auto.com, 1999, <http://auto.com>). These contributions put pressure on politicians to pass deregulation acts that allowed industries to compete globally. This is portrayed through the charts on the next page that show the contributions of the banking, securities, and insurance industries during the middle to late 1990’s. 4
  • 5. Top Left: Banking Industry Top Right: Securities Industry Bottom Left: Insurance Industry <http://opensecrets.org> Interest Group Perspectives While all of the financial industries mentioned above have the common goal of increasing their chance of success in global finance, some of these interest groups see things slightly differently. First, there were the banks, that “ were the leading proponents of legislation that would permitted them to offer checking accounts, insurance, and investment banking under one roof. Banks also favored oversight from federal banking regulators, specifically the FRB in regards to financial supermarkets. Rather than complying with 50 different sets of rules, banks wanted an overall federal precedent” (Banking Deregulation, 1999, <http://opensecrets.org/news/index.html>). Next, there was the state regulated insurance industry that strongly supported deregulation but wanted a level authority with banks. “Because legislation made it easier for lenders to sell insurance, agents lobbied for provisions that required banks to abide by the same state rules the insurance industry would be subject to. Insurance agents feared banks would gain a competitive advantage if federal authorities oversaw the new industry” (Banking Deregulation, 1999, <http://opensecrets.org/news/index.html>). 5
  • 6. Finally, securities firms lobbied for legislation that allowed the SEC (Securities & Exchange Commission) to supervise banks that sell stocks. “Banks, however wanted federal banking authorities to regulate the new financial conglomerates. Lawmakers were at odds on the two proposals… but House Members finally agreed to terms that gave the Federal Reserve Board and SEC dominant roles in the new system” (Banking Deregulation, 1999, <http://opensecrets.org/news/index.html>). This was all accomplished after years of debate with the Gramm Leach Bliley Act of 1999. Effects of Deregulation Now that it is clear how and why deregulation has taken place, it is necessary to discuss the effects that it is having in both national and international environments. The emergence of deregulation has provided for profound results upon the structure and capabilities of the financial industry. With the passing of recent acts relaxing restrictions on the financial industry, we now see… “Local banks becoming national banks, and national banks becoming global banks”(Jayaratne & Strahan, 1997). In addition, we are beginning to see financial institutions that offer a wide variety of financial services. Global banks are entering the United States and American banks are entering the global market. With the increase of deregulation, globalization, and technology, there is bound to be many more profound changes within the financial industry. GLOBALIZATION Globalization is the process of moving U.S. based financial institutions into foreign markets; this term also applies to the placement of foreign businesses into the United States. Globalization is important to the banking industry in regards to customer service for two reasons: 1. Globalization enables customers to internationally access their banks through Internet resources. It also provides financial services to more people across the globe, thus expanding their customer base. 2. Globalization offers a multitude of financial services. Suppose a bank in the United States merges with an investment firm in the United Kingdom. This merger gives the people of the United Kingdom access to American banking 6
  • 7. services in return. People of the United States are allocated resources to the UK investment firm. The Growth of Globalization In 1960 there were eight banks from the United States in foreign markets. By the late 1980’s, approximately150 U.S. banks had close to 900 foreign branches (Microsoft Encarta, 1998). The largest increase of foreign banks in the United States occurred during the late 1970’s and 1980’s. Most of these banks have a commercial orientation but some have residential interests. Legislation and Globalization In 1978 Congress passed the International Banking Act; this act imposed restrictions on foreign banks based in the United States. This gave U.S. banks a leading edge in domestic markets. Also, the North American Free Trade Agreement is largely responsible for the flourishing globalization of financial services. This Agreement recognizes that all firms providing some kind of financial service should have equal access to customers in all participant countries (White, 1996). For a further explanation of NAFTA, refer to Appendix D. WTO (World Trade Organization) Along with NAFTA and the various acts in the US that have affected deregulation and globalization, there have been some events which have significantly impacted deregulation on a direct global scale. One of these important events was the creation of the WTO. “On a global basis, substantial deregulation was achieved on December 12, 1997 when 102 World Trade Organization Members reached a multilateral agreement which established a set of rules with respect to financial services” (US Industry and Trade Outlook, 1999). These rules created new opportunities for financial service firms to operate globally. They “Created the right to establish and operate competitively, provided the same access to domestic markets as is accorded to domestic companies, required treatment on the same basis as domestic companies, removed restrictions on cross-border services, and granted majority ownership by foreign entities” (US Industry and Trade Outlook, 1999). 7
  • 8. Furthermore, organizations such as the WTO have put pressure on countries that didn’t want to open up their markets to the world, to enter the global marketplace and diversify the global economy. Incentives of Globalization When a bank goes into another country it automatically gains a number of advantages over domestic banks. An international bank gains a significant number of new customers as soon as it opens its doors on foreign soil. Most successful financial institutions follow their customers faithfully. Every year, more and more clients expand their business with overseas customers. Successful financial institutions realize the importance of providing services to support their organizations, domestically and internationally (US Industrial Trade Outlook, 1999). More customers and a faithful clientele are going to give the bank a greater opportunity for success among enhanced competition. A growing number of the countries that are emerging in the international marketplace are realizing the benefits that financial institutions receive (White, 1996). This competition can be beneficial to the customer by lowering fees or any other means by which financial institutions can contend with neighboring financial players. Technology Many technological changes are taking place in the business world today. These advances allow businesses to re-evaluate their marketing and production strategies. Many different industries are looking to the Internet as a major way of developing and advertising goods and services. Technology and competition within the financial service industry makes globalization a must. With the development of Internet technologies, globalization is increasing at a rapid rate. In the financial services industry, it is customary for companies to follow their clients internationally. With the huge impact of Internet banking, it is now easier and more efficient for financial institutions to provide all financial services to their customers across the globe. As a result of utilizing technological advances, many institutions have climbed to the top of their industries. Some of these leaders can be found in Appendix E. 8
  • 9. The Internet enables many industries, including the financial industry to become available on an international scale. Now, with electronic banking available, many banks operate overseas as well as in the United States. Many large-scale financial institutions have a common goal, which is to offer a wide variety of financial services on a global level. Not only must financial firms determine how to survive in the domestic market, but also in the rapidly changing global market (Deloitte Touche Tohmatsu Financial Services www.deloitte.com). Due to the rapid increase in technology, globalization will continue as the trend. This significantly affects the financial services industry. Banks are merging with other financial institutions such as investment banking and insurance companies, in order to provide more services, and increase international competition. Up to 50% of bank branches are expected to close in the next ten years due to technological advances and globalization. In the past decade, the number of American commercial banks has declined from 14,417 to 9,941 (Fast Facts, 1999 <http://www.dbm.com /trends/facts/facts9608v1/strange.html>). Globalization in the financial services industry is the cause of mergers and consolidations. This causes the number of actual banks to decrease. It looks as though this trend will continue to expand and will play a large role in how financial service companies compete and survive in the global market. “In addition to the other major trends of consolidation and globalization, technology is helping to transform banking and the financial services industry” (Lee M. Kunkel). FINANCIAL SERVICES As has been previously stated, the trend is now towards a financial services company, rather than a “traditional” bank. These financial services companies offer different products and services to their corporate and individual customers in order to both attract and retain these customers. It is important to realize that many of the services being offered today have a great deal to do with technology and a paperless society. Current Revenue Sources With the trend towards financial services that are described later in the analysis, banks are finding themselves in a relatively new position regarding sources of income. Banks have realized that for every service they offer, they can charge customers a fee for 9
  • 10. this, and in recent years this has become a major source of income for financial institutions. The fees banks make money on include some of the following: ATM Fees Late Fees NSF Fees Consulting Fees Interest Fees Item Copy Fees General Service Fees Legal Fees Teller Assistance Fees Gone are the days when banks relied solely on interest income to support the bank. Now, there is a major focus on lucrative fee income, which has no foreseeable end. Credit Cards One of the most obvious and arguably one of the most lucrative services offered is credit cards. These cards have opened many new doors in the financial services industry. Credit cards are being offered to consumers by more and more companies, and are accepted virtually anywhere that one would want to shop. The current world economy is definitely being shaped by the credit card frenzy. More and more, our society is moving towards a paperless society, and financial services companies that offer these short term loans to consumers will prosper in years to come. The popularity of credit cards has given rise to a similar service known as “pre- paid” cards and debit cards, also known as “plastic cash.” These cards operate similar to credit cards, except these do not have the strings attached such as interest and other typical constraints that a credit card would. Financial services companies are accepting this money in trust for many other companies, but it is most often seen in the gasoline or other retail-type industries. By moving to pre-paid and debit cards, a consumer has the ability to “carry” large amounts of cash without actually carrying the cash, proving to be a major security benefit (Consumer Products and Services, 2000 <http://www.financeservices.minin…ss/financeservices/library/blbusiness.htm>). Technology Hand in hand with credit cards, pre-paid cards, and debit cards comes the technology needed to utilize these cards. Many different companies are branching out 10
  • 11. into different technological fields such as ATM’s, ATM networks, the Internet, and online banking. All of these fields provide customers with convenient, “real-time” access to any and all of their account information. In addition, the individual institutions benefit from this trend as well, because the ATM’s and other services generate a large amount of fee-based revenue for the bank. It is quite safe to assume that if a company does not join the e-banking industry, their survivability in the market will be low. Obviously, the economy is being driven by the Internet and other electronically based industries, as seen in the booming technology stocks today. Financial Planning Another major service being provided to consumers is personalized financial planning. In this arena, companies are offering expertise in the financial world to the “everyday” customer regarding investments, and what the future may hold for their money. Many times customers feel overwhelmed by the vastness of the banking industry. If a company is established and willing to aid them in understanding and using the industry to the best of their abilities, the marketability of that company goes up. Nowadays, customers feel inundated by the number of options available to them, and are concerned about using their money in ways they may not understand. Large firms that take the time to explain options to their customers could actually end up being better suited for the average retiree’s long-term financial needs. (Consumer Products and Services, 2000 <http://www.financeservices.minin…ss/financeservices/library/ blbusiness.htm>). Retirement/Investment Planning In addition to planning for a persons financial needs, firms have begun to offer personalized investment and retirement planning for their everyday customers (GE Financial Assurance Products, 2000 <http://wwwgefinancial.com/products>). These services are quite helpful to the would-be investor who may be unsure of what areas would be best suited for their personal investing style. In addition to the investor’s uncertainty, there is much doubt as to the longevity of the Social Security program making way for more demand in regards to a solid retirement plan. Because of the state 11
  • 12. of the Social Security programs, and the diversity of investment possibilities, sound personalized advice is required to attract the investor who may not know what they want to invest in. The ultimate result of this trend has been that people who may not have invested on their own in the past, have begun to invest in their futures with the aid of a financial services company. An example of retirement planning would be investments in mutual funds. More information involving this activity can be found in Appendix F. Lending Another service that banks have traditionally offered, but must continue to push aggressively is the organization’s lending operations. The notion of lending one customers’ money to another customer in order to make money for the bank is one of great importance. Although today, fees account for a large part of a bank’s income, customers like to be able to rely on their financial institution in order to help them obtain the things in life that they may not be able to do on their own. These may include college education loans, auto loans, mortgages, and many other types of personal loans. Corporate Financial Services In addition to services offered to the personal customer, the financial services companies must offer packages to their corporate customers who keep larger amounts on deposit with the institution, and have the ability to generate more fee revenue for the bank. Some of the financial services offered to individuals could also be applied to the corporate customer as well. For example, many institutions will offer their retirement planning and management services to a corporation in order to manage the company’s 401(k) plan for all of its employees. The financial institution can also assist in providing capital for the business, or loans for new equipment, based on corporate needs. Another emerging service in the corporate arena is that of Accounts Receivable purchasing. In this transaction, a financial services company will purchase the outstanding balances owed to the corporation, and the corporation will receive the cash they might need for other functions within the business. By doing this, the corporation no longer has to worry about the possibility that one of their accounts will default. This is a major trend in corporate America today. Many companies are outsourcing whenever 12
  • 13. and wherever they can. Accounts receivable purchasing is simply a variation of outsourcing. (Business Products and Services, 2000 <http://www.financeservices.minin …ss/financeservices/ library/blbusiness.htm>). Mergers Another big trend of today is the merging of banks and other financial institutions. The main reason for this is so banks can offer their customers a wider variety of financial services. Banks of today are straying away from being just a bank, and leaning towards becoming a full financial service company. These companies not only offer the services of a bank, but the services of an investment firm, a credit firm, and an insurance company along with numerous other services. Mergers have become a way of life in banking; recently the Union Bank of Switzerland and the Swiss Bank Corporation merged to become the second largest bank in the world for now (Price Waterhouse Coopers, 1999, <http:// www.pwcglobal.com/extweb/industry.nsf/docid/>). According to the Industrial Bank of Japan Ltd., the five main principles of consolidation are: 1. To offer a wide range of the highest quality financial services to customers. 2. To maximize shareholders’ value and earn the trust of the society at large. 3. To offer attractive and rewarding job opportunities for employees. 4. To fully utilize the advantages and strengths of each bank and maximize the benefit of the consolidation through cost reduction. 5. To create a new corporate climate and culture. (IBJ, 1999, <http://www.ibjbank.co.jp/English/faq.html>) A major effect of consolidation is intensified competition among banks. During these times, banks are not only in competition for customers, but also for the dwindling number of smaller financial institutions. This increased competition has caused banks to expand their market share, increase efficiency, and offer a wide variety of financial services. This idea of “increased efficiency” has generated an “…acquire or be acquired…” mentality in the banking industry (S&P). Mergers also help the consumers in some aspects as well. For instance, banks which lower their operating costs through a merger may lower their rates or increase their 13
  • 14. services. Another main purpose of mergers is so a bank can afford more expensive technologies that are needed to provide more services that a customer has come to expect. Even though consolidation and mergers play a big role in the industry today, studies have shown that merger activity is decreasing. In 1998, 557 FDIC-insured commercial banks were acquired through mergers. This number was down from 599 in 1997, and 606 in 1995. The reason for this decrease in consolidation could be because of the cost of such activity. In 1995, the average bank was acquired for 1.7 to 1.9 times its book value. However, recently a price of three times book value has not been uncommon. One must look at the laws of supply and demand when examining the recent consolidation activity in the financial services industry. As the supply of available merger partners declines, acquisition prices will continue to rise, making mergers harder to come by (Standard and Poor’s, 1999). CONCLUSION/FUTURE OUTLOOK Over the course of history, banks and the entire financial services industry have gone through many changes. Much has happened over the last twenty years deregulation has taken place, technology has become more advanced, and globalizations within the industry has begun. There is no evidence that shows an end to these trends, especially with technological advances taking place every day. All of the deregulation has allowed banks to take on a whole different meaning. No longer do banks just accept deposits and make loans. These new “financial service companies” offer a wide range of services to their customers including credit cards, technological services such as ATM’s and on-line banking, financial planning, retirement/investment planning, lending, and corporate financial services. Deregulation and technology have also allowed financial service companies to enter the global market by way of mergers and electronic means. Currently globalization and technology are two huge trends in the industry. Companies are expanding across the globe to offer a wider variety of financial services and expand their customer base. Technology is allowing these companies to do so. As we approach the twenty-first century, these trends will continue to impact the industry. Financial service companies will continue to focus on customer service and adapt to their changing expectations and technologies. 14