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H05 Mngt concl and changes begin 080118a.ppt

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  • 1.
    • Handout for Lecture 5.
    • Note : Lecture will begin with concluding slides from last lecture.
    • Core / ‘traditional’ principles of bank management derive profit from asset transformation , i.e.
        • Draw in funds at lower cost on the liability side.
        • Put them to more profitable use on the asset side.
      • i.e. This bank profit is from items ‘ on the balance sheet ’.
  • 2.
    • Changes in banks’ balance sheets – review :
        • Rise of liability management :
          • Money markets / non-transactions deposits to acquire funds > customers’ deposits.
        • Same for liquidity management > high excess reserves.
    • Also : Interest rate risk : hedging instruments
          • > adjustments to balance of interest-sensitive and interest-insensitive assets items on BS.
    Balance sheet of all US commercial banks (%), December 2004.
  • 3.
    • Off-balance-sheet activities.
    • Deregulation , etc., -> banks now also -> further activities:
      • Not defined with respect to BS
      • i.e. Not appearing on the balance sheet.
    • Merging of activities of banks and non-bank financial institutions ( nbfis ).
      • Boundaries less distinct.
  • 4. Extent of Off-Balance-Sheet activity
    • Note : Actually now a declining proportion.
        • Due to increased competition from nbfis.
    Non-interest income as %age of gross income, UK large banks:
  • 5.
    • Examples of OBS activities.
      • Fee income from specialized services, e.g.
          • Investment services, as seen.
          • Other investment bank services, e.g.issue of securities.
          • Foreign exchange trades for customers.
          • Fund management.
          • Credit cards.
  • 6.
    • Examples of OBS activities , contd .
    • Trading activities and risk management on own behalf , e.g.
        • Foreign exchange dealings.
        • Dealing in derivatives :
          • Financial futures, interest rate and exchange rate hedging, etc.
    • Note : Original purpose of derivatives, etc.:
        • Mitigate risk .
    • But in fact -> massive speculation , including by banks.
      • -> whole new range of management problems.
  • 7.
    • The ‘ principal-agent ’ problem:
    • Agent / employee of bank:
        • Earns profits -> gets bonus.
        • Makes losses -> bank has to cover for him/her.
    • e.g. Barings employee Leeson 1992-5:
        • Lost bank $1.3 billion -> bank failed.
    • Strategies to counter PA problem:
        • Separate trading from book-keeping (‘back room’) activities.
        • ‘ Chinese Wall’ between departments of same firm / separate capital accounts, etc.
  • 8.
    • ‘ Disintermediation ’.
      • i.e. Intermediaries less dominant in credit market.
      • Affects both sides of intermediation process:
    • Banks increasingly turn to other activities apart from intermediation, as seen.
      • e.g. May provide investment services to companies to obtain best rate.
      • > Competing by lowering own ROA (i.e. competing ‘on-BS’).
      • i.e. Switch to Off-Balance-Sheet / fee income.
    • Companies may turn away from banks:
      • May get better loan rate from capital market.
      • i.e. direct finance > indirect / ‘ mediated ’ through bank.
  • 9.
    • Banks and ‘nbfis’: boundaries less distinct.
      • BUT: particular significance for the economy:
        • Payments system.
        • Sheer scale.
        • Money creation process, etc.
    • -> Heavy regulation .
    • Equivalently, -> further (interconnected) ‘basic’ principles of bank management:
      • Find ways to evade regulations (‘loophole mining’).
      • -> Keep up with innovations .
  • 10.
    • Effects of:
      • 1. Deregulation.
      • 2. Innovation.
      • 3. Globalisation.
    ECON7003 Money and Banking. Hugh Goodacre Lecture 5. THE CHANGING CHARACTER OF BANK MANAGEMENT
  • 11.
    • Conventional / traditional / ‘ mono-tasking ’:
        • Deposits in, loans out.
    • Remains basic.
    • BUT no longer the only or even main source of profit.
    • Now ‘ multi-tasking ’ / evolution in face of:
        • Increased competition , both from within banking sector and from nbfis.
          • -> Restructuring of sector:
            • Diversification of activities.
            • Increased efficiency (or ingenuity??).
            • Absorption (??) of greater risk .
  • 12.
    • Three interconnected trends in particular:
          • Deregulation.
          • Innovation.
          • Globalisation.
  • 13.
    • 1. Deregulation.
    • Contradictory situation:
      • Concern for stability of financial sector:
        • ‘ Prudential’ controls.
        • Countering ‘loophole mining’, etc.
      • -> Trend to tighten regulation .
      • Competition issues :
        • -> aim to allow banks greater freedom.
      • -> Trend to de regulation !
  • 14.
    • Two strands of deregulation:
      • Removal of government restrictions.
      • Removal of self-regulatory restrictions.
        • i.e. Established from within banking / financial sector itself:
          • e.g. Agreements among building societies on interest rates, etc.
  • 15.
    • Three phases of deregulation.
    • Note : Not same timing or even sequence in different countries:
      • (i) Decisive blow to traditional framework.
      • (ii) Ending sharp distinction between banks and nbfis.
      • (iii) Allowing increased competition within financial sector and from outside it.
  • 16.
    • Deregulation Phase (i) Decisive blow to traditional framework.
    • Ending ‘traditional’ / ‘mono-tasking’ structure of sector.
        • Asset side: Lifting quantitative controls on banks’ assets .
        • Liabilities side: Lifting ceilings on interest rates on deposits .
  • 17.
    • UK :
      • Began early:
        • ‘ Competition and Credit Control’, 1971.
        • Lifted credit restrictions.
        • Associated with very loose monetary policy / ‘Barber boom’.
        • Subsequent backsliding – ‘corset’ – deposits at BoE to restrain growth of MS.
        • But by early 1980s all exchange and credit controls ended.
  • 18.
    • US :
    • ‘ Regulation Q ’ (imposed in 1933):
        • Limited interest rate payable on deposits.
        • Not lifted till 1982.
    • Note : Traumatic effects of 1930s US bank failures.
        • -> Deregulation came later than in UK .
        • Very significant effects on international finance.
  • 19.
    • Variable rate lending .
    • 1970s :
      • Volatile interest rates.
      • Inflation.
    • -> Banks increasingly allowed to issue variable rate loans.
          • e.g. Linked to LIBOR (London Inter-Bank Offer Rate).
      • > ‘Stuck’ with unprofitable loan rate.
  • 20.
      • Variable rate lending:
        • -> Stock of loans could become determined by demand.
        • Near-horizontal credit supply curve!
        • -> Banks could now liability-manage.
      • -> Great expansion of banks’ balance sheets .
        • Also: Reduction in Capital:Asset ratios.
            • Exposure to greater risk.
  • 21.
    • From asset management to liability management.
    • Asset management of post-war decades :
      • Large public sector (war) debt.
      • Readily tradable.
    • Quantitative controls -> ‘traditional’ situation maintained:
      • Liabilities side: Largely passive supply / customers’ deposits.
      • Assets side: Active adjustment of balance sheets.
  • 22.
    • From asset management to liability management, contd
    • From 1970s:
      • Banks actively create liabilities / borrow from other banks / ‘ money markets ’, as seen.
    • Preview of globalisation : UK CCC but US maintained Q:
      • -> impelled move of US banks into Eurodollar market.
  • 23.
    • Deregulation Phase (ii) Ending sharp distinction between banks and nbfis.
    • UK : Banks and building societies :
          • 1980s: banks allowed to compete in mortgage market.
          • 1986: building societies allowed to compete in market for consumer credit.
          • i.e. both allowed to compete in each others’ markets .
    • US : Once again, much restrictive legislation of 1930s remained in force till late, but:
          • 1980s: some competition with ‘thrifts’ allowed.
          • 1999: banks allowed more freedom to compete in investment banking, insurance, etc.
  • 24.
    • Deregulation Phase (iii) Allowing increased competition within financial sector and from outside it.
    • Within financial sector :
      • nbfis -> new kinds of financial services.
          • e.g. online banking – Egg, etc.
      • -> new kinds of nbfis competing with traditional banking.
    • Firms from outside financial sector enter financial services market:
      • UK : Tesco, Marks and Spencer, Virgin, etc.
      • US : Not only retail firms but also industrial:
          • e.g. General Motors.
          • General Electric’s financial arm -> 1/3 of its revenue!

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