THE FUTURE OF BANKING

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THE FUTURE OF BANKING

  1. 1. FIN 653: Seminar in Bank Management <ul><li>Lecture 1.1: </li></ul><ul><li>Recent Bank Developments </li></ul><ul><li>Yea-Mow Chen </li></ul><ul><li>Department of Finance </li></ul><ul><li>San Francisco State University </li></ul>
  2. 2. <ul><li>I. Recent Bank Developments </li></ul>
  3. 3. I. Recent Bank Developments
  4. 4. I. Recent Bank Performance
  5. 5. I. Recent Bank Performance
  6. 6. I. Recent Bank Performance <ul><li>Bank Profitability Stabilized in the 90s </li></ul><ul><li>ROA of Different Size Banks, 1990-2000 </li></ul><ul><li>All $0m- $100m $1b- $10b </li></ul><ul><li>Year Banks $100m -$1b -$10b and above </li></ul><ul><li>____________________________________________________ </li></ul><ul><li>1990 0.49% 0.79% 0.78 0.76% 0.38% </li></ul><ul><li>1991 0.54 0.83 0.83 0.54 0.44 </li></ul><ul><li>1992 0.95 1.08 1.05 0.95 0.92 </li></ul><ul><li>1993 1.22 1.16 1.19 1.33 1.24 </li></ul><ul><li>1994 1.17 1.16 1.22 1.19 1.17 </li></ul><ul><li>1995 1.17 1.18 1.25 1.28 1.10 </li></ul><ul><li>1996 1.19 1.23 1.29 1.31 1.10 </li></ul><ul><li>1997 1.24 1.25 1.39 1.30 1.18 </li></ul><ul><li>1998 1.19 1.14 1.31 1.52 1.08 </li></ul><ul><li>1999 1.31 1.01 1.34 1.48 1.28 </li></ul><ul><li>2000 1.19 1.01 1.28 1.29 1.16 </li></ul><ul><li>2001 1.15 </li></ul><ul><li>2002 </li></ul><ul><li>2003 1.40 </li></ul><ul><li>2004________1.31________________________________________________ </li></ul>
  7. 7. I. Recent Bank Performance <ul><li>Bank Profitability Stabilized in the 90s </li></ul><ul><li>ROE of Different Size Banks, 1990-2000 </li></ul><ul><li>All $0m- $100m $1b- $10b </li></ul><ul><li>Year Banks $100m -$1b -$10b and above </li></ul><ul><li>____________________________________________________ </li></ul><ul><li>1990 7.64% 9.02% 9.95 10.25% 6.68% </li></ul><ul><li>1991 8.05 9.40 10.51 7.50 7.35 </li></ul><ul><li>1992 13.24 11.93 12.60 12.52 13.86 </li></ul><ul><li>1993 15.67 12.29 13.61 14.02 16.81 </li></ul><ul><li>1994 14.90 12.01 13.49 14.19 15.73 </li></ul><ul><li>1995 14.68 11.37 13.48 15.04 15.60 </li></ul><ul><li>1996 14.40 11.69 13.63 14.82 14.93 </li></ul><ul><li>1997 14.71 11.57 14.50 14.30 15.32 </li></ul><ul><li>1998 13.95 10.15 13.57 15.96 13.82 </li></ul><ul><li>1999 15.34 9.07 14.24 16.02 15.97 </li></ul><ul><li>2000 14.07 9.09 13.56 14.57 14.42 </li></ul><ul><li>________________________________________________________ </li></ul>
  8. 8. I. Recent Bank Performance
  9. 9. I. Recent Bank Performance
  10. 10. I. Recent Bank Performance
  11. 11. I. Recent Bank Performance
  12. 12. I. Recent Bank Performance
  13. 13. I. Recent Bank Performance
  14. 14. I. Recent Bank Performance
  15. 15. I. Recent Bank Performance
  16. 16. I. Recent Bank Performance
  17. 17. I. Recent Bank Performance
  18. 18. I. Recent Bank Performance
  19. 19. I. Recent Bank Performance
  20. 20. I. Recent Bank Performance
  21. 21. I. Recent Bank Performance <ul><li>The Increased Concentration in U.S. Banking ( trillions of 1999 dollars) </li></ul><ul><li>1990 1993 1996 1999 </li></ul><ul><li>_________________________________________________________ </li></ul><ul><li>Number of banks 12,370 11,001 9,576 8,698 </li></ul><ul><li>Total assets $4.22 $4.23 $4.80 $5.47 </li></ul><ul><li>% held by fifty largest BHCs 55.3 % 59.7 % 66.6 % 68.1% </li></ul><ul><li>%held by ten largest BHCs 25.6 % 31.6 % 38.5 % 44.8 % </li></ul><ul><li>Total domestic deposits $2.93 $2.76 $2.85 $3.08 </li></ul><ul><li>% held by fifty largest BHCs 48.0% 51.4% 56.9% 58.2% </li></ul><ul><li>% held by ten largest BHCs 17.3 % 22.0 % 26.2 % 33.6 % </li></ul><ul><li>_________________________________________________________ </li></ul><ul><li>Source: Consolidated Reports of Condition and Income , 1990-99. </li></ul>
  22. 22. II. Recent Banking Trends <ul><li>1. Deregulation/Re-regulation </li></ul><ul><li>Regulations took many forms including: </li></ul><ul><ul><li>Maximum interest rates that could be paid on deposits or charged on loans; </li></ul></ul><ul><ul><li>Minimum capital-to-asset ratios; </li></ul></ul><ul><ul><li>Minimum legal reserve requirements; </li></ul></ul><ul><ul><li>Limited geographic markets for full-service banking; </li></ul></ul><ul><ul><li>Constraints on the type of investments permitted, and restrictions on the range of products and services offered. </li></ul></ul>
  23. 23. II. Recent Banking Trends <ul><li>1. Deregulation/Re-regulation </li></ul><ul><li>CAMELS System: </li></ul><ul><li>Capital </li></ul><ul><li>Asset Quality </li></ul><ul><li>Management Quality </li></ul><ul><li>Earning Quality </li></ul><ul><li>Liquidity </li></ul><ul><li>Sensitivity to Market Risk </li></ul>
  24. 24. II. Recent Banking Trends <ul><li>1. Deregulation/Re-regulation </li></ul><ul><li>Banks and other market participants have consistently restructured their operations to circumvent regulation and meet perceived customer need. </li></ul><ul><li>In response, regulators or lawmakers would impose new restrictions, which market participants circumvented again. </li></ul><ul><li>This process of regulation and market response (financial innovation) and imposition of new regulations (re-regulation) is the regulatory dialectic. </li></ul>
  25. 25. II. Recent Banking Trends <ul><li>1. Deregulation/Re-regulation </li></ul><ul><li>Today banks are accessing the formerly forbidden areas of investment banking, by the repeal of the Glass-Steagall Act via the Financial Services Modernization Act (Gramm-Leach-Bliley Act of 1999). </li></ul>
  26. 26. II. Recent Banking Trends <ul><li>1. Deregulation/Re-regulation </li></ul><ul><li>Efforts at deregulation and re-regulation generally address: </li></ul><ul><ul><li>Pricing issues: removing price controls on the maximum interest rates paid to depositories and the rate charged to borrowers (usury ceilings). </li></ul></ul><ul><ul><li>Allowable geographic market penetration: The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 has eliminated branching restrictions. </li></ul></ul><ul><ul><li>New Products and services: Gramm-Leach-Bliley Act of 1999 has dramatically expanded the banks’ product choices; i.e., insurance, brokerage services, and securities underwriting. </li></ul></ul>
  27. 27. II. Recent Banking Trends <ul><li>Shortcomings of Current Banking Regulations: </li></ul><ul><ul><li>Does not prevent bank failures </li></ul></ul><ul><ul><li>Cannot eliminate economic risk </li></ul></ul><ul><ul><li>Does not guarantee that bank management will make good decisions </li></ul></ul>
  28. 28. II. Recent Banking Trends <ul><li>2. Rising Competition from other Financial Services Companies: </li></ul><ul><ul><li>Non-bank financial institutions especially finance companies, foreign institutions, and the public capital markets, have increased their market share in commercial lending at the expense of domestic commercial banks. </li></ul></ul><ul><ul><li>Non-financial institutions, such as Sears, AT&T, and General Motors, have increased their market share in consumer lending at the expense of the banks. </li></ul></ul>
  29. 29. II. Recent Banking Trends <ul><li>2. Rising Competition from other Financial Services Companies: </li></ul><ul><ul><li>Competition for deposits </li></ul></ul><ul><ul><li>Competition for loans </li></ul></ul><ul><ul><li>Competition for payment services </li></ul></ul><ul><ul><li>Competition for other financial services </li></ul></ul>
  30. 30. II. Recent Banking Trends <ul><li>Competition for deposits </li></ul><ul><ul><li>MMMFs were created by investment banks in 1973 and grew from $10.4 b in 1978 to almost $189 b in 1981. </li></ul></ul><ul><ul><li>Congress passed legislation enabling banks and thrifts to offer similar accounts including money market deposit accounts (MMDAs) and Super NOWS. </li></ul></ul><ul><li>Competition for loans comes in many forms: </li></ul><ul><ul><li>Commercial paper </li></ul></ul><ul><ul><li>Captive automobile finance companies </li></ul></ul><ul><ul><li>Other finance companies </li></ul></ul><ul><ul><li>Junk bonds </li></ul></ul>
  31. 31. II. Recent Banking Trends <ul><li>Competition for payment services is coming from emerging electronic payment systems, such as: </li></ul><ul><ul><li>Smart and stored-value cards </li></ul></ul><ul><ul><li>Automatic bill payment </li></ul></ul><ul><ul><li>Bill presentment processing </li></ul></ul><ul><ul><li>Cash money can be acquired at any teller machine </li></ul></ul><ul><ul><li>Open a checking account, apply for a loan and receive funds electronically </li></ul></ul>
  32. 32. II. Recent Banking Trends <ul><li>Competition for investment banking services: </li></ul><ul><ul><li>National Full-Line Firms </li></ul></ul><ul><ul><li>Investment Banking Firms </li></ul></ul><ul><ul><li>Underwriter </li></ul></ul><ul><ul><ul><li>Underwriter syndicate </li></ul></ul></ul><ul><ul><li>Broker versus Dealer </li></ul></ul>
  33. 33. II. Recent Banking Trends <ul><li>Competition for other financial services: </li></ul><ul><ul><li>Trust services </li></ul></ul><ul><ul><li>Brokerage </li></ul></ul><ul><ul><li>Data Processing </li></ul></ul><ul><ul><li>Securities underwriting </li></ul></ul><ul><ul><li>Real estate appraisal </li></ul></ul><ul><ul><li>Credit life insurance </li></ul></ul><ul><ul><li>Personal financial consulting </li></ul></ul>
  34. 34. II. Recent Banking Trends <ul><li>3. Financial Innovation </li></ul><ul><li>Innovations take the form of new securities and financial markets, new products and services, new organizational forms, and new delivery systems. </li></ul><ul><ul><li>Regulation Q brought about financial innovation as depository institutions tried to slow disintermediation. </li></ul></ul><ul><ul><li>Banks developed new vehicles to compete with Treasury bills, money market mutual funds, and cash management accounts. </li></ul></ul><ul><ul><li>Recent innovations take the form of new futures, options, options-on-futures, and the development of markets for a wide range of securitized assets. </li></ul></ul>
  35. 35. II. Recent Banking Trends <ul><li>3. Financial Innovation </li></ul><ul><li>One competitive response to asset quality problems and earnings pressure has been to substitute fee income for interest income by offering more fee-based services. </li></ul><ul><li>Banks also lower their capital requirements and reduce credit risk by selling assets and servicing the payments between borrower and lender rather than holding the same assets to earn interest. </li></ul><ul><li>This process of converting assets into marketable securities is called securitization. </li></ul>
  36. 36. II. Recent Banking Trends <ul><li>4. Off-Balance-Sheet Activities </li></ul><ul><li>Loan Commitments </li></ul><ul><li>Loan guarantees </li></ul><ul><li>Standby Letters of Credit </li></ul><ul><li>Interest Rate Swaps </li></ul><ul><li>Futures, Forwards & Options </li></ul><ul><li>Leases </li></ul>
  37. 37. II. Recent Banking Trends
  38. 38. II. Recent Banking Trends
  39. 39. II. Recent Banking Trends <ul><li>Securitization </li></ul><ul><li>Securitization is the process of converting assets into marketable securities. </li></ul><ul><li>It enables banks to move assets off-balance-sheet and increase fee income. </li></ul><ul><li>It increases competition for standardized produces such as mortgages and other cerdit-scored loans. </li></ul>
  40. 40. II. Recent Banking Trends <ul><li>Securitization </li></ul><ul><li>Benefits to financial institutions: </li></ul><ul><ul><li>Free capital for other uses </li></ul></ul><ul><ul><li>Improve ROE via servicing income </li></ul></ul><ul><ul><li>Diversify credit risk </li></ul></ul><ul><ul><li>Obtain new sources of liquidity </li></ul></ul><ul><ul><li>Reduce interest rate risk </li></ul></ul>
  41. 41. II. Recent Banking Trends <ul><li>5. Information Technology and Banking </li></ul><ul><li>(1). New technology had made offering new products available: </li></ul><ul><ul><li>Securitization would not be possible without the servicing software that controls and monitors cash flows. </li></ul></ul><ul><ul><li>Investors trade pools of credit card loans because they can assess default risk without knowing the creditworthiness of each borrower. </li></ul></ul><ul><ul><li>Swaps, swaptions, collars and caps are feasible and easier to use because computer pricing models narrow the bounds of mispricing and other errors. </li></ul></ul>
  42. 42. II. Recent Banking Trends <ul><li>(2). Derivative products for risk management: Banks' risk management has been improved with the striking advances in information technology: </li></ul><ul><ul><li>Artificial intelligence software can narrow the role of human judgment in the management of credit risk. </li></ul></ul><ul><li>(3). Internet banking had reduced costs substantially; </li></ul><ul><li>(4). New technology had relaxed the geographical market and product constraints, which led to a greater market consolidation. </li></ul>
  43. 43. II. Recent Banking Trends <ul><li>(5). But low-cost information is a double-edged sword: </li></ul><ul><ul><li>1. If loans are more liquid, then banks' private information about these loans and their role in monitoring the loans are both diminished. </li></ul></ul><ul><ul><li>2. If loans are securitized, any broker should be able to pool loans, issue traded claims against the pool, collecting interest and principal, and disbursing it to claim-holders. </li></ul></ul><ul><ul><li>3. If the bank's clients can manage interest risk with derivatives, why should they pay the bank for such protection? </li></ul></ul>
  44. 44. II. Recent Banking Trends <ul><li>6. Globalization </li></ul><ul><li>The gradual evolution of markets and institutions so that geographic boundaries do not restrict financial transactions. </li></ul><ul><li>Firms must recognize that businesses in other countries as well as their own are competitors, and that international events affect domestic operations. </li></ul>
  45. 45. II. Recent Banking Trends <ul><li>The 20 largest banks in the world, July 1, 2004 </li></ul>806,207 United Kingdom 10. Royal Bank of Scotland 950,448 Japan 9. Sumitomo Mitsui Financial Group 974.950 Japan 8. Mitibush Tokyo Financial Group 988,982 France 7. BNP paribus 1,014,845 Germany 6. Deutsche Bank 1,034,216 United Kingdom 5. HSBC Holdings 1,105,378 France 4. Credit Agricole Mutual 1,120,543 Switzerland 3. UBS Group 1,264,032 United States 2. Citigroup $1,285,471 Japan 1. Mizuho Financial Group Total Assets ($M) Country Bank
  46. 46. II. Recent Banking Trends <ul><li>The 20 largest banks in the world, July 1, 2004 </li></ul>637,829 China Industrial and Commercial Bank of China 650,721 United Kingdom 19. HSBC 667,636 Netherlands 18. ABN-AMRO Bank 681,218 France 17. Societe Generake 684,004 Netherlands 16. ING Bank 736,445 United Statements 15. Bank of America 753,631 Japan 14. UFJ Holdings 770,912 United States 13. J.P. Morgan Chase 777,849 Switzerland 12. Credit Suisse Group $791,292 United Kingdom 11. Barclays Bank Total Assets ($M) Country Bank

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