Presentation on theme: "FUNDAMENTAL FORCES OF CHANGE IN BANKING"— Presentation transcript:
1FUNDAMENTAL FORCES OF CHANGE IN BANKING SESSION 1INTRODUCTION TO BANK MANAGEMENTFUNDAMENTAL FORCES OF CHANGE IN BANKINGChapter 1
2Historical Bank Regulation Definition of Commercial BankAccept demand deposits and make commercial loans.Limitations on:Geographic ScopeProducts and Services
3Goals and Functions of Bank Regulation Ensure the Safety and Soundness of BanksProvide an Efficient and Competitive Financial SystemProvide Monetary StabilityMaintain the Integrity of the Payments SystemProtect Consumers from Abuses
4Safe, Sound, Efficient & Competitive System Supervision and ExaminationCAMELSCapitalAsset QualityManagement QualityEarnings QualityLiquiditySensitivity to Market Risk
5Safe, Sound, Efficient & Competitive System Supervision and ExaminationMemorandum of UnderstandingFormal regulatory documentCease and Desist OrderLegal documentHas legal standing
6Safe, Sound, Efficient & Competitive System New ChartersDual Banking SystemOffice of the Comptroller of the CurrencyCharters national banksOffice of Thrift SupervisionCharters federal savings banks and savings associationsNational Credit Union AdministrationCharters federal credit unions
7Safe, Sound, Efficient & Competitive System New ChartersState Banking AuthoritiesCharter state banksState Savings AuthoritiesCharter state savings banksState Credit Union AuthoritiesCharter state credit unions
8Safe, Sound, Efficient & Competitive System National versus State CharterAll banks obtain FDIC deposit insurance as part of the chartering processNational banks must join the FedPrimary regulator is the OCC
9Safe, Sound, Efficient & Competitive System National versus State CharterState banks may join the FedState banks are regulated by their state banking authority.State banks also have a primary federal regulatorThe primary federal regulator of state banks that are members of the Fed is the Federal ReserveThe primary federal regulator of Non-Fed member state banks is the FDIC
10Safe, Sound, Efficient & Competitive System Commercial Banks, Savings Institutions, and Credit UnionsCommercial BanksSpecialize in short-term business creditSavings InstitutionsSpecialize in real estate loans“Qualified Thrift Lender”Unitary Thrift Holding CompanyCredit Unions“Common Bond” requirement
12Safe, Sound, Efficient & Competitive System Federal Deposit InsuranceDepositors are currently insured up to $100,000 per qualify account per insured bankOriginal limit in 1933 was $5,000FDIC maintains the deposit insurance fund at 1.25% of insured deposits.Currently, the fund is “well-funded” and over 90% of banks pay no insurance premium
13Safe, Sound, Efficient & Competitive System Shortcomings of Restrictive Bank RegulationDoes not prevent bank failureCannot eliminate economic riskDoes not guarantee that bank management will make good decisions
14Monetary Stability & the Payments System The Federal Reserve SystemFundamental FunctionsConduct monetary policyProvide and maintain the payments systemSupervise and regulate banking operationsOrganizationBoard of Governors12 Federal Reserve District Banks
15Monetary Stability & the Payments System The Federal Reserve SystemMonetary Policy ToolsOpen Market OperationsOpen market purchases (sales) increase (decrease) reserves & the money supplyDiscount RateDecreasing (Increasing) the discount rate makes bank borrowing less (more) expensive, which leads to an increase (decrease) in the money supplyReserve RequirementsDecreasing (Increasing) reserve requirements increases (decreases) the money supply
16Monetary Stability & the Payments System Commercial Banks and the EconomyBanks are the primary conduit for monetary policyBanks are the primary source of credit for most small businesses and many individuals
17Efficient and Competitive Financial System Organizational Form of the Banking IndustryUnit banking versus Branch bankingBranching and Interstate ExpansionRiegle-Neal Act
18Efficient and Competitive Financial System Organizational Form of the Banking IndustryBank Holding CompaniesParentSubsidiariesOne-Bank Holding CompaniesMulti-Bank Holding Companies
19Exhibit 1.10 Organizational structure of the BHC
20Efficient and Competitive Financial System Organizational Form of the Banking IndustryFinancial Holding CompaniesCan engage in financial activities not permitted in a bank or bank holding companyFederal Reserve may not permit a bank holding company to convert to a financial holding company if the bank holding company is not well capitalized, well managed, or did not receive a satisfactory rating on its most recent CRA exam.
21Exhibit 1.11 Organizational structure of a financial holding company BankHoldingCompanySecuritiesSubsidiariesInsuranceSubsidiaryThrift HoldingRealEstateFinancial Holding Companyand ServiceCompaniesThrift CompanyNonbankBanking Company
22Efficient and Competitive Financial System Organizational Form of the Banking IndustryHolding Company Cash FlowParent company’s net income is typically derived from dividends, interest, management fees from equity in subsidiaries, and interest paid on holding company debt.Parent company typically pays little in income tax since 80% of dividends from subsidiaries is exempt.
23Efficient and Competitive Financial System Organizational Form of the Banking IndustryNon-bank Activities Permitted By Bank Holding Companies“Closely related to banking”* Loans* underwriting and brokerage* consulting* general management services
24Efficient and Competitive Financial System Organizational Form of the Banking IndustryMergers and ConsolidationsMergers must be approved, dependent on the classification of the surviving bankOCC approves national bank mergersState member banks by the Federal ReserveState non-member banks by the FDIC
25Efficient and Competitive Financial System Organizational Form of the Banking IndustryMergers and ConsolidationsMotivation for mergers and consolidation:Cut costsImprove profitabilityIncrease competitive positionCross-sell financial products & services
26Consumer Protection Reg. B Reg. Z Equal Credit Opportunity Cannot discriminate on the basis of sex, race, marital status, religion, age, or national origin.Reg. ZTruth-in-LendingRequires disclosure of:Effective interest rates, total interest paid, total of all paymentsWhy credit was denied
27Trends in Federal Legislation & Regulation Current Unresolved Regulatory IssuesCapital AdequacyIncreased capital requirements make banks safer, from a regulator’s perspectiveHowever, increasing capital requirements also has disadvantages:Equity is more expensive than debtMost banks do not have ready access to the equity marketsThis can lead to more consolidation
28Trends in Federal Legislation & Regulation Current Unresolved Regulatory IssuesDeposit Insurance ReformToo Big to FailShould $100,000 insurance limit be increased?Non-bank Financial Services CompaniesShould banks that lend to hedge funds, like Long-Term Capital Management, be required to hold additional capital?
29Trends in Federal Legislation & Regulation Current Unresolved Regulatory IssuesNew PowersReq. Q still prevents banks from paying explicit interest on commercial demand deposit accountsMost banks would like to be able to pay interest on commercial demand deposit accountsWhat are the costs and benefits?
30Banking Business Models Global BanksInternational presenceNationwide BanksCoast-to-coast presenceSuper-Regional BanksExtensive operations in a limited geographic area of the U.S.Regional BanksSpecialty Banks
31Exhibit 1.17 DISTRIBUTION OF THE NUMBER OF BANKS AND TOTAL ASSETS BY TOTAL ASSETS: 1995 - 2004
32Banking Business Models Specialty BanksAlso known as:Community BanksIndependent BanksTypically have less than $1 billion in assetsOrganization
33Exhibit 1.18 Organizational structure of an independent bank
34Banking Business Models Specialty BanksPersonnelSenior Credit OfficerCashier/Chief Financial OfficerSenior Operations OfficerSenior Investment OfficerBranch Area Executive
35Fundamental Forces of Change Deregulation/ReregulationFinancial InnovationSecuritizationGlobalizationAdvances in Technology
36Fundamental Forces of Change Role of Regulation Regulatory DialecticProcess of regulation, market response, and reregulationFinancial Innovation
37Fundamental Forces of Change Increased Competition For DepositsInterest rate ceilings and inflationFor LoansCommercial paperJunk bondsCredit scoringCredit derivatives
38Fundamental Forces of Change: Off-Balance Sheet Activities Loan CommitmentsLoan guaranteesStandby Letters of CreditInterest Rate SwapsFutures, Forwards & OptionsLeases
39Fundamental Forces of Change: Impact of Nonbank Competition Captive Finance CompaniesGeneral Finance CompaniesFund their loans by issuing commercial paper and long-term bonds. Their cost of funds is higher than a bank’s, but they charge higher rates.
40Fundamental Forces of Change: Competition for Payments Services Credit CardsDebit CardsPrepaid CardsCHIPSACH
41Fundamental Forces of Change: Competition for Other Bank Services Trust ServicesBrokerage ServicesData ProcessingReal Estate AppraisalCredit Life InsurancePersonal Financial Consulting
42Fundamental Forces of: Change Investment Banking National Full-Line FirmsInvestment Banking FirmsUnderwriterUnderwriter syndicateBroker versus Dealer
43Fundamental Forces of Change: Deregulation and Re-regulation Eliminating existing regulationsReregulationImplementing new restrictions on banking activities
44Fundamental Forces of Change: Financial Innovation Innovation may be caused by a bank wanting to:Enter into a new geographic marketEnter into a new product marketDeliver services less expensivelyEtc.
45Fundamental Forces of Change: Securitization The process of converting assets into marketable securitiesMortgagesCredit card receivables
46Fundamental Forces of Change: Globalization Is the evolution of markets and institutions where geographic boundaries do not restrict financial transactions or competition
47Fundamental Forces of Change: Technology Advances in TechnologyAdvances in technology increase the scope of the global market place and competitionAdvances in technology also reduce the need for an intermediary by providing easy access to informationIncreasing competition by reducing the cost of being an information intermediary