Chapter 11 Part 1: Banking and the Forces of Change in the Financial-Services Industry Chapter 1: Overview of Banking and the Financial-Services Industry Chapter 2: Drivers of Change, Innovation, and Consolidation in the Financial-Services Industry Chapter 3: Technology in Banking: E-Money, E-Banking, and E-Commerce

Chapter 12 CHAPTER 1 OVERVIEW OF BANKING AND THE FINANCIAL-SERVICES INDUSTRY

Chapter 13 LEARNING OBJECTIVES The functions of a financial system and that “Banks do it” How to judge the efficiency of a financial system and how it interacts with the real economy Who the major players in the FSI are and how they are organized The role of the federal safety net and the difference between regulatory discipline and market discipline The dimensions of bank competition and how regulation shapes them TO UNDERSTAND....

Chapter 14 THE FUNCTIONS OF A FINANCIAL SYSTEM: Do Banks Do It? Clear and settle payments to facilitate trade and commerce Aggregate and disaggregate wealth and flows of funds so that both large-scale and small-scale projects can be financed Transfer economic resources over time, space, and industries Accumulate, process, and disseminate information for decision-making purposes Provide ways for managing uncertainty and controlling risk Provide ways for dealing with incentive and asymmetric-information problems that arise in financial contracting

Chapter 15 JUDGING THE EFFICIENCY OF A FINANCIAL SYSTEM Allocative Efficiency Operational or Cost Efficiency Informational or Price Efficiency

Chapter 16 HOW THE FINANCIAL SECTOR AFFECTS THE REAL SECTOR Credit Screening Activities Credit Rationing Creating Liquidity Facilitate Trade and Investment Activities Debt Restructurings Feedback Role

Chapter 17 PLAYERS IN THE FINANCIAL- SERVICES INDUSTRY Financial Holding Companies Ex: Citigroup, American Express, Capital One Financial Bank Holding Companies Ex: Bank of America, Wells Fargo, SunTrust Community Banks Securities Firms Ex: Merrill Lynch, MSDW, Charles Schwab Thrift Institutions Ex: Washington Mutual, Charter One Financial, Dime Bancorp

Chapter 18 PLAYERS IN THE FINANCIAL SERVICES INDUSTRY (Continued) Insurance Companies Ex: Aetna, AFLAC, Allstate Pension Funds Finance Companies Investment Funds Nonfinancial Corporations Venture Capitalists

Chapter 19 THE “-IZATION” OF THE FSI Institutionalization Securitization Globalization Privatization Modernization

Chapter 110 TYPES AND CLASSES OF COMMERCIAL BANKS National Banks -- Charters are issued by the Office of the Comptroller of the Currency (OCC) State Banks -- chartered by states and D.C. Fed-Member Bank -- Must be insured by the Federal Deposit Insurance Corporation Bankers’ Banks Pawnshops (“shadow banks”)

Chapter 111 BANK HOLDING COMPANIES (BHCs) Dominant Organizational Form in US is the BHC One-Bank Holding Company Multi-Bank Holding Company Evolution to LCBOs and FHCs

Chapter 112 MARKET CAPITALIZATION OF LARGE BHCs Citigroup = $285 Billion J.P. Morgan Chase Co = $96 Billion Bank of New York = $37 Billion These data are as of September 13, 2000 – update them. Have they recovered from the financial aftermath of the “Attack on America”?

Chapter 113 THE FEDERAL SAFETY NET: Two Basic Components Discount Window -- The lender of last resort for banks that encounter liquidity crises Deposit Insurance -- Provided by the FDIC, provides public confidence to the banking system The TBTF policy is implemented through these two components Moral Hazard -- refers to behavior that is altered by the existence of insurance

Chapter 114 HOW DOES THE SAFETY NET WORK? When banks experience financial difficulty, they... 1.Borrow funds from the lender of last resort, the Fed 2.The FDIC has time, called “forbearance”, to arrange a permanent solution to the bank’s problems, usually a merger with another viable bank in a purchase-and- assumption transaction 3.FDICIA (1991), however, calls for “prompt corrective action” or PCA

Chapter 115 Principal-Agent Relations, Regulatory, Discipline, and Market Discipline The key players in regulatory discipline are: Taxpayers as principals President/Congress as agents and then as principals Regulators as agents and then as principals Managers of insured depositories as agents and then as principals See Figure 1-2 (p. 16) for additional details

Chapter 116 TECHNIQUES FOR MANAGING THE SAFETY NET Monitoring the value of the collateral Restricting the kinds of assets acceptable as collateral, and Charging risk-based premiums

Chapter 117 THE “CAMEL” MODEL C = Capital Adequacy A = Asset Quality M = Management E = Earnings L = Liquidity (S = systemic risk, CAMELS)

Chapter 118 Regulatory Dialectic or Struggle Model Thesis Antithesis Synthesis

Chapter 119 THE RISKS OF BANKING Credit Risk Interest-Rate Risk Liquidity Risk Foreign-Exchange Risk

Chapter 120 Strength-in-Banking Equation Strength = New powers + Firm supervision New powers: GLB Act of 1999 (Modernization) Firm supervision: Risk-based capital requirements (regulatory discipline) and market discipline

Chapter 121 The Dimensions of FSI Competition Price User convenience/service Public confidence Both market forces and regulations shape these dimensions

Chapter 122 Chapter Summary Banks do it when it comes to the functions of a financial system We judge financial systems in terms of their efficiency – allocative, operating (cost), and price Banks are heavily regulated firms (e.g., risk- based capital requirements, CAMEL, etc.) and structured as holding companies – BHCs, LCBOs, and FHCs

Chapter 123 Summary (continued) Customers pick financial-services providers based on price, convenience, and confidence as shaped by market forces and regulators As banks gain new powers (GLB Act of 1999) firm supervision by markets and regulators is required to maintain strength in banking

Chapter 124 Summary (continued) Principal-agent relations play a key role in understanding how regulatory and market disciplines work The regulatory dialectic or struggle model captures the ongoing battle between regulated FSFs and their regulators – thesis, antithesis, and synthesis