1. Trust Services as a Source of Fee Income
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Trust Services as a Source of Fee Income
Trust services is the management of property owned by customers, such as securities, land, buildings, and other assets
Among the oldest nondeposit services that banks and some of their closest competitors offer parts of the financial firm
Trust departments often generate large deposits because they manage property for their customers
Deposits placed in a bank by a trust department must be fully secured
Popular kinds of trusts:
Living trusts
Testamentary trusts
Irrevocable trusts
Charitable trusts
Indenture trusts
Establishment of fiduciary relationship is critical
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2. Sales of Insurance-Related Products
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Sales of Insurance-Related Products
Banks can use their branches to sell insurance
Over 100 banks today sell their own insurance products in the United States
Types of insurance products sold today:
Life insurance policies
Property/casualty insurance policies
Life insurance underwriters and property/casualty insurance underwriters manage their respective risks
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3. Sales of Insurance-Related Products (continued)
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Sales of Insurance-Related Products (continued)
There are mandatory public disclosures on the part of depository institutions selling insurance products that stipulate:
An insurance product or annuity is not a deposit or other obligation of a depository institution or its affiliate
An insurance product or annuity sold by a depository institution in the United States is not insured by the FDIC, any other agency of the U.S. government, the depository institution itself, or its affiliates
Insurance products or annuities may involve investment risk and possible loss of value
U.S. depository institutions cannot base granting loans on the customer’s purchase of an insurance product or annuity from a depository institution or any of its affiliates or on the customer’s agreement not to obtain an insurance product or annuity from an unaffiliated entity
These disclosures must be made both orally and in writing before completion of the sale of an insurance product
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4. The Alleged Benefits of Financial-Services Diversification
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The Alleged Benefits of Financial-Services Diversification
When two or more different industry types merge with each other, this strategic move is called convergence
One possible benefit is the relatively low correlation that may exist between cash flows or revenues generated by the sale of traditional industry products versus the sale of nontraditional products
But because streams of revenue from different product lines may move in different directions at different times, the overall impact of combining these different industries and products under one roof may be to stabilize combined cash flows and profitability
The risk of failure might also be reduced
This potential consequence of the convergence of two or more financial-service industries is called the product-line diversification effect
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5. The Alleged Benefits of Financial-Services Diversification (continued)
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The Alleged Benefits of Financial-Services Diversification (continued)
Example of what could happen to overall institutional risk by combining traditional and nontraditional financial services
Suppose a banking company decides to add insurance services to its existing product menu
It expects to earn a 12 percent average return from sales of its traditional banking products and a 20 percent return from selling or underwriting insurance services
These two service lines are equally risky in the variance of their cash flows (with a standard deviation of about 5 percent each)
The banking firm expects to receive 20 percent of its revenues from insurance sales and 80 percent from sales of traditional banking products
The cash flows from the two sets of services are negatively correlated over time with a correlation coefficient of -0.50
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6. The Alleged Benefits of Financial-Services Diversification (continued)
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The Alleged Benefits of Financial-Services Diversification (continued)
What would happen to the bank’s overall return from sales of traditional and nontraditional products in this case?
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7. The Alleged Benefits of Financial-Services Diversification (continued)
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The Alleged Benefits of Financial-Services Diversification (continued)
And what happens to the risk of return for this bank?
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8. The Alleged Benefits of Financial-Services Diversification (continued)
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The Alleged Benefits of Financial-Services Diversification (continued)
And what happens to the risk of return for this bank?
Offering both traditional and nontraditional banking services lowers the bank’s standard deviation of its overall return
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9. The Alleged Benefits of Financial-Services Diversification (continued)
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The Alleged Benefits of Financial-Services Diversification (continued)
Other potential benefits from offering multiple services include economies of scale and economies of scope
Economies of scope refer to a situation in which the joint costs of producing two or more services in one firm are less than the combined cost of producing each of these services through separate firms
For example, if a single financial firm produces two services (S1 and S2), instead of producing only one service (S1), using the same resources, its cost of production (C) may be lower as follows
As a result, expanding the number of financial services offered may result in more intensive use of resources, reducing overall costs and widening a multiservice firm’s profit margin
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10. Information Flows within the Financial Firm
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Information Flows within the Financial Firm
Financial firms have become more and more like pure information-gathering, information-processing, and information-dispersing businesses
The Gramm-Leach-Bliley Act of 1999 allowed financial- service companies to share customer information among their affiliated firms and also with independently owned third parties provided customers did not expressly say “no” to (or “opt out” of) having their personal data distributed to others
Protecting customer privacy became increasingly more important
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11. 14-11
EXHIBIT 14–1 Key Items That Must Be Included in a Financial Firm’s Privacy Policy and Be Sent to Its Customers at Least Once a Year
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12. 14-12
Quick Quiz
What services are provided by investment banks? Who are their principal clients?
What advantages do commercial banks with investment banking affiliates appear to have over competitors that do not offer investment banking services? Possible disadvantages?
What are investment products? What advantages might they bring to an institution choosing to offer these services?
How do trust services generate fee income and often deposits as well for banks and other financial institutions offering this service?
What is convergence? Product-line diversification? Economies of scale and scope? Why might they be of considerable importance for banks and other financial-service firms?
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