4
Chapter
The Future of the Financial System
and the Money and Capital Markets
Money and Capital Markets
Financial Institutions and Instruments in a Global Marketplace
Eighth Edition
Peter S. Rose
McGraw Hill / Irwin
Slides by Yee-Tien (Ted) Fu
4-2
 Learning Objectives 
 To understand the economic, demographic,
social, and technological forces reshaping the
financial system today.
 To study where recent trends in the financial
system appear to be leading us and how we
may be affected.
 To understand how the problems of the
financial system today may influence the shape
of the financial marketplace of the future.
McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Introduction
 Powerful forces are reshaping the financial
system today, as well as the public’s demand
for financial services.
 These forces for change include powerful new
trends within the financial sector itself, major
changes in the structure and functioning of the
economy, and new social and demographic
trends that are altering the public’s need for
innovative financial services.
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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Financial Forces
Reshaping the Financial System Today
 Financial innovation - the development of new
financial services and instruments
 Service proliferation - the expansion of the
menu of financial services offered
 Competition - the intense struggle for the
customer’s business
 Homogenization - the blurring of the
traditional distinctions among the different
types of financial institutions
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Financial Forces
Reshaping the Financial System Today
 Consolidation and convergence - mergers and
acquisitions across sectors have created
financial giants and decreased the number of
firms in the industry
 Deregulation - the lightening or elimination of
government rules
 Globalization - the global expansion of
operations and the falling of geographical
barriers
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Financial Forces
Reshaping the Financial System Today
 Harmonization - the coordination of financial
and economic policies
 Market broadening - the expansion of
traditionally local markets to become regional,
national, or even international in scope
 Securitization - the pooling of loans and the
issuance of securities as claims against the
loan pool
 Greater emphasis on risk management
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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Social, Economic, & Demographic Forces and Trends
Reshaping the Financial System Today
 Aging population - there is a greater need for
retirement, tax and estate planning
 Changing basic family unit - the rise in the
proportion of single-parent households, parents
and children living apart, immigrants, and
well-educated working women will increase
the demand for new forms of housing, daycare
facilities, flexible work schedules, and less
expensive medical care.
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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Social, Economic, & Demographic Forces and Trends
Reshaping the Financial System Today
 Displacement of the manufacturing industries
by service industries in more developed
economies
 Technological innovation - the dissemination
and storage of information today is broader,
cheaper, faster, and more accurate
 Internationalization of markets - such as the
formation of the European Community
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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Risk in the Financial System:
The Challenges and Opportunities
 The money and capital markets and the
financial institutions that operate within them
depend heavily on public confidence.
 Ways to promote the strength and viability of
financial institutions, and hence public
confidence, include
government insurance systems
 capital adequacy regulations
 market discipline
 risk-management tools

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Risk in the Financial System:
The Challenges and Opportunities
 However, the efforts made at promoting public
confidence are limited by the information
problem - capital market investors can only
approximately price the securities of
institutions that do not fully disclose their
financial condition and prospects.
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New Technology:
The Challenges and Opportunities
 The technological revolution in information
analysis, storage, and transfer is moving at an
accelerating pace.
 Global integrated electronic networks are
changing the design and delivery of financial
services:
Internet or World Wide Web
 Cellular telephones and hand-held computers
 Smart cards

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New Technology:
The Challenges and Opportunities
 However, the adjustment of the public to the
unfolding technological revolution will
probably be slower than the revolution itself.
 The areas to watch include:
friendliness of the user interface
 operating costs and service prices
 ease of technological upgrade
 data integrity and system security

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Homogenization of Financial-Service Suppliers:
The Challenges and Opportunities
 Financial-service firms will face increasingly
intense competition and price-sensitive
customers.
 Financial institutions with extensive service
delivery systems will have a competitive
advantage.
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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Homogenization of Financial-Service Suppliers:
The Challenges and Opportunities
 The unfolding new markets will require new
financial institutions and instruments, such as
credit risk derivatives and additional secondary
markets for loans.
 New institutions will also be needed to
facilitate the continuing trend of securitization,
such as those that deal in mortgage-backed
securities.
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Consolidation and Convergence:
The Challenges and Opportunities
 Proponents argue that:
The elimination of duplication will bring about
substantial savings in operational costs.
 The broadening of services and customer segments
will accelerate the growth in revenue.
 The greater diversification will reduce overall risk.
 The combination of expertise will result in higherquality products and services.
 The greater economies of scale will increase the
affordability of the latest technologies.

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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Consolidation and Convergence:
The Challenges and Opportunities
 Opponents point out that:
The greater complexities of the firm may increase
its operating costs.
 The public’s demand for “one stop” financial
shopping may be overestimated.
 Smaller financial-service companies may have
their own competitive advantage.
 Smaller financial-service companies may compete
effectively in terms of the range of services
available by outsourcing part of their operations.

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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Financial Services Regulation
 The growing consolidation and convergence of
financial-service companies poses major new
challenges for the regulatory agencies charged
with maintaining a competitive, yet safe and
stable, financial system.
 Different approaches to regulation are possible
depending on the organizational structures that
are allowed.
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Financial Services Regulation
 Financial Holding Company Model
Financial Holding Company
Banking
Firms
McGraw Hill / Irwin
Insurance
Companies,
Underwriters
and Agents
Security
Brokers,
Dealers and
Underwriters
Other
FinancialService
Companies
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
4 - 19
Financial Services Regulation
 Subsidiary Model
Banking or Other Controlling Firm
Securities
Subsidiary
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Insurance
Subsidiary
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Financial Services Regulation
 Single Regulator Model - One regulatory
agency supervises the operations of the whole
financial service firm.
Holding Company or Parent Firm
Affiliated and/or Subsidiary Companies
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Financial Services Regulation
 Functional Regulator Model
Holding
Company
Regulator
McGraw Hill / Irwin
Holding Company or Parent Firm
Bank
Securities
Firm
Insurance
Company
Bank
Regulator
Securities
Regulator
Insurance
Regulator
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
4 - 22
Management Coordination
 The difficulties of coordination and control in
larger and more diversified financial
institutions call for:
employees who are well trained in coordination
and control skills,
 strong internal auditing procedures and
management information systems, and
 continual evaluation of subsidiary firms, profit
centers, and service functions for their
contributions to the goals of the financial firm.

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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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The Future of the Payments System
 Tomorrow’s economy and financial
marketplace will depend crucially upon the
continuing ability of the world’s payments
system to function efficiently, speedily, and
accurately.
 In the U.S., the retail payments system lags
significantly behind the wholesale payments
system in converting from expensive paper
transactions to electronic systems.
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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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The Future Need for
Regulation of Financial Institutions
 The recent trend toward deregulation is likely
to continue, leading to:
reduced barriers to geographic diversification,
 reduced restrictions on the portfolio choices made
by financial institutions,
 reorganization of regulatory agencies, and
 reduced barriers to product-line diversification.

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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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The Future Need for
Regulation of Financial Institutions
 However, there are some regulations which
will be maintained or even re-emphasized:
financial disclosure regulations,
 privacy protection regulations,
 regulations pertaining to social responsibility, and
 regulations that promote a level playing field.

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 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
4 - 26
Money and Capital Markets in Cyberspace
 A number of web sites are devoted to the
changes and trends that are reshaping the
money and capital markets. See, for example:

http://www.goldmoney.com/

http://www.thebankingchannel.com/

http://www.financetech.com/

http://www.ex.ac.uk/~RDavies/arian/money.html
McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Chapter Review
 Introduction
 Forces Reshaping the Financial System Today
Financial Forces
 Social, Economic, and Demographic Forces and
Trends

McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
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Chapter Review
 The Challenges and Opportunities Presented
by Recent Trends
Dealing with Risk in the Financial System:
Ensuring the Strength and Viability of Financial
Institutions
 The Effect of New Technology on the Design and
Delivery of Financial Services
 The Changing Mix of Financial-Service Suppliers
 Consolidation and Convergence Trends Within the
Financial System

McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
4 - 29
Chapter Review
 A New Role for Financial Services Regulation
in an Age of Financial-Service Consolidation
and Convergence
 Management Coordination within Diversified
Financial Institutions
 The Future of the Payments System
 The Future Need for Regulation of Financial
Institutions
McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.