Chapter 4
The Future of the Financial
System and the Money and
Capital Markets
4-2
 Learning Objectives 
• To explore the economic, demographic, social, and
technological forces reshaping the financial system today.
• To learn about recent trends in the financial system and how
they may affect us in the future.
• To understand how the problems the financial system faces
today may affect its future, leading to a new financial
marketplace.
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Introduction
• Powerful forces are reshaping financial institutions and
financial services today.
• 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 new financial
services.
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Financial Forces
Reshaping the Money and Capital Markets Today
• Financial innovation - the development of many 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
• Consolidation - mergers and acquisitions have created
financial giants out of numerous smaller financial-service
providers
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Financial Forces
Reshaping the Money and Capital Markets Today
• Deregulation - the lightening or elimination of government
rules brought about by a strategy of privatization of the
financial sector
• Convergence - the blurring of the traditional distinctions
among different types of financial-service institutions
• Homogenization - the growing similarity in the service menus
offered by financial institutions
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Financial Forces
Reshaping the Money and Capital Markets Today
• Globalization - the global expansion of operations and the
falling of geographical barriers
• 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
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Social, Economic, & Demographic Forces
Reshaping the Financial System
• 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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Social, Economic, & Demographic Forces
Reshaping the Financial System
• Displacement of 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 emergence of the
European Union
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Forces Affecting the Financial System of the Future
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Dealing with 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.
• Loss of public confidence not only produces adverse
consequences for individual financial institutions but also
damages the efficiency of financial market processes.
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Dealing with Risk in the Financial System:
The Challenges and Opportunities
• The strength and viability of financial institutions, and hence
public confidence, can be promoted through:
- government insurance systems
• Federal Deposit Insurance Corporation (FDIC)
• Pension Benefit Guaranty Corporation (PBGC)
- regulation of capital
• equity capital requirements
- private responses
• market discipline
- developing better 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 upgrades
data integrity and system security
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The Changing Mix of Financial-Service
Suppliers:
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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The Changing Mix of Financial-Service
Suppliers:
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 towards securitization of many of the credit-related
assets held by lending institutions and other corporations.
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Consolidations and Convergences:
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 higher-quality
products and services.
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Consolidations and Convergences:
The Challenges and Opportunities
• Proponents argue that:
- The greater economies of scale will increase the affordability of
the latest technologies.
- The greater efficiency in joint marketing and cross-selling will
help tie in customers.
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Consolidations and Convergences:
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 have
been 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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Financial Services Regulation
• The growing consolidation and convergence of financialservice companies poses major new challenges for the
regulatory agencies charged with maintaining a competitive,
yet safe and stable, financial system.
• This dual concern has led to the development of several
different regulatory approaches.
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Financial Services Regulation
• Financial Holding Company Model
Financial Holding Company
Banking
Firms
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Insurance
Companies,
Underwriters
and Agents
Security
Brokers,
Dealers and
Underwriters
Other
FinancialService
Companies
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Financial Services Regulation
• Subsidiary Model
Banking or Other Controlling Firm
Securities
Subsidiary
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Insurance
Subsidiary
Other
FinancialService
Subsidiaries
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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
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Holding Company or Parent Firm
Bank
Securities
Firm
Insurance
Company
Bank
Regulator
Securities
Regulator
Insurance
Regulator
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Financial Services Regulation
• 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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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 behind the
wholesale payments system in converting from expensive
paper transactions to electronic systems.
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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,
- reduced barriers to product-line diversification, and
- greater reliance on firms’ self-assessments of financial risks.
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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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Markets on the Net
• American Bankers Association at
www.aba.com/Industry+Issues
• Consumer Law at www.consumerlaw.org
• Federal Deposit Insurance Corporation at www.fdic.gov
• Federal Reserve System at www.federalreserve.gov
• Federal Trade Commission at www.ftc.gov
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Markets on the Net
•
•
•
•
•
FinPipe at www.finpipe.com/derivglossary.htm
New York Stock Exchange at www.nyse.com
Pension Benefit Guaranty Corporation at www.pbgc.gov
Quote.com at www.quote.com
U.S. Bureau of the Census at www.census.gov
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Chapter Review
• Introduction: The Financial Markets in Change
• Financial Forces Reshaping the Money and Capital Markets
Today
• Social, Economic, and Demographic Forces Reshaping the
Financial System
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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 and Increasing
Public Confidence
- The Effect of New Technology on the Design and Delivery of
Financial Services
- The Changing Mix of Financial-Service Suppliers
- Consolidations and Convergences within the Financial System
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Chapter Review
• A New Role for Financial-Services Regulation in an Age of
Financial-Services Consolidation and Convergence
• The Future of the Payments System
• The Future Need for Regulation of Financial Institutions
- Regulations That Could Grow
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