Chapter One An Overview of the Changing Financial-Services Sector McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Key Topics • Powerful Forces Reshaping the Industry • What Is a Bank? • The Financial System and Competing FinancialService Institutions • Old and New Services Offered to the Public • Key Trends Affecting All Financial-Service Firms • Appendix: Career Opportunities in Banking and Financial Services McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-2 Introduction • Banks are the principal source of credit (loanable funds) for millions of individuals and families and for many units of government • Worldwide banks grant more installment loans to consumers (individuals and families) than any other financial-service provider • The assets held by U.S. banks represent about one-fifth of the total assets ▫ In other nations banks hold half or more of all assets in the financial system McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-3 What Is a Bank? • A bank can be defined in terms of: 1. The economic functions it performs 2. The services it offers its customers 3. The legal basis for its existence McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-4 Economic Function • Banks are involved in transferring funds from savers to borrowers (called financial intermediation) and in paying for goods and services. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-5 Services • Historically, banks have been recognized for the great range of financial services they offer • These services include checking and debit accounts, credit cards, savings plans, and loans ▫ Bank service menus are expanding rapidly today to include investment banking, insurance protection, financial planning, advice for merging companies, the sale of risk-management services to businesses and consumers, and numerous other innovative financial products McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-6 Legal Basis ▫ A bank is any business offering deposits subject to withdrawal on demand and making loans of a commercial or business nature ▫ Congress then defined a bank as any institution that could qualify for deposit insurance administered by the Federal Deposit Insurance Corporation (FDIC) ▫ Under federal law in the U.S., a bank had come to be defined, not so much by its array of service offerings, but by the government agency insuring its deposits McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-7 History of Banks • Most early banks were Greek or Roman in origin. ▫ Pledged their own money to support early ventures, but the idea of attracting deposits and lending emerged. ▫ Granted loans to shippers, landowners, and others at interest rates. • Spread through Europe. ▫ Encountered religious opposition during the Middle Ages because loans to poor carried the highest interest rates. ▫ The Industrial Revolution helped grow banks due to the need for ways to make payments and obtain credit in global trade. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-8 History of Banks (continued) • Banks in Europe were also used as a safe place for wealth such as gold and silver for a fee. ▫ In England, blacksmiths’ shops would hold valuables and issue tokens or certificates indicating the value of the items deposited. These soon became used as money. • In America, colonies used banks from the countries in which they had come, but later the states started chartering banking companies and the US federal government became involved in banking during the Civil War. • Other banking activities started emerging such as life insurance companies, saving and loan association, mutual McGraw-Hill/Irwin fund companies, and hedge© 2008 funds. The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 7/e 1-9 EXHIBIT 1-1 The Many Different Kinds of Financial-Service Firms Calling Themselves Banks McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-10 What Is a Bank? (continued) • Money-Centered Banks vs. Community Banks ▫ Money-center banks ▫ ▫ ▫ ▫ ▫ Industry leaders Cover whole regions, nations, and continents Offer the widest possible menu of financial services Acquire smaller businesses Face tough global competition ▫ Community banks ▫ Much smaller ▫ Service local communities and towns ▫ Offer a narrower, but often more personalized, menu of financial services McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-11 Banks as Financial Intermediaries • Financial-service providers are often referred to as financial intermediaries. • This is a business that interacts with the following two groups: 1. Deficit-spending individuals and institutions 2. Surplus-spending individuals and institutions • Act as a bridge between the two groups attracting surplus funds and distributing these funds to deficit spending individuals McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-12 The Financial System and Competing Financial-Service Institutions • Roles of the Financial System ▫ The primary purpose of the financial system is to encourage saving and to transfer those savings to individuals and institutions planning to invest and needing credit to do so ▫ This process of encouraging savings and transforming savings into investment spending causes the economy to grow, new jobs to be created, and living standards to rise ▫ The financial system also provides a variety of supporting services: ▫ ▫ ▫ ▫ Payment services Risk protection services Liquidity services Credit Services McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-13 The Financial System and Competing Financial-Service Institutions (continued) • The Competitive Challenge for Banks ▫ Lately, the financial market share that banking comprised has fallen ▫ Some authorities in the financial-services field fear that this apparent erosion of market share may imply that traditional banking is dying ▫ Other experts counter that banking is not dying but changing by offering new services and changing its form ▫ The banking industry’s largest customers have found ways around banks to obtain the funds that they need ▫ Borrowing in the open market ▫ Perhaps banking is being “regulated to death” McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-14 EXHIBIT 1–2 Comparative Size by Industry of Commercial Banks and Their Principal Financial-Service Competitors McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-15 The Financial System and Competing Financial-Service Institutions (continued) • Leading Competitors with Banks ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ Savings Associations Credit Unions Fringe Banks Money Market Funds Mutual Funds (Investment Companies) Hedge Funds Security Brokers and Dealers Investment Banks Finance Companies Financial Holding Companies Life and Property/Casualty Insurance Companies McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-16 The Financial System and Competing Financial-Service Institutions (continued) • Leading Competitors with Banks ▫ Financial-service providers are converging in terms of the services they offer ▫ The U.S. Financial Services Modernization (GrammLeach-Bliley) Act of 1999 has allowed many different types of financial firms to offer the public one-stop shopping for financial services ▫ The challenge of differentiating banks from other financial-service providers is difficult today McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-17 Services Banks and Many of Their Closest Competitors Offer the Public • Services Banks Have Offered for Centuries ▫ Carrying Out Currency Exchange ▫ Discounting Commercial Notes and Making Business Loans ▫ Offering Savings Deposits ▫ Safekeeping of Valuables and Certification of Value ▫ Supporting Government Activities with Credit ▫ Offering Checking Accounts (Demand Deposits) ▫ Offering Trust Services McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-18 Services Banks and Many of Their Closest Competitors Offer the Public (continued) • Services Banks and Many of Their Financial-Service Competitors Began Offering in the Past Century ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ Granting Consumer Loans Financial Advising Managing Cash Offering Equipment Leasing Making Venture Capital Loans Selling Insurance Policies Selling and Managing Retirement Plans Dealing in Securities: Offering Security Brokerage and Investment Banking Services ▫ Offering Mutual Funds, Annuities, and Other Investment Products ▫ Offering Merchant Banking Service ▫ Offering Risk Management and Hedging Services McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-19 TABLE 1–1 The Many Different Roles Banks and Their Closest Competitors Play in Today’s Economy McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-20 TABLE 1–2 Some of the Leading Financial-Service Firms around the Globe McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-21 Key Trends Affecting All Financial-Service Firms – Crisis, Reform, and Change • • • • • • • • • Service Proliferation Rising Competition Government Deregulation and then Reregulation Crisis, Reform, and Change in Banking and Financial Services An Increasingly Interest-Sensitive Mix of Funds Technological Change and Automation Consolidation and Geographic Expansion Convergence Globalization McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-22 Banking Ethics • Throughout history, the business of banking has rested on one fundamental principal- public trust. ▫ Institutions must have public trust or else deposits and services are sought elsewhere • Bear Sterns represents lost public trust ▫ Rumors started spreading that Bear Sterns was in trouble and unable to meet its obligations to other firms and customers worldwide. ▫ Sources of borrowed funds dried up and other financial institutions refused to lend to them ▫ The Federal Reserve stepped in and organized a McGraw-Hill/Irwin buyout to prevent a “domino effect” © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 7/e 1-23 Quick Quiz • What is a bank? How does a bank differ from most other financialservice providers? • Why are some banks reaching out to become one-stop financialservice conglomerates? Is this a good idea? • Which businesses are banking’s closest and toughest competitors? What services do they offer that compete directly with banks’ services? • What is happening to banking’s share of the financial marketplace and why? • How have banking and the financial-services market changed in recent years? What powerful forces are shaping financial markets and institutions today? McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-24 Appendix: Career Opportunities in Banking and Financial Services • What different kinds of professionals work inside financial firms? ▫ ▫ ▫ ▫ ▫ ▫ ▫ ▫ Loan Officers Credit Analysts Managers of Operations Branch Managers Systems Analyst Auditing and Control Personnel Trust Department Specialist Tellers McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-25 Appendix: Career Opportunities in Banking and Financial Services (continued) • What different kinds of professionals work inside financial firms? ▫ Security Analysts and Traders ▫ Marketing Personnel ▫ Human Resources Managers ▫ Investment Banking Specialists ▫ Bank Examiners and Regulators ▫ Regulatory Compliance Officers ▫ Risk Management Specialists McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-26