AN OVERVIEW OF
BANKING SECTOR
Chapter 1
1
William Chittenden edited and updated the PowerPoint slides for this edition.
 Nearpod
 Chapter review: mind-map
2
Key topics
1.
2.
Bank definitions
Bank regulation
Goals of regulation
 Regulators
 Rationality of regulation

3.
4.
5.
6.
Bank functions
Bank services
Bank organization
Fundamental sources of changes
3
What is a bank?

Definition by functions it serves
 Institutions
involves in transferring funds from
savers to borrowers (financial intermediation)
& in paying for goods and services

Definition by services it offers to
customers
 Accept
deposits, make commercial loans,
offer trust services, manage cash, etc.
4
What is a bank?

Necessity of a legal definition:
 Regulation
purpose
 Banking service menu is expanding
 Other financial-service institution provide
similar services
5
What is a bank?

Definition by legal basis for regulation
 US:
any institution that could qualify for
deposit insurance administered by the
FDIC
 VN:
a credit institution permitted to conduct
all banking activities and other related
business operations.
6
What is a bank?

Definition by legal basis for regulation
 VN:
"Banking activities" are monetary
business activities and banking services, the
regular operation of which is the receipt of
deposits and use of that to extend credits,
provide payment services;
 VN: "Non-bank credit institution" is a credit
institution permitted to engage in some
banking activities as its regular business, but
not permitted to receive individual deposits
and to provide payment services.
7
homework
 Diagram of banking activities based on
the Law on credit institution
8
Page. 3/Exhibit 1-1
9
10
11
Financial service competitors of banks










Savings associations
Credit unions
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
12
Page. 6, 7
13
Page. 6, 7
14
Page. 6, 7
15
The Many Different Roles Banks and Their
Closest Competitors Play
 Page. 9/Table 1-1
16
17
Rationale of regulations on financial firms


Regulations of financial firms and
experiences of youth – p. 28
Read Insights and Issues – p. 30
18
Goals of bank regulation







Ensure safety and soundness of banks protecting
public’s savings and confidence
Provide an efficient and competitive financial system
Provide monetary stability to achieve national broad
economic goals
Maintain the integrity of the payments system
Ensure equal opportunity and fairness in the public’s
access to financial services
Provide government with credit, tax revenues and
other services
Help sectors that have special credit needs
19
Banking principal regulatory agencies (US)

Federal Reserve System (FED)

Comptroller of the Currency (OCC)

Federal Deposit Insurance Corporation (FDIC)

Department of Justice

Securities and Exchange Commission (SEC)

State Boards of Commissions
20
Banking principal regulatory
agencies (VN)

State Bank of Vietnam (SBV)

Deposit Insurance of Vietnam (DIV)

Ministry of Finance (MOF)

State Securities Commission of Vietnam (SSC)
21
Why banks are closely regulated?


Banks are among leading repositories of public’s
savings
Bank’s power of creating money in form of readily
spendable deposits

Banks provide individuals and businesses with loans for
consumption and investment, which should be equally
and adequately supplied.

Government rely upon banks in conducting economic
policies, collecting taxes and dispensing government
payment.
22
Shortcomings of restrictive bank regulation

May encourage monopoly due to conditional entry

Does not prevent bank failure

Cannot eliminate economic risk

Does not guarantee that bank management will
make good decisions, but create a struggle
between regulators and banks going on definitively

Less-regulated business win customers away from
more-regulated banks.
23
The Federal Reserve System

The Federal Reserve System
 Fundamental
 Conduct
 Provide
Functions
monetary policy
and maintain the payments system
 Supervise
and regulate banking operations
 Organization
 Board
 12
of Governors
Federal Reserve District Banks
24
State Bank of Vietnam
25
The Federal Reserve System

Monetary Policy Tools
 Open
Market Operations
 Open
market purchases (sales) increase
(decrease) reserves & the money supply
 Discount
Rate
 Decreasing
(Increasing) the discount rate makes
bank borrowing less (more) expensive, which
leads to an increase (decrease) in the money
supply
 Reserve
Requirements
 Decreasing
(Increasing) reserve requirements
increases (decreases) the money supply
26
Commercial banks and the economy

Banks are the primary conduit for monetary policy

Banks are the primary source of credit for most
small businesses and many individuals

Banks are the major repository of public savings

Banks are the principal operator of payment
system.
27
Nearpod
Code
Name
28
Traditional services offered by banks
1. Carrying out currency exchange
2. Discounting commercial notes and making
business loans
3. Offering savings deposits
4. Safekeeping of valuables
5. Supporting government activities with credit
6. Offering checking accounts
7. Offering trust services
29
Carrying out currency exchange




Bank trade one form of currency to another in
return for fee
Start from early days of banks
Become more complicated in the global
financial market
Be provided by large and well-experienced
banks
30
example
USD/VND: 23400 – 23430- 23770
Customer: $10.000 sell to VCB
Calculate VND customer receives?
Solution:
VND = 10.000* 23400 =
$10.000 available in customer’s demand
deposit VND = 10.000*24430
31
Discounting commercial notes and
making business loans

Discounting commercial notes/making loans to
merchants based on accounts receivable

Making direct loans for purchasing inventories
of goods (short-term) or for constructing new
facilities (long-term)

Be provided by banks and many other financialservice competitors

Be the core and main revenue-earning service
of many banks
32
Offering savings deposits

Be the earliest and major source of fund for
making loan

Compose of many types different in maturity,
form of currency, interest, etc.

Be the most stable funding source

Deposit is subject to reserve requirement and
insurance
33
Safekeeping of valuables
 Keep gold and other valuables of customers in secure
vaults in return for fee
 Start since the old days of banks in the Middle Ages
 Question: which banks are famous for this service?
Why?
34
Supporting government with credit

Banks in Europe during the Industrial
Revolution and in America during the
Revolutionary War had to purchase
government bonds with a portion of deposits.

The custom continues in the modern world

Banks use government bond as a shelter of
liquidity risk and a source of revenue
35
Offering checking accounts

Demand deposits permit depositors to write
draft/cheque for payment of goods and services

Be one of the most important offerings of the
industry

Service is provided by not only banks but also
credit unions, savings associations, etc.

Today the service is extended to the internet
with the use of smart cards

Provide banks with cheap source of fund.
36
 Suppose a bank raised $100 in selling
deposits (savings deposit and demand
deposits)
 Can a bank lend the entire $100 to
borrowers? No
(1) Reserve requirement (1% to 8%) => MS
(2) Deposit insurance: premium =>
Leftover
37
Offering trust services

Banks manage financial affairs and property of
individuals and firms in return for fee

In property management, banks acts as a
trustee for wills, managing the deceased
customer’s estate,…

In commercial trust department, bank manages
pension plan for businesses and acts as an
agent issuing stocks and bonds.
38
More recent services offered by banks
8. Granting consumer loans
9. Providing financial advice
10. Managing cash
11. Offering equipment leasing
12. Making venture capital loans
13. Selling insurance policies
14. Selling retirement plans
15. Dealing in securities: brokerage and
investment banking services
39
Granting consumer loans




By early 20th century, banks started lending
consumers given the heavy competition for
business deposits and loans
The trend has increased rapidly after the World
War 2
Other current competitors for the consumer
credit accounts are credit unions and credit
card companies.
The service bears high risk but returns high
earnings.
40
 Customers: individuals and households
 Purpose of lending: to finance the
purchase of new houses, automobiles,
appliances; to repair or modernize
houses; to cover personal expenses
(education cost, medical cost…)
 Features: high risk but small size, high
interest rate on consumer loans
41
Providing financial advice

Banks gains good reputation for understanding
and experience in the financial market

Customers ask for advice, particularly in credit
utilization, saving or investing funds

Services provided are plentiful including
financial plan preparation, marketing
opportunity consultation, fund seeking,
investment options, etc.
42
Managing cash

Bank handle cash collection and disbursement
for firms, invest temporary cash surpluses

Service is expanded to individuals and firms

Bank earns not only fee, but also low-cost fund
in demand deposit accounts
43
Offering equipment leasing
Bank/Lessor
Firm/Lessee
Equipment
Vendor
44
 Term of leasing: last at least 60% of
economic life of leased assets
 At the end of contract, lessee can buy
leased asset at favourable price
 Bank’s revenue = fixed payments
periodically
=> The present value of series of fixed
payments will cover the market value of
leased asset.
45
 Operating lease
 Financial lease
46
Making venture capital loans

Finance the start-up cost of new companies

Implement through a venture capital firm
because added risk

The venture capital firm raise fund from
investors, who are looking for high profit
47
Selling insurance policies




Banks sell insurance policies through acquiring
control of insurance companies
Banks can gain high earning in the high-risk
insurance industry
Banks possess privileges over independent
insurer in terms of customers, branches,
system, etc.
Insurance agencies are affiliates or Bank
Holding Company (BHC) or Financial Holding
Company (FHC)
48
 3 ways using to offer insurance policies
(i) Banks permit insurance company to rent
banks’ lobby
(ii) Banks establish insurance company in
terms of (a) associated company or (b)
affiliated company
49
Selling retirement plans



Bank actively involves in managing retirement
plan of businesses make available to
employees
Incoming fund is invested to wisely selected
securities ensuring acceptable risk and return
Bank also is in charge of dispensing payment to
retired or disabled employees.
50
Dealing in securities





Bank provides security brokerage service and security
underwriting/investment banking services
Bank offer mutual funds, annuities and other
investment products with clear consultation to
customers regarding higher expected yields and risk
Bank temporarily buy stocks of large corporation aiding
new business launching or company expansion by
offering merchant banking services
Bank acts as risk intermediation providing customer
with risk hedging tools (e.g. swap, option, future
contract) offered by themselves or from third party
Services are provided through affiliated securities firms
or security companies.
51
Organizational form of the banking industry
 Unit
banking versus Branch banking
 Offer
all Services from one office
 One
of the oldest kinds of banks
 New
banks are generally unit banks until can
grow and attract more resources
52
Assignment
 List name of revenues, expenses or
profit banks gain or incur from offering
each of financial services.
53
Organizational form of the banking industry

Branch banking
Offer full range of services from several
locations
 Senior management at the home office
 Each branch has its own management team with
limited decision making ability
 Some functions are highly centralized, while
others are decentralized

54
3-55
Organizational form of the banking industry
What trend in branch banking has been
prominent in the U.S. in recent years?
Year
# of Bank
Main
Offices
# of
Branch
Offices
Total of
U.S. Bank
Offices
Ave # of
Branches/
U.S. Bank
1934
14,146
2,985
17,131
0.21
1970
13,511
21,810
35,321
1.61
1982
14,451
39,784
54,235
1.75
2007
7,241
77,947
85,188
10.76
From Table 3-2; Source: FDIC
55
Bank branch policy in Vietnam
New branch set up – Circular No. 21/2013/TT-NHNN
VND 300 billion x N1 + VND 50 billion x N2 < C
Of which:

C: the real value of the charter capital of commercial bank till the
time of request (VND billion).
 N1: quantity of branches which have been established and
requested for establishment at Hanoi and Ho Chi Minh urban area.
 N2: quantity of branches which have been established and
requested for establishment at Hanoi suburban, Ho Chi Minh
suburban; and other provinces and centrally-run cities.
56
Question for discussion
a)
b)
c)
Why do the quantity of branches are
directly related to equity value?
What is the difference between head
quarter and branch of banks?
Why quality of bank branches are strictly
supervised by Central bank?
57
Quality of branching
c) To comply with limitations to ensure safety in
operation of credit institutions specified in Articles
126, 127, 128, 129; Clause 1 Article 130 and
Article 135 of Law on Credit Institutions in 2010
and guides of State Bank of Vietnam for this
provision uninterruptedly during 12 months before
the request month;
58
Organizational form of the banking industry
 Bank
holding companies
 Parent
 Subsidiaries
 One-Bank
holding companies
 Mutli-Bank
holding companies
59
Organizational form of the banking industry

Bank holding companies
A
corporation chartered for the purpose of
holding the stock of one or more banks
 Control of a bank is assumed when 25% or
more of the stock is owned
 Must get approval from federal reserve board
to control a bank
 One-Bank holding companies vs. multibank
holding companies
60
Bank holding companies vs financial
hoding companies

BHC: A corporation chartered for the purpose
of holding the stock (equity shares) of at least
one bank, often along with other businesses.

OBHC (One-bank holding company): control
one or more non-bank businesses.

MBHC (Multibank holding company): a minority
of bank holding company organizations. (eg.
Exhibit 3.8 + ad/dis on MBHC – p80)
61
Bank holding companies vs financial
hoding companies




Affiliated banks: banks acquired by holding
companies.
Independent bank: Not owned by holding
companies
FHC: special type of holding company that may
offer the broadest range of financial services,
including dealing in and underwriting securities,
and selling and underwriting insurances.
E.g. of FHC: p 83 – Exhibit 3.9
62
Exhibit 1.10
Organizational structure of the BHC
Single Bank Holding Company
Board of Directors
Parent Company
Bank Subsidiary
Each subsidiary has a
president and line officers
Nonbank Subsidiaries
Bank Branches
The bottom four levels have the same organizational form as the independent bank.
Multibank Holding Company
Board of Directors
Parent Company
Bank Subsidiary
Nonbank Subsidiaries
Bank Subsidiary
63
Bank Branches
Bank Branches
3-64
Organizational form of the banking industry
Nonbank Businesses of BHCs








Finance Companies
Mortgage Companies
Data Processing
Companies
Factoring Companies
Security Brokerage Firms
Financial Advising
Credit Insurance
Underwriters
Merchant Banking







Investment Banking
Firms
Trust Companies
Credit Card Companies
Leasing Companies
Insurance Companies
and Agencies
Real Estate Services
Savings Associations
64
Organizational Form of the Banking Industry





Financial holding companies
Special type of holding company
Offers the broadest range of services
List of activities offered may expand as
regulators decide what services are
‘compatible’ with banking
Each affiliated financial firm has its own
capital and management and its own profit
or loss
65
Organizational Form of the Banking Industry
 Financial
Holding Companies
 Can
engage in financial activities not permitted
in a bank or bank holding company
 Federal Reserve may not permit a company to
form a financial holding company or a bank
holding company to convert to a financial
holding company if

any of its insured depository institution subsidiaries is
not well capitalized, well managed, or
 did not receive a satisfactory rating on its most
recent CRA (Community Reinvestment Act) exam.
66
Exhibit 1.11
Organizational structure of a financial holding company
Financial Holding
Company
Bank
Securities
Subsidiaries
Holding
Insurance
Subsidiary
Company
Banking
Company
Real
Thrift Holding
Company
Estate
Subsidiary
Nonbank
Subsidiaries
Thrift Company
Subsidiaries
and Service
Companies
67
Quick quiz

What are the differences between Bank
Holding Companies and Financial Holding
Companies?
68
Organizational form of the banking industry

Bank subsidiaries
 Bank
controls one or more subsidiaries
 Subsidiaries offer other services such as
insurance and security brokerage services
 Profits and losses of each subsidiary impact
parent Bank
 Parent
company’s net income is typically
derived from dividends, interest,
management fees from equity in subsidiaries,
and interest paid on holding company debt.
69
Banking Business Models

Global Banks
 International

presence
Nationwide Banks
 Coast-to-coast

presence
Super-Regional Banks
 Extensive
operations in a limited
geographic area of the U.S.
Regional Banks
 Specialty Banks

70
Exhibit 1.17 DISTRIBUTION OF THE NUMBER OF
BANKS AND TOTAL ASSETS BY TOTAL ASSETS:
1995 - 2004
1995
1997
1999
2001
2003
2004
1995
1997
1999
2001
2003
2004
Number of
Banks
10,242
9,451
8,580
8,080
7,769
7,630
Total
Assets
$4,116
$4,642
$5,735
$6,569
$7,603
$8,413
< $100 M
7,123
(69.55%)
6,147
(65.04%)
5,157
(60.10%)
4,486
(55.52%)
3,911
50.34%
3,655
(47.90%)
Assets Size
$100M - $1B
$1B - $10B
2,741
331
(26.76%)
(3.23%)
2,900
331
(30.68%)
(3.50%)
3,029
318
(35.30%)
(3.71%)
3,194
320
(39.53%)
(3.96%)
3,434
341
44.20%
4.39%
3,530
360
(46.26%)
(4.72%)
> $10B
63
(0.62%)
73
(0.77%)
76
(0.89%)
80
(0.99%)
83
1.07%
85
(1.11%)
< $100 M
$310
(7.54%)
$277
(5.97%)
$243
(4.23%)
$222
(3.37%)
$201
(2.64%)
$189
(2.25%)
Asset Size
$100M - $1B
$1B - $10B
$668
$1,077
(16.22%)
(26.17%)
$711
$995
(15.32%)
(21.45%)
$755
$915
(13.16%)
(15.96%)
$819
$915
(12.47%)
(13.93%)
$910
$947
(11.97%)
(12.46%)
$953
$973
(11.33%)
(11.57%)
> $10B
$2,061
(50.07%)
$2,658
(57.27%)
$3,823
(66.65%)
$4,613
(70.22%)
$5,545
(72.93%)
$6,297
(74.85%)
71
Banking Business Models

Specialty banks
 Also
known as:
 Community
Banks
 Independent Banks
 Typically
have less than $1 billion in
assets
 Organization
72
Exhibit 1.18
Organizational structure of an independent bank
73
Organizational structure – Vietcombank
Operation Center
INTERNAL AUDIT DEPT
ADMINISTRATION DEPT
HUMAN RESOURCES MGMT DEPT
DIRECTOR
LOAN WORKOUT UNIT
Nguyen My Hao
PROJECT INVESTMENT DEPT
CORPORATE BANKING DEPT
DEPUTY DIRECTOR
DEPUTY DIRECTOR
DEPUTY DIRECTOR
Nguyen Hung Son
Nguyen Thi Bao
Pham Thi Mai
TRANSACTION OFFICES
SME CREDIT DEPT
FOREX AND TREASURY DEPT
GUARANTEE DEPT
INTERNATIONAL PAYMENT DEPT
VIP DEPT
FOREX AND TREASURY DEPT
DEBT HANDLING DEPT
AID AND LOANS SETTELEMENT DEPT
PERSONAL BANKING DEPT
CARDS DEPT
BUDGET DEPT
INFORMATION TECHNOLOGY DEPT
SERVICE BUSINESS DEPT
FINANCIAL ACCOUNTING DEPT
TRANSACTION ACCOUNTING DEPT
74
Banking business models

Specialty banks
 Personnel
 Senior
Credit Officer
 Cashier/Chief Financial Officer
 Senior Operations Officer
 Senior Investment Officer
 Branch Area Executive
75
Fundamental forces of change

Service Proliferation

Rising competition

Deregulation/reregulation

Crisis, reform and change in banking and financial
services

Increasingly interest-sensitive mix of funds

Tech change and automation

Consolidation & geographic expansion

Convergence

Globalization
76
Fundamental forces of change:
Role of Regulation

Regulatory Dialectic
 Process
of regulation, market response,
and reregulation

Financial Innovation
77
Fundamental forces of change:
Increased Competition

For Deposits
 Interest

rate ceilings and inflation
For Loans
 Commercial
paper
 Junk
bonds
 Credit scoring
 Credit derivatives
78
Fundamental forces of change:
Off-Balance Sheet Activities
Loan commitments
 Loan guarantees
 Standby letters of credit
 Interest rate swaps
 Futures, forwards & options
 Leases

79
Fundamental forces of change:
Impact of Nonbank Competition

Captive Finance Companies
A
subsidiary whose purpose is to provide
financing to customers buying the parent
company's product (e.g. General Motors
Acceptance Corporation (GMAC))

General Finance Companies
 Fund
their loans by issuing commercial
paper and long-term bonds. Their cost of
funds is higher than a bank’s, but they
charge higher rates.
80
Fundamental forces of change:
Competition for Payments Services

Credit Cards

Debit Cards

Prepaid Cards

CHIPS

ACH
81
Fundamental forces of change:
Competition for Other Bank Services

Trust services

Brokerage services

Data processing

Real estate appraisal

Credit life insurance

Personal financial consulting
82
Fundamental forces of change:
Change Investment Banking

National full-line firms

Investment banking firms

Underwriter
 Underwriter

syndicate
Broker versus Dealer
83
Fundamental forces of change:
Deregulation and Re-regulation
 Deregulation
 Eliminating
existing regulations
 Reregulation
 Implementing
new restrictions on banking
activities
84
Fundamental forces of change:
Financial Innovation

Innovation may be caused by a bank
wanting to:

Enter into a new geographic market

Enter into a new product market

Deliver services less expensively

etc.
85
Fundamental forces of change:
Securitization

Securitization
 The
process of converting assets into
marketable securities
 Mortgages
 Credit
card receivables
86
Fundamental forces of change:
Globalization

Globalization
 Is
the evolution of markets and institutions
where geographic boundaries do not restrict
financial transactions or competition.
87
Fundamental forces of change:
Technology

Advances in Technology

Advances in technology increase the scope of the
global market place and competition

Advances in technology also reduce the need for
an intermediary by providing easy access to
information

Increasing competition by reducing the cost of
being an information intermediary
88
Problems
You recently graduated from university with a business degree
and accepted a position at a major corporation earning
more than you could have ever dreamed. You want to
1. Open a checking account for transaction purposes
2. Open a saving account for emergencies
3. Invest in an equity mutual fund for that far-off future called
retirement
4. See if you can find more affordable auto insurance, and
5. Borrow fund to buy a condo given you uncle said he was so
proud of your grades and he wanted to give $20,000 for a down
payment.
Make five lists of financial service firms that could provide you
with each of these services
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Problems - Answers
(1) Financial service firms that provide checking account
services include banks, credit unions and savings and
loan associations. Even securities brokers allow you to
open checking accounts. Recently brokers such as
Schwab have become more aggressive in offering
interest-bearing online checkable accounts that often post
higher interest rates than many banks are willing to pay.
(2) To open a savings account, one could approach
traditional commercial banks, savings associations, credit
unions, or online brokerages and banks with higher yields
but less ‘brick and mortar’ support.
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Problems - Answers
(3) For a retirement fund one could choose from a plethora of
defined benefit and defined contribution schemes from
private pension funds. Banks, brokerages and insurance
firms offer a variety of retirement investment options
including equity mutual funds.
(4) For affordable auto insurance one could use a traditional
insurer such as Allstate or State Farm or approach some of
the newer discount insurers including Geico and
Progressive. Alternatively, one could use a reverse auction
service such as Esurance to get the best rate.
Note: reverse auction service: http://en.wikipedia.org/wiki/Reverse_auction
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Problems - Answers
(5) To borrow funds to buy a condo one could
approach a traditional bank, savings associations
that specialize in granting home mortgage loans,
or financial companies such as GMAC. A reverseauction site such as LendingTree might also be
useful in this exercise. The borrower is not limited
to a mortgage loan for financing the purchase of a
condo. Other lending mechanisms are available to
finance such purchases.
Note: LendingTree: http://www.answers.com/topic/lendingtree
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Joint-venture, foreign branch and
100% foreign banks

Allowed to conduct operations similar to
domestic banks

Obligatorily follow regulations in VN

For foreign branch, decisions are made
depending on the foreign home bank policy 
less independence
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Rep office of foreign banks
1. Operate as liaison office
2. Conduct market research
3. Develop investment projects of foreign credit
institutions in Vietnam ;
4. Promote and monitor the implementation of
contracts, agreements signed between foreign
credit institutions and Vietnamese credit
institutions and enterprises, projects funded by
foreign credit institutions in Vietnam
 No direct profitable activities
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AN OVERVIEW OF
BANKING SECTOR
Chapter 1
95
William Chittenden edited and updated the PowerPoint slides for this edition.