FINANCIAL SERVICES LECTURE 1 1 Chara Charalambous CDA COLLEGE Objectives Define the changing market for personal financial services: Political, Economic and social climate for financial services. 2 Chara Charalambous CDA COLLEGE Financial Services Financial services refer to services provided by the financial industry. The finance industry includes a broad range of organizations that deal with the management of the money. Among these organizations are banks ,credit card companies, insurance companies, stock brokerages and investment funds. 3 Chara Charalambous CDA COLLEGE Types of financial services Banks Issuance of cheque books Provide personal loans / commercial loans Foreign Exchange Services Currency exchange Foreign currency banking ATMs Wire transfer 4 Chara Charalambous CDA COLLEGE Investment Services Asset Management Insurance Insurance brokerage The Market-place for Financial Services It is a reality that the range of financial services has been increased and competition between providers of financial services has become intense. Financial markets faced drastic changes in the demand conditions and supply conditions which in turn brought changes in the financial – economic environment. To survive in the new environment financial institutions search for innovations and design new products and services that would meet customer needs and prove profitable.This process is called financial engineering. 5 Chara Charalambous CDA COLLEGE Reasons of changes in financial services Why these changes occurred? Reasons: 1. The authorities wanted to make financial services more competitive because this benefits the consumer, so restrictions on various institutions (such as bank lending) have been removed. 2. The consumer became more educated in financial matters and also the attitude and needs of individuals changed in nowadays. 3. The idea of the financial services ‘supermarket’ from which the customer can get access to a wide range of financial services and advice. 4. Technological innovation making it possible to service increased numbers of customers 5. Managers are looking to diversify – to spread – the risk of investing 6. Globalization: access to new markets and opportunities, remove of restrictions of international capital flows, introduction of worldwide standards in most fields of finance. 6 Chara Charalambous CDA COLLEGE The Changing Customer Lifestyle changes: people owning their own house, cars and other 7 means of convenience, also travelling e.t.c and therefore the material comfort and inflation increased our needs for borrowing and investing. It is generally accepted that is better to buy immediately and pay the cost of borrowing because later prices will go up and also is better to enjoy the benefit today than waiting in the future. Personal loans and credit cards facilitate immediate spending and the above trends. Increasing demand for long term investments due to the shifts toward contributory private pension system. Technological developments such as ATM machines (Automatic Teller Machines) which give availability of cash 24 hours per day benefit the producers of goods and services. Chara Charalambous CDA COLLEGE People are more educated in nowadays and also women are more independent, career pursuers and in this has contributed the maternity leave. Also Technological developments have reduced asymmetric information and transaction costs permitting individuals to gather and analyze information more efficiently. Customer attitudes to various banking facilities have changed over recent years: since 1970 the bank accounts have increased almost by 50%. 8 Chara Charalambous CDA COLLEGE The banking industry has responded to these changes by using a wide range of technologies: 1. They use statistical and economical models to improve portfolio management. 2. Create new and complex products and they can satisfy multiple needs of their customers. 3. Telecommunication emergence of internet and the IT connectivity: purchase of a product electronically, transfer of deposits electronically, payments electronically (payroll, suppliers e.t.c). 9 Chara Charalambous CDA COLLEGE Industry Consolidation and Integrated Financial Services 10 Chara Charalambous CDA COLLEGE An integrated financial services company is an organization that provides insurance, banking and asset management to its customers through a variety of distribution channels (internet or advisors e.t.c). Stand-alone bank or stand alone insurance can not satisfy anymore the needs of consumers 11 Chara Charalambous CDA COLLEGE The Financial Supermarket Model: Integrated Online Financial Services 12 Chara Charalambous CDA COLLEGE 13 Online banking (or Internet banking or E-banking) allows customers of a financial institution to conduct financial transactions on a secure website operated by the institution, which can be a retail bank or building society. The common features fall broadly into several categories, including : viewing account balances viewing recent transactions downloading bank statements, for example in PDF format viewing images of paid cheques ordering cheque books Bank customers can transact banking tasks through online banking, including Funds transfers between the customer's linked accounts Paying third parties, including bill payments and wire transfers Investment purchase or sale Loan applications and transactions, such as repayments of enrolments Make bill payments Transaction approval process Some financial institutions offer unique Internet banking services, for example some online banking platforms support account aggregation to allow the customers to monitor all of their accounts in one place whether they are with their main bank or with other institutions. Chara Charalambous CDA COLLEGE Online Banking Online banking pioneered by NetBank and WingSpan Established brand name national banks have taken a substantial lead in market share Over 50 million people use online banking, and around 40 million households Movement toward online banking is global 14 Slide 11-14 Chara Charalambous CDA COLLEGE The Growth of Online Banking, 2000–2010 Figure 11.3, Page 628 SOURCE: Based on data from eMarketer, Inc., 2005a. 15 Chara Charalambous CDA COLLEGE E-commerce in Action: E*Trade E*Trade: 4.3 million online customers; offers online brokerage, banking, lending, corporate financial services Discounted commissions on stock trades, free online information, online order entry, more efficient order execution, and better customer service Online brokerage industry growth noticeably 1998 - 2000; has slowed somewhat since. 16 Slide 11-16 Chara Charalambous CDA COLLEGE Financial Portals and Account Aggregators Financial portals: Provide comparison shopping services, independent financial advice and financial planning Examples: Yahoo! Finance, Quicken.com, MSN Money, AOL’s Money and Finance channel Account aggregation: Process of pulling together all of a customer’s financial (and even non-financial) data at a single personalized Web site Yodlee, a leading provider of account aggregation technology; used by Merrill Lynch, Citigroup, Chase, others. Yodlee is an American software company that develops an account aggregation service that allows users to see their credit card, bank, investment, email, travel reward accounts, etc. on one screen. In addition, Yodlee MoneyCenter, a free web application that helps consumers manage their finances online, provides features such as bill payment, expense tracking, and investment management Raises issues about privacy and control of personal data, security, etc. 17 Chara Charalambous CDA COLLEGE 'Financial Portal' A website that provides a variety of financial data and information, acting as an information centre for clients who are individual investors requiring timely financial news and data to make their investment decisions. Financial portals are intended to give clients all the financerelated information they need. Often, the portals themselves will provide visitors with quotes, research, articles, analyst recommendations, etc. Financial portals may also provide links to various relevant sites that offer this kind of information. In addition, many financial portals provide email accounts, chat rooms and web forums. 18 Chara Charalambous CDA COLLEGE 'Account Aggregation A process by which accounts are linked for the purpose of combining fees or to ease access for account holders. Example: One form of account aggregation is house holding, whereby all the savings, checking and brokerage accounts of a household are linked. In householded accounts, statements and online summaries display all accounts within the household. Account aggregation may also include credit card accounts that are issued by the institution where the linked accounts are held or which are tied in some way to a particular account. Account aggregation usually only occurs within a single institution, although certain assets held outside a financial institution may be linked if there is a prearranged procedure for doing so. Aggregating accounts can be particularly useful for families who have multiple financial goals, since the statements give a complete picture of the family's financial assets. One of the first major account aggregation services was Citibank’s My Accounts service, though this service ended in late 2005 without explanation from Citibank. Account aggregation has evolved with single sign-on at most major banks such as Bank of America. 19 Chara Charalambous CDA COLLEGE Sources of finance Banks Buildings Societies Finance houses 20 Chara Charalambous CDA COLLEGE Building Societies A type of financial institution that provides banking and other financial services to its members especially mortgage lending. A cooperative organization that accepts deposits of money from savers and uses them to make loans, secured by mortgages, to house buyers. Since 1986 they have been empowered to offer banking services. They are owned entirely by their members. These societies offer mortgages and demand-deposit accounts and are often backed by insurance companies. "Building society" was first introduced as a term in 19th century England from groups of co-operative saving groups - savers in the building trades. These institutions are now major competitors of banks in the U.K for most consumer banking services, especially mortgage lending and savings accounts. and are the equivalent of U.S. savings and loan institutions. Building societies can also be found in other countries, such as Australia, Ireland and Jamaica 21 Chara Charalambous CDA COLLEGE 'In-House Financing‘ or ‘Finance House’ A financial institution that lends to people or businesses, so that they can buy things such as cars or machinery. Finance companies are often part of commercial banks, but operate independently. In-house financing eliminates the firm's dependence on the financial sector as it provides the customer with funds to complete a transaction. The automobile sales industry is a major user of in-house financing. Many vehicle sales rely on the buyer taking a loan. In-house financing allows the firm to complete more deals by accepting more customers. Whereas banks or other financial intermediaries might turn down a loan application, car dealerships of finance houses can choose to lend to customers with poor credit ratings. In-house financing is linked with hire-purchase contracts. 22 Chara Charalambous CDA COLLEGE 'Hire Purchase' A method of buying goods through making regular instalment payments over time while enjoying the use of the goods. The term hire purchase originated in the U.K., and is similar to what are called "rent-to-own" arrangements in the United States. Under a hire purchase contract, the buyer is leasing (hire/rent) the goods and does not obtain ownership until the full amount of the contract is paid: During the repayment period, ownership (title) of the item does not pass to the buyer. Upon the full payment of the loan, the title passes to the buyer. 23 Chara Charalambous CDA COLLEGE Personal Saving and Home Loans There have been significant changes in personal saving. A key indicator of the level of funds available for savings is the Personal Savings Ratio. This ratio shows savings as a percentage of personal disposable income which is mainly wages and salaries. It is influenced by the pattern of savings, borrow and spending on capital assets. People save for a number of reasons including retirement, for those ‘rainy days’ or a specific purpose such as a piece of furniture, wedding, baby or car. The level and variability of income is important and also the general level of prices and services. High interest rates may encourage savings and inflation may also have an effect. For example the increased uncertainty associated with inflation may have generated higher levels of savings as a form of protection. There have also been significant changes in the home loans market. The retail banks re-entered the market in early 1980and have become serious alternative providers to the buildings societies, who previously dominated the mortgage market. Also during 1994-95 many lenders introduced ‘mortgage direct’ services through which possible customers make enquiries and even mortgage applications on the telephone. This development is changing the role of traditional branches and agencies. 24 Chara Charalambous CDA COLLEGE Privatizations in UK and other financial services Privatizations: it is the process of transferring ownership of a business, enterprise, agency, public service or public property from the public sector (a government) to the private sector: to a business that operate for a profit. Share ownership has been increased in the decade of1980 because of the UK’s Government privatization program of nationalized industries (British Telecom, British Gas, Abbey National Building Society) also because of the rising share values and because of the profit seeking of individuals. This trend has been adopted by the rest of the world. However in late 2000 stock markets around the world suffered a general decline. Many other areas have seen changing customer attitudes. Both insurance and pensions customers have become more aware, partly due to the advertisement of insurance and pension products, of the need to make appropriate provision for the future. Therefore there is the emerge of life insurance products, whole life insurance products, annuities, insurance based investments. Further more the PEPs arise and Unit Trusts. 25 Chara Charalambous CDA COLLEGE Personal Equity Plans (Peps) An investment vehicle formerly used in the United Kingdom in1986 26 to encourage investment by small investors. A government-backed scheme to encourage share-ownership and investment in industry. Individual taxpayers can each invest a certain amount of money in shares each year, and not pay tax on either the income or the capital gains, provided that the shares are held for a certain period of time. PEPs were replaced by ISAs (Individual Savings Accounts) in April 1999, but existing schemes will continue. There are several types of equity PEP: the single-company PEP, where only shares in one company are allowed, and the general PEP, where shares in several companies can be held or other types of investment can be made. The advantages of a Personal Equity Plan are, first that it is a very easy way of investing in the stock market. Under the scheme an authorized plan manager looks after the individual investor’s investments. The plan manager purchased shares and sells them on behalf of the individual to make the most of stock market opportunities. Secondly, Personal Equity Plans are tax – free. Profits from the sales of shares held within the plan are free of any capital gains tax. Chara Charalambous CDA COLLEGE Units Trusts Many individuals cannot accumulate large enough pools of money to 27 give them access to an expensive service or product or a financial product. Unit Trust enables the individual investor to have access and invest in expensive shares-securities! Unit Trust is a form of collective investment represented by a trust deed. A collective investment scheme is a way of investing money together with other investors in order to benefit from the advantages of working as part of a group. Unit trusts are the pooled – concentrated - gathered resources of thousands of investors who have entrusted their money to a management company. Unit trusts are not insurance products. Many insurance companies who market life assurance, retirement annuities and other related products, also act as management companies for unit trusts. Along with life assurance, retirement annuities, etc., unit trusts fulfil a very important role in the individual's portfolio. Chara Charalambous CDA COLLEGE The success of a unit trust depends on the expertise and experience of the management company. Common types of investments undertaken by unit trusts are property, securities, mortgages and cash equivalents. In the U.K. the term "unit trust" is synonymous with "mutual fund" as it is used in North America. 28 Chara Charalambous CDA COLLEGE Appendix 'Asymmetric Information’: A situation in which one party in a transaction has more or superior information compared to another. 'Portfolio Management’: The art and science of making decisions about investment mix and policy, matching investments to objectives, asset share for individuals and institutions, and balancing risk against performance. Portfolio management is all about strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs encountered in the attempt to maximize return at a given appetite for risk. 29 Chara Charalambous CDA COLLEGE