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W. Jean Kwon, Ph.D., CPCU
School of Risk Management, St. John’s University
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E-mail: Kwonw@stjohns.edu
Risk Management and Insurance: Perspectives in a Global Economy
25. Financial Services Integration
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Study Points
 Meanings and forms of integration
 The economics of integration
 Management issues in integration
 Public policy concerns in integration
 The future of financial services integration
3
Meanings and Forms of Integration
4
Meanings of Financial Services Integration
 Meaning
• It occurs when a financial service traditionally associated with one of
the three main financial sectors is produced or distributed by
companies in another financial sector.
• It occurs at one of three levels: (1) supplier, (2) product or (3) advice.
 Various terms
•
•
•
•
Bancassurance
Allfinanz
Universal bank
Financial conglomerate – de facto or mixed
 Advisory integration
5
Structures for Delivery
 Full integration
 Universal bank (German variations)
 Bank (or insurer) patent
 Holding company arrangement
 Joint venture (or other similar arrangements)
6
Full Financial Services Integration (Figure 25.1)
Banking
Securities
Insurance
Other Financial
Activities
Activities
Activities
Activities
7
Universal Bank – German Variant (Figure 25.2)
Commercial Banking
Investment Banking
Activities
Activities
Insurance
Activities
Securities
Activities
8
Bank Ownership (Figure 25.3)
Commercial Banking
Activities
Securities
Activities
Insurance
Activities
Other Financial
Activities
9
Holding Company (Figure 25.4)
Financial Services
Holding Company
Banking
Activities
Securities
Activities
Insurance
Activities
Other Financial
Activities
10
The Economics of Integration
11
The Economics of Integration
 Cost effects
 Revenue effects
 Profit efficiency
12
The Economics – Cost Effect Analysis
 Economies of scale
 Economies of scope in production resulting from
•
•
•
•
Investment operations
Information technology
Distribution
Reputation
 Operational efficiencies
13
The Economics – Revenue Effect Analysis
 Economies of scope in consumption
 Market power
14
The Economics – Profit Efficiency Analysis
 A conglomerate could incur greater costs (resulting in cost
inefficiency) yet realize greater revenues (from revenue
efficiency) such that net profits increased.
 The reverse is also possible.
15
Management Issues in Integration
16
Issues in Integration (Figure 25.5)
17
Group Structure
 De jure (law-based) structure
 De facto (fact-based) structure
 Group structure decisions also relate to whether the
necessary manufacturing platforms will be acquired or
created de novo.
• Organic growth has been more successful than growth through
acquisition.
• Organic growth requires more time (investment).
18
Operational Complexity
 Especially relevant when integration is accomplished via
merger or acquisition
 The problem of complexity seems largely to be ignored at
present.
• “It is, to say the least, surprising that there should be such
widespread and critical [sic] acceptance of this need, with no precise
distinction between types of business and without meticulous
analysis of the many drawbacks that these processes may involve
and of the problematic nature of their purported advantages.”
19
Corporate Culture
 Corporate cultures varying across firms/industries
• Challenges for management of financial conglomerates, especially
those resulting from merger and acquisition.
 National differences in management dedication to
shareholder value – a principal-agent agency problem
• Focused banks
• Operate within a culture of shareholder value, use internationally
accepted accounting principles and have a sharper focus on
retail banking operations
• Universal banks
• Operate within a managerial culture, follow inferior accounting
practices and believe in universal banking as a concept
20
Inexperience and Lack of Expertise
 Pose vexing problems at the early stage of integration
• Particularly relevant in markets where financial services integration
was unprecedented
 Joint ventures and strategic alliances between domestic and
experienced foreign companies may prove most appealing
to both domestic and foreign entrants.
21
Marketing and Distribution
 Distribution among the most challenging for management of
integrated financial institutions
• Especially those groups created via merger and acquisition
• Insight 25.1
 Channel conflict less of a management challenge for de
novo operations
 Marketing issues associated largely with demand-side
economies of scope
22
Target Market Clarity
 Management must be clear about the group’s target market.
• Management must determine
• The classes of products to be offered
• Asset accumulation
• Debt management and asset protection products
• Distribution channels
 To date, most success in financial services integration has
been in the retail market.
 Some financial products may carry the potential of creating
diseconomies of scope
• Nonlife insurance is perhaps the most commonly discussed product
line.
23
Financial Management Issues
 Enterprise risk management
• Understanding the risk profile of the group as a whole
 Performance appraisal
• Banks historically have focused on interest spread, with return on
equity of more recent importance.
• Life insurers increasingly use embedded value analysis.
• Nonlife insurers use combined and operating ratios and return on
equity.
24
Conflict of Interest
 Conflicts
•
•
•
•
•
Salesperson’s stake
Stuffing fiduciary accounts
Bankruptcy risk transfer
Tie-in sales
Internal information transfer
 Incentive conflicts can be managed through regulation or by
finding a market solution
 Management of reputational risk is an increasing concern.
• Franchise
• Goodwill
25
Public Policy Concerns
26
Public Policy Concerns
 Financial services regulators are concerned primarily with
three broad categories of market imperfections:
• Information problems
• Market power
• Negative externalities
 Regulatory interventions
• Prudential
• Market conduct
• Competition policy
Refer to Figure 25.5
27
Public Policy Concerns – Information Problems
 Six issues in prudential regulation
•
•
•
•
•
•
Transparency
Contagion
Double and multiple gearing
Unregulated group entities
Fit and proper requirements
Regulatory arbitrage
“Issues in prudential regulation”
discussed in pages 669-673.
 Issues in market conduct regulation
• Conflict of interest
“Issues in market conduct regulation”
discussed in page 673.
28
Information Problems – Transparency
 Group transparency
 Disclosure (to external parties)
 Large international financial conglomerates can be
particularly complex
29
Information Problems – Contagion
 The risk
• Financial distress encountered by one unit in a financial
conglomerate could have adverse effects on the financial stability of
the group or on the entire market (i.e., negative externalities)
 Two types of contagion
• Psychological
• Inter-group exposures such as:
• Credit extensions or lines of credit between affiliates
• Cross-shareholdings
• Intra-group trading in securities
• Insurance or other risk management services provided by one
unit for another
• Intra-group guarantees and commitments
30
Information Problems – Gearing
 Types
• Double gearing
• Multiple gearing
 The issue is more on the proper assessment of a financial
conglomerate’s consolidated capital
• That is, less on the ownership structure flowing from it
31
Information Problems – Unregulated Entities
 Excessive leveraging
• An intra-group exposure
• An unregulated parent issues debt or other instruments not
acceptable as regulatory capital in a downstream entity and
downstreams the proceeds to a subsidiary firm in the form of equity
or other regulatory capital
• May also occur when the unregulated entity is an intermediate
holding company
 With an unregulated holding company, an assessment of
group-wide capital adequacy should encompass the effect
of the holding company’s structure.
32
Information Problems – Fit and Proper Requirements
 The probity and competence of the top management
 For regional and international financial conglomerates,
issues of supervisory jurisdiction arise.
33
Information Problems – Regulatory Arbitrage
 To the extent that industry-specific regulations and taxation
differ, arbitrage possibilities are created.
 Arbitrage possibilities influence decisions about the
structure of the group.
 A move toward consolidated financial regulation suggested
as a solution
34
Public Policy Concerns – Market Power
 Market power could:
• Arise from size alone if barriers to entry are great
• Evolve through predatory pricing
 The predatory pricing option seems remote, provided there
are not substantial barriers to entry.
35
Public Policy Concerns – Negative Externalities
 Systemic risk, most commonly associated with commercial
banking
 Are financial conglomerates riskier?
• A “too-big-to-fail” (TBTF) position?
 Does financial service integration pose additional burdens
on the safety net?
• Safety nets such as deposit insurance, guaranty funds, the discount
window and payment system guarantees
36
Regulatory Structure
 Single regulator?
• Could minimize the problems of information sharing and coordination
associated with sector-specific supervision
• Permit a less complex approach for addressing issues discussed
above
• Facilitate needed harmonization of accounting and capital adequacy
requirements across financial intermediaries
• Lessen opportunities for regulatory arbitrage
 Is creating a single regulator feasible in the local market?
• No international consensus has yet emerged on this issue.
37
Regulatory Structure
 Consolidated regulation suitable in a market where:
• Similar products/services are offered by different types of
intermediaries in the same market segments.
• Institutions in competing sectors have similar strategies for growth
and development in the domestic and/or the international market.
• Institutions in one sector create systemic risk exposure for another
industry.
• Competing sectors are at a similar and advanced stage of
development.
• Institutions are combining in ways that make it difficult to distinguish
a bank from an insurance firm.
• The financial services industry is pushing for reform to meet
competitive pressures.
38
The Future
 The present pressures for integration seem strong.
• The globalization of business in particular and financial services
specifically fosters integration.
 Financial services innovation and production efficiency are
essential to economic development.
• How integrated financial services fit into this evolution?
• Whether it poses unacceptable risk to consumers and the financial
system?
 The market will determine whether financial conglomeration
makes good business sense and, if so, the optimum
operational structure.
39
The Future
 Regulatory convergence in two dimensions
• Those aspects of national regulation and taxation that are specific to
one financial services industry or its products can be expected to
cause increasing distortion.
• International differences in regulation and taxation of financial
institutions and products increasingly will afford opportunities for
international regulatory and tax arbitrage.
40
Discussion Questions
41
Discussion Question 1
 If bancassurance becomes a globally accepted method of
insurance distribution, are consumers more likely to be
helped or harmed? How would your answer differ if the
same question were asked about a perfectly competitive
market compared with an oligopolistic market?
42
Discussion Question 2
 From a strictly marketing perspective, what role might
culture play in the process of financial services integration?
As the executive vice president of marketing for a global
conglomerate, how might your overcome these challenges?
43
Discussion Question 3
 Speculate about the degree to which each of the following
market segments would be affected (either positively or
negatively) if financial services competition were dominated
by financial services conglomerates: low, middle and upper
income?
44
Discussion Question 4
 What are some of the political ramifications of financial
services integration? As the financial services regulation
czar for the E.U., list the three most pressing challenges you
would have to overcome. How would you accomplish each?
45
Discussion Question 5
 Choose any two public policy issues. Argue either for
integration, citing potential solutions, or against integration,
citing reasons why the issue cannot be overcome?
46
Discussion Question 6
 If full integration were permitted tomorrow in your country,
how would the financial landscape look 1, 10 and 25 years
from now? What would be the impact on (a) the national
economy and (b) consumers?
47