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- AMERICAN COLLEGE
- S K O P J E
- PRINCIPLES OF BANKING
- Chapter 5
- Instructror : Tome Nenovski, Ph. D.
2. 5. BANK INDUSTRY INNOVATIONS
- - Bank innovation factor for keeping or even, increasing bank wealth;
- - Because of many reasons, traditional banking is not as profitable as it used to be:
- - Some traditional bank products have stopped being sold;
- - Fund resources have become narrow;
- - Strong bank regulation: Liabilities interest rates limitation;
- - Needs for new profitable bank products;
- 5. BANK INDUSTRY INNOVATIONS
- - Developing new balance and off balance products;
- - Appearance of bank innovations;
- - Innovations = Systemic bank changes process;
4. 5. BANK INDUSTRY INNOVATIONS
- Innovation forms:
- - new products and services;
- - new organizational forms;
- - new systems for realizing bank clients
- - finding new markets for securing
- - changes in financial instruments etc.
- 5. BANK INNOVATIONS
- - Computer and information technology as innovation source;
- - Introducing and developing financial engineering: inbounding some financial instruments to their consisted parts and their rebounding (new packing) in new instruments;
- - Introducing financial derivatives (futures, options, swaps);
- - New possibilities for transfer risk to other subjects;
- - Final result of introducing innovations: Bank profitability increase.
- 5.1. Factors that create innovations
- -Instigators of huge banking changesin particular countryare:
- Tax laws changes; technology progress; inflation rate changes; interest rates changes; foreign exchange rate changes; economic activity changes; regulation framework changes etc.
- 5.1. Factors that create innovations
- - On global levelthere are couple of factors that induced innovations which are spread to the banks all round the world:
- b)information technology;
- d)economy of scale;
- e)economy of scope (diversification).
- 5.1.1. Deregulation
- - Banks are most regulated institutions within the economy;
- - Bank regulator determines what products and services bank can sell, who can govern bank, on which market bank can act etc.;
- - Big alternation: Bank deregulation= No limits for interest rates, directing bank credits and narrow bank specialization; possibility for usage new flexible financial instruments (financial derivatives, new off-balance sheet products etc.);
- Notice: Deregulation is not same as reregulation!
- 5.1.2. Competition
- - Deregulation derived bigger bank (and financial
- market) competition and rivality;
- - Two types of competition:
- a)Price (interest rates) competititon;
- b)Product competition.
- 5.1.3. Information technology
- - Info-technological revolution;
- - Transfering money and data at the same moment;
- - Need for changing classic bank organization (narrowing the number of branches);
- - Internet development (banking on line);
- - Virtual bank appearance.
- 5.1.4. Globalization
- -Internationalization and globalization of bank activities;
- - Global or planet banks;
- - Big banks buy majority of shares of a certain bank they are interested in;
- - Universal banks are mostly represented in this process.
- 5.1.5. Economies of scale
- - Bank deregulation smaller bank profits margins;
- - Creating new bank products for compensating profit decrease;
- - Developing cost-benefit and trade-off bank functions and activities;
- - Two ways for introducing and developingeconomies of scale:
- a)Internal (bank own total development);
- b)External (bank merger and acquisition).
- -Goal:Decreasing bank costs.
- 5.1.6. Economies of scope
- - Bank activities diversification;
- - Broadening bank activities in insurance, brokerage, investment funds;
- - Additional bank activities, lower costs and higher bank income;
- - Cross-selling services;
- - One-stop- banking;
- - Banks as financial supermarkets.
- 5.2. More important bank innovation
- -Banks use new instruments for financing their activities, lowering costs and reducing risks;
- - Most important instruments are:
- a)Financial derivatives;
- c)Selling credits;
- d)Stand by guarantees;
- e)Credit derivatives;
- f)Electronic banking;
- g)Bank innovations in dealing with securities.
- 5.2.1. Financial derivatives
- - Instruments for hedging bank risks;
- - Appeared in 80s and 90s of XX century;
- - Types: forwards, futures, options and swaps;
- - More elaboration about these bank innovation in
- Chapter 7.
- 5.2.2. Securitization
- - Definition:Conversion of part of the bank assets with lowered market value in securities that are acceptable for investors on secondary market;
- - Transforming part of bank credits into securities, usually bonds Asset backed securities;
- - Goals:Regulating bank liquidity, hedging interest rate risk, finding income resource, accomplishing capital adequacy obligation etc.;
- - Securitization process(to be explained);
- 5.2.2. Securitization/2
- Participants in securitization process:
- 5.2.2. Securitization/3
- - Bank benefits from securitization:
- a)Securing liquidity;
- b)Hedging interest risk;
- c)Decreasing credit risk;
- d)Increasing bank profit;
- e)Accomplishing capital adequacy;
- 5.2.2. Securitization/3
- - Usage of securitization for collecting funds on lower price rather than costs for collecting deposits:
- - Bonds are part of the bank balance sheet;
- - Bonds obligation are paid by the bank;
- - Bonds price is lower than deposit price;
- - The term of bond maturity, usually, is longer than
- deposit term of maturity The average Liabilities
- term of maturity becomes longer;
- - Weaknesses of that kind of securitization:
- -Need for additional increase the capital amount
- (Problem with accomplishing capital adequacy level);- Reserve requirement accomplishing problems.
- 5.2.3. Selling credits
- - Banks sell new credits or credits with term to maturity
- up to 3 months;
- - Reasons why banks sell credits:
- - changing lower yield with higher yield credits;
- - lowering credit and interest rate risk;
- - lowering credit exposure;
- - getting liquid funds needed for investing in higher
- yield projects etc.
- 5.2.3. Selling credits/2
- - Credits buyers are: other banks, insurance companies, pension funds, mutual funds, big investment banks etc.;
- - Usually bank-credit seller keeps the right to take care for that credit on behalf of the credit-buyer;
- - Types of selling credits;
- - Participative credits;
- - Reproaching (transfering) credit to its buyer;
- - Selling credits on parts.
- - Selling credits weaknesses.
- 5.2.4. Stand by guarantee
- - Definition:Financial instrument through which the bank guarantees that a particular client will fulfill his credit, securities or project obligation;
- - Stand by guarantee could be:
- a)Performance guarantee;
- b)Repayment guarantee.
- - Stand by guarantee is bank potential obligation;
- -Advantages:low issuing costs; low risk; profitability; big help for bank client;
- -Weaknesses:liquidity risk and interest rate risk.
- 5.2.5. Credit derivatives
- - Bank security in a case of inability of a credit pay off;
- - Credit swaps:Two banks agree to change repaid partsof credits they have extended to their clients;
- -Advantagesof credit swap:
- - Each bank can disperse its credit portfolio risk;
- - Spreading bank presence on other markets.
- 5.2.5. Credit derivatives/2
- - Full return swap;
- - Credit options:
- - Bank protection from extended credit value loss;
- - Setting off higher borrowing costs because of bank credit rating changes.
- 5.2.6. Electronic banking
- - Modern technology revolution;
- - Electronic funds transfer;
- - Automatic teller machines ATM introduction;
- - Point of sale POS or Electronic funds transfer at the
- point of sale EFTPOS;
- - Home banking;
- - Internet;
- - Intranet;
- 5.2.6. Electronic banking/2
- -Virtual banks;
- -Advantagesfor banks that have accepted new information technology:
- 1)Bank competition increase;
- 2)Economies of scale and economies of scope development (Bank productivity increase and bank costs decrease);
- 3)Bank organization changes (merger and acquisition);
- 4)Bank credit rating increases.
- 5.2.7. Bank innovations in dealing with securities
- a)Mutual funds (A way for deposit disintermediation protection);
- b)Note Issuance Facilities NIF
- - Revolving underwriting facility;
- c)Trade banking (temporarily companys shareholder);
- d)Securities consulting.
- KEY WORDS/TERMS
- Bank innovation
- Financial derivatives
- Information technology
- Economies of scale
- Economies of scope
- KEY WORDS/TERMS/2
- Cross-selling services
- One-stop banking
- Selling credits
- Participative credits
- Reproach credits
- Stand by guarantee
- Performance guarantee
- Repayment guarantee
- Credit derivatives
- Electronic banking
- Risk hedging
- Automate teller machine
- Post of sale POS
- KEY WORDS/TERMS/3
- Electronic funds transfer at the point of sale EFTPOS
- Home banking
- Mutual funds
- Note issuance facilities NIF
- Trade banking
- CHECKING QUESTIONS
- What are the main reasons for bank innovation appearence?
- In which forms do innovations appear?
- What is the final result of introducing bank innovations?
- What are the main factors that create innovations?
- What does deregulation consist of?
- Explain price and product competition.
- What is hideen behind information technology?
- Define bank globalization.
- Define economies of scale.
- Explain what cross-selling services means.
32. CHECKING QUESTIONS/2
- 11. Define securitization.
- 12. What are bank benefits from securitization?
- 13. Why banks sell credits?
- 14. Enumerate types of selling credits.
- 15. Explain the meaning of performance and repayment guarantee.
- 16. How does credit swap function?
- 17. How does credit option function?
- 18. What are the main characteristics of electronic banking?
- 19. What are mutual funds?