Chapter 21 CHAPTER 2 DRIVERS OF CHANGE, INNOVATION, AND CONSOLIDATION IN THE FINANCIAL-SERVICES...
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Transcript of Chapter 21 CHAPTER 2 DRIVERS OF CHANGE, INNOVATION, AND CONSOLIDATION IN THE FINANCIAL-SERVICES...
Chapter 2 1
CHAPTER 2
DRIVERS OF CHANGE, INNOVATION, AND
CONSOLIDATION IN THE FINANCIAL-SERVICES
INDUSTRY
Chapter 2 2
Learning Objectives To understand …
1. The drivers of change in the FSI as the components of TRICK
2. Innovation as a diffusion process and the technological and contractual aspects of innovation
3. Consolidation and corporate restructuring in the FSI, especially bank mergers
Chapter 2 3
Chapter Theme Heraclitus, the Greek philosopher,
said: “All is flux, nothing stays still. Nothing endures but change.”
This chapter focuses on change in banking and the FSI and what drives it
Innovation and consolidation, among other things, reflect the effects of the changes driving banking and the FSI
Chapter 2 4
COMPONENTS OF A DYNAMIC MODEL OF
CHANGE: TRICK
Transparency
Risk exposure
Information technology
Competition for customers
Kapital adequacy
Model: TRICK + Rational Self-Interest => Financial Innovation
Chapter 2 5
TRANSPARENCY
Readily understood, clear, or easily detected with regard to financial statement information, disclosure, monitoring and discipline by holders of debt and equity contracts, market valuations, and accountability of managers, directors, and safety-net managers
Chapter 2 6
Risk-Management Techniques Asset-Liability Management (ALM)
Credit Analysis
Derivatives: Futures, Forwards, Options,
and Swaps
Securitization
RISK EXPOSURE (leads
to)
Chapter 2 7
Exposure to What? The risks of banking
1. Credit risk 2. Interest-rate risk 3. Liquidity risk 4. Foreign-exchange risk 5. Operational risk 6. Solvency (capital-adequacy) risk
depends on the risks above
Chapter 2 8
“The information standard has replaced the gold standard as the basis for world finance”
- Walter Wriston
INFORMATION TECHNOLOGY
Chapter 2 9
Basic Ingredients to Attract Customers
Price
Convenience
Confidence (federal safety net/guarantee)
COMPETITON FOR CUSTOMERS
Chapter 2 10
Market Discipline Costs of financial distress and cost of funds
Regulatory Discipline Risk-based capital requirements
Graham-Leach-Bliley Act of 1999
Community Reinvestment Act
(modernization tied to fairness)
KAPITAL ADEQUACY
Chapter 2 11
INNOVATION AS A DIFFUSION PROCESS
Innovation -- the introduction of something new
Ex: 1961 introduction of the first negotiable certificate of deposit
Preliminary Distinctions1 .Invention vs. innovation2 .Autonomous innovation vs. induced innovation3 .Market-induced innovation vs. regulation-
induced innovation
Chapter 2 12
NEW TECHNOLOGY AND PRODUCT DIFFUSION
August 2000 Internet Penetration for U.S. Households = 41%
Top Ten Cities for Penetration: San Francisco (66%)Seattle (64%)San Diego (62%)Portland (62%)Washington D.C. And Boston (59%)Denver and Kansas City (57%)Orlando (56%)Baltimore (55%)
Chapter 2 13
DIFFUSION OF E-BANKING
Except for ATMs, diffusion rate has been slow
“Paper currency and checks are still used for the overwhelming majority of consumer payments, while electronic transfer, such as those made over the ACH, account for a very small fraction. In contrast, for the major money and securities markets in this country, electronic payments are the rule rather than the exception”
-- Edward W. Kelley, Jr.
Chapter 2 14
INNOVATION AND THE DESIGN OF FINANCIAL
CONTRACTS
Two Basic Contracts of Banking1.Deposit Account
Checking Accounts Savings Accounts Certificate of Deposits Individual Retirement Accounts
2.Loan Agreement Fixed or Adjustable Rate Mortgages C&I Term Loans Automobile Loans Credit-Card Loans
Chapter 2 15
CREDIT EXTENTION BUILDING BLOCKS
The Blocks
Zero Coupon
Fixed Rate
Variable Rate
Amortized
Can Be Viewed In Terms
Of:
Present Value
Future Value
Payment
Interest Rate
Number of Periods
Chapter 2 16
Background: TVM Formulas Panel B of Table 2-2 presents the
time-value-of-money (TVM) formulas on a pair-wise basis 1. PV and FV of a lump sum 2. FV of an annuity (payment) and
annuity repaying a future amount 3. PV of an ordinary annuity and
annuity repaying a present value (loan-recovery factor, e.g., for a mortgage payment)
Chapter 2 17
THE COSTS OF INNOVATIVE FINANCIAL PRODUCTS AND
REPUTATIONAL CAPITAL
Legal, accounting, regulatory, and tax advisors
Computer systems for pricing and trading
Capital and personnel to support market-making, and
Educating issuers, investors, and traders
Chapter 2 18
BACKGROUND TO BANK CONSOLIDATION
Within an industry within a country
Across industries within a country
Across countries but in the same
industry
Across countries and industries
Chapter 2 19
MOTIVES FOR CONSOLIDATION
Cost Economies Economies of Scale Economies of Scope
Market Power Managerial Agency Costs Exploitation of the Federal Safety
Net
Chapter 2 20
Alternative Merger Hypotheses Hypothesis Source of value creation Information Undervaluation Market power Horizontal mergers Synergy Cost efficiencies Taxes Tax (financial) synergy Inefficient mgm Mismanagement Earnings diversification Higher cash flows
Chapter 2 21
M&A in Banking and the FSI Citigroup merger (1998) predated GLB Act
(1999) and helped force passage of the act JPM and Chase (2000) Bank of America and NationsBank (1998) Wells Fargo and Norwest (1998) Hostile takeovers (SunTrust failed in its bid
for Wachovia – First Union won the battle but lost its name)
Chapter 2 22
View Consolidation in Terms of the ROE Model ROE = ROA x EM ROA = PM x AU Profitability (accounting) measures
are: PM, ROA, ROE Sales, turnover, or utilization
measure is: AU Leverage factor is: EM
Chapter 2 23
BANK ORGANIZATIONAL FORMS IN THE US
Independent Banks
One-Bank Holding Companies
Multi-Bank Holding Companies
Together, BHCs and independent banks are referred to as BANKING COMPANIES
Chapter 2 24
PHENOMENA DRIVING DECLINE IN # OF BANKING
COMPANIES
Mergers among BHCs BHCs acquiring viable independent banks The failure of independent banks during
the 1980s and 1990s
“The whole banking structure is turning into an oligopoly in which four or five institutions dominate any particular geographic-based market”
-- Furash
Chapter 2 25
A Long View Year Unit banks Branch banks Total 1935 13,329 796 14,125 2000 2,733 5,848 8,581 Change -10,596 5,052 -5,544 Counting ATMs, point-of-sale systems,
automated clearing houses (for direct deposit), and opportunities for home banking via the Internet numerous e-based systems for delivering financial services also exist, besides the traditional brick-and-mortar banks and branches
Chapter 2 26
CONSOLIDATION
Mergers Takeovers and Hostile Takeovers Anti-Takeover Strategies
Shark Repellants Poison Pills Greenmail Golden Parachutes
Chapter 2 27
Competition and Access to Financial Services The Fed favors the industrial-
organizational (IO) model, which has the following linkages, given the conditions of supply and demand:
Market structure => Conduct => Performance
Chapter 2 28
MERGER AND ACQUISITION STRATEGIES
“Hit ‘em where they ain’t”Ex: KeyCorp and Interstate Banking
Buck the Merger TrendEx: SunTrust but then a failed hostile-
takeover attempt
Chapter 2 29
OPPORTUNTIES FOR COMMUNITY BANKS IN THE
MERGER ENVIRONMENT
Businesses are Worried About
Fewer Local Banks
(16%) Fewer Customized
Services (18%) Less Responsive to
Community (26%) Decline in Customer
Service (28%)
Community Banks are Worried About
Credit Unions (78%) Brokerage/Securities
Firms (63%) Other Community Banks
(60%) Mutual-Fund Companies
(52%) Regional / Money-Center
Banks (41%) Farm-Credit Banks (40%)
Chapter 2 30
Regulatory Concerns Safety Stability Structure (competition)
Chapter 2 31
Chapter Summary TRICK + Rational self-interest =>
Financial Innovation T = Transparency R = Risk exposure (=> risk
management) I = Information technology C = Competition for customers K = Kapital adequacy