THE FUTURE OF BANKING

FIN 653: Seminar in Bank Management

Lecture 1.1: Recent Bank Developments

Yea-Mow ChenDepartment of Finance

San Francisco State University

I. Recent Bank Developments

I. Recent Bank Developments

Assets Size

Number of Banks < $100 M $100M - $1B $1B - $10B > $10B 10,242 7,123 2,741 331 63

1995 (69.55%) (26.76%) (3.23%) (0.62%)

9,451 6,147 2,900 331 73 1997

(65.04%) (30.68%) (3.50%) (0.77%) 8,580 5,157 3,029 318 76

1999 (60.10%) (35.30%) (3.71%) (0.89%)

8,080 4,486 3,194 320 80 2001

(55.52%) (39.53%) (3.96%) (0.99%) 7,769 3,911 3,434 341 83

2003 50.34% 44.20% 4.39% 1.07%

7,630 3,655 3,530 360 85 2004

(47.90%) (46.26%) (4.72%) (1.11%)

Asset Size

Total

Assets < $100 M $100M - $1B $1B - $10B > $10B $4,116 $310 $668 $1,077 $2,061

1995 (7.54%) (16.22%) (26.17%) (50.07%)

$4,642 $277 $711 $995 $2,658 1997

(5.97%) (15.32%) (21.45%) (57.27%) $5,735 $243 $755 $915 $3,823

1999 (4.23%) (13.16%) (15.96%) (66.65%)

$6,569 $222 $819 $915 $4,613 2001

(3.37%) (12.47%) (13.93%) (70.22%) $7,603 $201 $910 $947 $5,545

2003 (2.64%) (11.97%) (12.46%) (72.93%)

$8,413 $189 $953 $973 $6,297 2004

(2.25%) (11.33%) (11.57%) (74.85%)

I. Recent Bank Performance


Bank Profitability Stabilized in the 90s ROA of Different Size Banks, 1990-2000 All $0m- $100m $1b- $10b Year Banks $100m -$1b -$10b and above ____________________________________________________ 1990 0.49% 0.79% 0.78 0.76% 0.38% 1991 0.54 0.83 0.83 0.54 0.44 1992 0.95 1.08 1.05 0.95 0.92 1993 1.22 1.16 1.19 1.33 1.24 1994 1.17 1.16 1.22 1.19 1.17 1995 1.17 1.18 1.25 1.28 1.10 1996 1.19 1.23 1.29 1.31 1.10 1997 1.24 1.25 1.39 1.30 1.18 1998 1.19 1.14 1.31 1.52 1.08 1999 1.31 1.01 1.34 1.48 1.28 2000 1.19 1.01 1.28 1.29 1.16 2001 1.15 2002 2003 1.40 2004________1.31________________________________________________


Bank Profitability Stabilized in the 90s ROE of Different Size Banks, 1990-2000 All $0m- $100m $1b- $10b Year Banks $100m -$1b -$10b and above ____________________________________________________ 1990 7.64% 9.02% 9.95 10.25% 6.68% 1991 8.05 9.40 10.51 7.50 7.35 1992 13.24 11.93 12.60 12.52 13.86 1993 15.67 12.29 13.61 14.02 16.81 1994 14.90 12.01 13.49 14.19 15.73 1995 14.68 11.37 13.48 15.04 15.60 1996 14.40 11.69 13.63 14.82 14.93 1997 14.71 11.57 14.50 14.30 15.32 1998 13.95 10.15 13.57 15.96 13.82 1999 15.34 9.07 14.24 16.02 15.97 2000 14.07 9.09 13.56 14.57 14.42 ________________________________________________________


The Increased Concentration in U.S. Banking ( trillions of 1999 dollars)

1990 1993 1996 1999 _________________________________________________________ Number of banks 12,370 11,001 9,576 8,698 Total assets $4.22 $4.23 $4.80 $5.47 % held by fifty largest BHCs 55.3 % 59.7 % 66.6 % 68.1% %held by ten largest BHCs 25.6 % 31.6 % 38.5 % 44.8 %

Total domestic deposits $2.93 $2.76 $2.85 $3.08 % held by fifty largest BHCs 48.0% 51.4% 56.9% 58.2% % held by ten largest BHCs 17.3 % 22.0 % 26.2 % 33.6 % _________________________________________________________ Source: Consolidated Reports of Condition and Income, 1990-99.

II. Recent Banking Trends

1. Deregulation/Re-regulation

Regulations took many forms including: Maximum interest rates that could be paid on

deposits or charged on loans; Minimum capital-to-asset ratios; Minimum legal reserve requirements; Limited geographic markets for full-service banking; Constraints on the type of investments permitted,

and restrictions on the range of products and services offered.


1. Deregulation/Re-regulation CAMELS System: Capital Asset Quality Management Quality Earning Quality Liquidity Sensitivity to Market Risk


1. Deregulation/Re-regulation Banks and other market participants have

consistently restructured their operations to circumvent regulation and meet perceived customer need.

In response, regulators or lawmakers would impose new restrictions, which market participants circumvented again.

This process of regulation and market response (financial innovation) and imposition of new regulations (re-regulation) is the regulatory dialectic.



Today banks are accessing the formerly forbidden areas of investment banking, by the repeal of the Glass-Steagall Act via the Financial Services Modernization Act (Gramm-Leach-Bliley Act of 1999).



Efforts at deregulation and re-regulation generally address:

Pricing issues: removing price controls on the maximum interest rates paid to depositories and the rate charged to borrowers (usury ceilings).

Allowable geographic market penetration: The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 has eliminated branching restrictions.

New Products and services: Gramm-Leach-Bliley Act of 1999 has dramatically expanded the banks’ product choices; i.e., insurance, brokerage services, and securities underwriting.


Shortcomings of Current Banking Regulations: Does not prevent bank failures Cannot eliminate economic risk Does not guarantee that bank

management will make good decisions


2. Rising Competition from other Financial Services Companies: Non-bank financial institutions especially finance

companies, foreign institutions, and the public capital markets, have increased their market share in commercial lending at the expense of domestic commercial banks.

Non-financial institutions, such as Sears, AT&T, and General Motors, have increased their market share in consumer lending at the expense of the banks.


2. Rising Competition from other Financial Services Companies: Competition for deposits Competition for loans Competition for payment services Competition for other financial services


Competition for deposits MMMFs were created by investment banks in 1973 and

grew from $10.4 b in 1978 to almost $189 b in 1981. Congress passed legislation enabling banks and thrifts

to offer similar accounts including money market deposit accounts (MMDAs) and Super NOWS.

Competition for loans comes in many forms: Commercial paper Captive automobile finance companies Other finance companies Junk bonds


Competition for payment services is coming from emerging electronic payment systems, such as: Smart and stored-value cards Automatic bill payment Bill presentment processing Cash money can be acquired at any teller

machine Open a checking account, apply for a loan and

receive funds electronically


Competition for investment banking services: National Full-Line Firms Investment Banking Firms Underwriter

Underwriter syndicate

Broker versus Dealer


Competition for other financial services: Trust services Brokerage Data Processing Securities underwriting Real estate appraisal Credit life insurance Personal financial consulting


3. Financial Innovation

Innovations take the form of new securities and financial markets, new products and services, new organizational forms, and new delivery systems.

Regulation Q brought about financial innovation as depository institutions tried to slow disintermediation.

Banks developed new vehicles to compete with Treasury bills, money market mutual funds, and cash management accounts.

Recent innovations take the form of new futures, options, options-on-futures, and the development of markets for a wide range of securitized assets.


3. Financial Innovation

One competitive response to asset quality problems and earnings pressure has been to substitute fee income for interest income by offering more fee-based services.

Banks also lower their capital requirements and reduce credit risk by selling assets and servicing the payments between borrower and lender rather than holding the same assets to earn interest.

This process of converting assets into marketable securities is called securitization.


4. Off-Balance-Sheet Activities

Loan Commitments Loan guarantees Standby Letters of Credit Interest Rate Swaps Futures, Forwards & Options Leases


Securitization Securitization is the process of

converting assets into marketable securities.

It enables banks to move assets off-balance-sheet and increase fee income.

It increases competition for standardized produces such as mortgages and other cerdit-scored loans.


Securitization Benefits to financial institutions:

Free capital for other uses Improve ROE via servicing income Diversify credit risk Obtain new sources of liquidity Reduce interest rate risk


5. Information Technology and Banking (1). New technology had made offering new

products available: Securitization would not be possible without the servicing

software that controls and monitors cash flows. Investors trade pools of credit card loans because

they can assess default risk without knowing the creditworthiness of each borrower.

Swaps, swaptions, collars and caps are feasible and easier to use because computer pricing models narrow the bounds of mispricing and other errors.


(2). Derivative products for risk management: Banks' risk management has been improved with the striking advances in information technology:

Artificial intelligence software can narrow the role of human judgment in the management of credit risk.

(3). Internet banking had reduced costs substantially;

(4). New technology had relaxed the geographical market and product constraints, which led to a greater market consolidation.


(5). But low-cost information is a double-edged sword: 1. If loans are more liquid, then banks' private

information about these loans and their role in monitoring the loans are both diminished.

2. If loans are securitized, any broker should be able to pool loans, issue traded claims against the pool, collecting interest and principal, and disbursing it to claim-holders.

3. If the bank's clients can manage interest risk with derivatives, why should they pay the bank for such protection?


6. Globalization The gradual evolution of markets and

institutions so that geographic boundaries do not restrict financial transactions.

Firms must recognize that businesses in other countries as well as their own are competitors, and that international events affect domestic operations.

II. Recent Banking Trends The 20 largest banks in the world, July 1, 2004

Bank Country Total Assets ($M)

1. Mizuho Financial Group Japan $1,285,471

2. Citigroup United States 1,264,032

3. UBS Group Switzerland 1,120,543

4. Credit Agricole Mutual France 1,105,378

5. HSBC Holdings United Kingdom 1,034,216

6. Deutsche Bank Germany 1,014,845

7. BNP paribus France 988,982

8. Mitibush Tokyo Financial Group Japan 974.950

9. Sumitomo Mitsui Financial Group Japan 950,448

10. Royal Bank of Scotland United Kingdom 806,207

II. Recent Banking Trends The 20 largest banks in the world, July 1, 2004

Bank Country Total Assets ($M)

11. Barclays Bank United Kingdom $791,292

12. Credit Suisse Group Switzerland 777,849

13. J.P. Morgan Chase United States 770,912

14. UFJ Holdings Japan 753,631

15. Bank of America United Statements 736,445

16. ING Bank Netherlands 684,004

17. Societe Generake France 681,218

18. ABN-AMRO Bank Netherlands 667,636

19. HSBC United Kingdom 650,721

Industrial and Commercial Bank of China

China 637,829

THE FUTURE OF BANKING

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