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FIN 653: Seminar in Bank Management Lecture 1.1: Recent Bank Developments Yea-Mow Chen Department of Finance San Francisco State University I. Recent Bank Developments I. Recent Bank Developments I. Recent Bank Performance I. Recent Bank Performance I. Recent Bank Performance
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FIN 653: Seminar in Bank Management Lecture 1.1: Recent Bank Developments Yea-Mow Chen Department of Finance San Francisco State University
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________________________________________________
I. Recent Bank Performance • 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 • ________________________________________________________
I. Recent Bank Performance 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.
II. Recent Banking Trends • 1. Deregulation/Re-regulation • CAMELS System: • Capital • Asset Quality • Management Quality • Earning Quality • Liquidity • Sensitivity to Market Risk
II. Recent Banking Trends • 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.
II. Recent Banking Trends • 1. Deregulation/Re-regulation • 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).
II. Recent Banking Trends • 1. Deregulation/Re-regulation • 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.
II. Recent Banking Trends • Shortcomings of Current Banking Regulations: • Does not prevent bank failures • Cannot eliminate economic risk • Does not guarantee that bank management will make good decisions
II. Recent Banking Trends • 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.
II. Recent Banking Trends • 2. Rising Competition from other Financial Services Companies: • Competition for deposits • Competition for loans • Competition for payment services • Competition for other financial services
II. Recent Banking Trends • 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
II. Recent Banking Trends • 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
II. Recent Banking Trends • Competition for investment banking services: • National Full-Line Firms • Investment Banking Firms • Underwriter • Underwriter syndicate • Broker versus Dealer
II. Recent Banking Trends • Competition for other financial services: • Trust services • Brokerage • Data Processing • Securities underwriting • Real estate appraisal • Credit life insurance • Personal financial consulting
II. Recent Banking Trends • 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.
II. Recent Banking Trends • 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.
II. Recent Banking Trends • 4. Off-Balance-Sheet Activities • Loan Commitments • Loan guarantees • Standby Letters of Credit • Interest Rate Swaps • Futures, Forwards & Options • Leases
II. Recent Banking Trends • 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.
II. Recent Banking Trends • 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
II. Recent Banking Trends • 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.
II. Recent Banking Trends • (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.
II. Recent Banking Trends • (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?
II. Recent Banking Trends • 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
II. Recent Banking Trends • The 20 largest banks in the world, July 1, 2004