Chapter Three

1. Chapter Three The Organization and Structure of Banking and the Financial-Services Industry

2. Key Topics • The Organization and Structure of Banks and the Banking Industry • The Array of Organizational Structures in Banking: Unit, Branch, Holding Company, and Electronic Services • Interstate Banking and the Riegle-Neal Act • The Financial Holding Company (FHC) • Mergers and Acquisitions • Banking Structure and Organization in Europe and Asia • The Changing Organization and Structure of Banking’s Principal Competitors • Economies of Scale and Scope and Expense Preference Behavior

3. Introduction • Chapter 1 explored many of the roles and services of the modern bank and competitors of banks • Over the years, bankers and the managers of competing financial institutions have evolved into different organizational forms • A financial institution’s role and size are not the only determinants of how it is organized or how well it performs • In this chapter, we will discuss the causes that have dramatically changed the structure, size, and types of organizations dominating the financial-services industry today

4. The Organization and Structure of the Commercial Banking Industry • Advancing Size and Concentration of Assets • Commercial banking is the dominant supplier of credit and payments services to businesses and households • Many banks in the United States are small by global standards • These smallest financial institutions, numerous as they are, held little more than one percent of total industry assets • In contrast, the American banking industry also contains some of the largest financial service organizations on the planet • Citigroup, JP Morgan Chase, and the Bank of America hold about 6 trillion dollars combined • Thus, banking continues to be increasingly concentrated not only in the smallest, but also in the very largest of all financial firms

5. EXHIBIT 3–1 The Structure of the U.S. Commercial Banking Industry, December 31, 2009

6. EXHIBIT 3–1 The Structure of the U.S. Commercial Banking Industry, December 31, 2009

7. Internal Organization of the Banking Firm • The great differences in size across the industry that have appeared in recent years have led to marked differences in the way banks and other service providers are organized internally and in the variety of financial services each institution sells in the markets it chooses to serve

8. EXHIBIT 3–2 Small and Medium-Size U.S. Banks Lose Market Share to the Largest Banking Institutions

9. Internal Organization of the Banking Firm (continued) • Community Banks and Other Community-Oriented Financial Firms • Devoted principally to the markets for smaller, locally based deposits and loans and are often referred to as a retail bank • Financial firms of this type stand in sharp contrast to wholesale banks • Close contact between top management and management and staff of each division is common • Community banks are usually significantly impacted by changes in the health of the local economy and keeping up with new regulations • These institutions have been losing ground, both in numbers of institutions and in industry shares • Around 14,000 community banks in 1985 and about 6,000 in 2010

10. EXHIBIT 3–3 Organization Chart for a Smaller Community Bank

11. Internal Organization of the Banking Firm (continued) • Larger Banks – Money Center, Wholesale and Retail • A large money center bank is usually located in a large city and has a focus towards wholesale or wholesale plus retail • Some of the largest banks have moved toward the profit-centered or performance approach • The largest money-center banks possess some important advantages over community oriented institutions • Better diversified – both geographically and by product line • Can better withstand the risks of a changing economy • Able to raise huge amounts of financial capital at relatively low cost • Can attract top managerial talent

12. EXHIBIT 3–4 Organization Chart for a Money Center or Wholesale Bank Serving Domestic and International Markets

13. Internal Organization of the Banking Firm (continued) • Trends in Organization • The tendency in recent years has been for most financial institutions to become more complex organizations over time • When a financial firm begins to grow, it usually adds new services and new facilities • Another significant factor influencing financial organizations today is the changing makeup of the skills financial-service providers need to function effectively • Financial firms have needed growing numbers of people with computer skills • Call centers have grown in the industry to sell profitable services and respond to customer problems • Automated bookkeeping has reduced the time managers spend in routine operations

14. The Array of Organizational Structures and Types in the Banking Industry • There are so many different types of financial institutions today that the distinctions between these different types of organizations often get very confusing • Insured banks • State chartered banks • National banks • Member banks

15. EXHIBIT 3–5 U.S. Commercial Banks with Federal versus State Charters, Membership in the Federal Reserve System, and Deposit Insurance from the Federal Government (as of December 31, 2009)

16. The Array of Organizational Structures and Types in the Banking Industry (continued) • Unit Banking Organizations • Unit banks, one of the oldest kinds, offer all of their services from one office • Some services (such as taking deposits, cashing checks, or paying bills) may be offered from limited-service facilities, such as drive-up windows and automated teller machines (ATMs) • These organizations are still common today • One reason for the large numbers of unit banks is the continuing formation of new banks • Many customers still seem to prefer smaller banks, which often seem to know their customers better than larger banks • Many new banks start out as unit organizations

17. TABLE 3–1 Entry and Exit in U.S. Banking

18. The Array of Organizational Structures and Types in the Banking Industry (continued) • Branching Organizations • As a unit financial firm grows larger in size it usually decides at some point to establish a branching organization • They offer the full range of services from several locations, including a head office and one or more full-service branch offices • Likely to offer limited services through a supporting network of drive-in windows, ATMs, computers networked with the bank’s computers, point-of-sale terminals in stores and shopping centers, the Internet, and other advanced communications systems • Senior management of a branching organization is usually located at the home office, though each full-service branch has its own management team with limited authority to make decisions

19. EXHIBIT 3–6 The Branch Banking Organization

20. The Array of Organizational Structures and Types in the Banking Industry (continued) • Branching’s Expansion • During the Great Depression of the 1930s, only one in five American banks operated a full-service branch office • By the beginning of the 21st century, the average U.S. bank operated close to 12 full-service branch offices • One contributing factor has been the exodus of population from cities to suburban communities • The passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act in 1994 provided the basis for expansion • However, in recent years new bank branch office expansion appears to have slowed somewhat

21. TABLE 3–2 Growth of Commercial Bank Branch Offices in the United States

22. The Array of Organizational Structures and Types in the Banking Industry (continued) • Electronic Branching – Websites and Electronic Networks: An Alternative or a Supplement to Traditional Bank Branch Offices? • Electronic branches • Internet banking services • Automated teller machines (ATMs) • Point-of-sale (POS) terminals • Personal computers • Call-center systems • Virtual banks

23. The Array of Organizational Structures and Types in the Banking Industry (continued) • Holding Company Organizations • A bank holding company is simply a corporation chartered for the purpose of holding the stock of at least one bank, often along with other businesses • The growth of holding companies has been rapid in recent decades • The principal reasons for this rapid upsurge: • Access to capital markets in raising funds • Ability to use higher leverage • Tax advantages • Ability to expand into businesses outside banking

24. TABLE 3–3 The 10 Largest Bank Holding Companies Operating in the United States (Total Assets as Reported on June 30, 2010)

25. The Array of Organizational Structures and Types in the Banking Industry (continued) • Most registered bank holding companies in the United States are one-bank companies • However, these one-bank companies frequently control one or more nonbank businesses as well • The principal advantage for holding companies entering nonbank lines of business is the prospect of diversifying sources of revenue and profits and reducing risk exposure • A minority of bank holding company organizations are multibank holding companies • Multibank companies control more than 70 percent of the total assets of all U.S. banking organizations • One dramatic effect of holding company expansion has been a sharp decline in the number of independently owned banking organizations • Banks acquired by holding companies are referred to as affiliated banks • Banks not owned by holding companies are known as independent banks

26. TABLE 3–4 The Most Important Nonbank Financially Related Businesses That Registered Holding Companies Can Acquire under U.S. Banking Regulations

27. EXHIBIT 3–8 The Multibank Holding Company

28. The Array of Organizational Structures and Types in the Banking Industry (continued) • Holding company banking has been blamed for reducing competition by critics • Supporters of the holding company movement claim greater efficiency, more services, lower probability of organizational failure, and higher and more stable profits • The holding company as a whole tends to be more profitable than banking organizations that do not form holding companies • Moreover, the failure rate for holding company banks appears to be below that of comparable-size independent banks • However, there is anecdotal evidence that multibank holding companies may drain scarce capital from some communities and weaken smaller towns and rural areas

29. Interstate Banking Organizations and the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 • Riegle-Neal allows holding companies to acquire banks throughout the United States without needing any state’s permission to do so and to establish branch offices across state lines • Why did the federal government eventually enact and the states support interstate banking laws? • The need to bring in new capital to revive struggling local economies • The expansion of financial-service offerings by nonbank financial institutions that faced few restrictions on their ability to expand nationwide • A strong desire on the part of the largest financial firms to geographically diversify their operations and open up new marketing opportunities • The belief among regulators that larger financial firms may be more efficient and less prone to failure • Advances in the technology of financial-services delivery, permitting service to customers over broader geographic areas

30. An Alternative Type of Banking Organization Available as the 21st Century Opened: Financial Holding Companies (FHCs) • Under the terms of the Gramm-Leach-Bliley (GLB) Act, financial holding companies (FHCs) are defined as a special type of holding company that may offer the broadest range of financial services, including dealing in and underwriting securities and selling and underwriting insurance • With the FHCs, each affiliated financial firm has its own • Capital • Management • Profits or losses separate from the profits or losses of other affiliates of the FHC • Some protection against companywide losses • Led to consolidation and convergence within the industry

31. EXHIBIT 3–9 The Financial Holding Company (FHC)

32. TABLE 3–5 Leading Financial Holding Companies (FHCs) Registered with the Federal Reserve Board

33. Mergers and Acquisitions Reshaping the Structure and Organization of the Financial-Services Sector • The rise of branching, bank holding companies, and financial holding companies has been fueled by multiple factors • Another powerful factor spurring these organizational types forward is their ability to carry out mergers and acquisitions • Bigger companies have pursued smaller financial-service providers and purchased their assets in great numbers • Since 1980 more than 12,000 bank mergers have occurred in the United States

34. The Changing Organization and Structure of Banking’s Principal Competitors • Banking’s principal competitors – credit unions, savings associations, finance companies, insurance firms, security dealers, hedge funds, and other financial firms • All are affected by powerful forces such as rising operating costs and rapidly changing technology • A notable exception until very recently has been hedge funds • All financial firms are starting to look alike, especially in the menu of services offered • Convergence • Great structural and organizational changes have “spilled over” into one financial-service industry after another

35. Efficiency and Size: Do Bigger Financial Firms Operate at Lower Cost? • If not, then why have some financial institutions become some of the largest businesses on the planet? • Two possible sources of cost savings • Economies of scale • Economies of scope • For financial firms, there is evidence for at least moderate economies of scale in banking, though most studies find only weak evidence or none at all for economies of scope • Studies of selected nonbank financial firms often reach conclusions that roughly parallel the results for banking firms

36. EXHIBIT 3–10 The Most Efficient Sizes for Banks and Selected Other Financial Firms

37. Quick Quiz 3. What trends are affecting the way banks and their competitors are organized today? 7. What trend in branch banking has been prominent in the United States in recent years? 9. What is a bank holding company? 12. Are there any significant advantages or disadvantages for holding companies or the public if these companies acquire banks or nonbank business ventures? 14. Can you see any advantages to allowing interstate banking? What about potential disadvantages? 16. What relationship appears to exist between bank size, efficiency, and operating costs per unit of service produced and delivered?

38. Quick Answers 3. What trends are affecting the way banks and their competitors are organized today? Banks are becoming larger and more complex with more departments and services and greater specialization. Deregulation and innovation have accelerated this trend as intense competition has encouraged banks to become larger. 7. What trend in branch banking has been prominent in the United States in recent years? Branch banking has become more important with most all states allowing it. There has been an increase in the number of branches in the 1960’s through the 1980’s. Now there are about 5,200 banking organizations with over 80,000 full service branch offices. Due to high costs of building branch offices, in recent years, and more ATM machines there is not as much need going forward.

39. Quick Answers 9. What is a bank holding company? It is a corporation that holds an ownership interest in at least one bank. It is also allowed to own nonbank businesses as long as they are related to banking. 12. Are there any significant advantages or disadvantages for holding companies or the public if these companies acquire banks or nonbank business ventures? Bank holding companies can acquire such nonbank businesses as finance companies, mortgage firms, leasing companies, insurance agencies, and other businesses. Today, the Gramm-Leach-Bliley Act allows financial service companies to be affiliated with each other. This includes investment-banking activities which allow banks to write securities such as stocks and bonds.

40. Quick Answers 14. Can you see any advantages to allowing interstate banking? What about potential disadvantages? Interstate banking increases the concentration of banking resources in the US in various regions of the US. This concentration could lead to higher prices and less service as smaller banks cannot stay in business due to the competition. However, interstate banking may bring a greater stability allowing banks to diversify their operations over different markets offsetting losses in one market with gains in another market. 16. What relationship appears to exist between bank size, efficiency, and operating costs per unit of service produced and delivered? Economies of scale and scope can lead to significant savings in costs as there are greater efficiencies and many more services thus reducing operating costs.