Chapter 1

Banking and the

Financial Services
Industry

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whole or in part.
 How Do Banks Differ?
 Global Banks
 Offer a wide array of products and
services globally
 Super-Regional Banks
 Similar to global banks but smaller in
size and market penetration
 Community Banks
 Smaller trade area with total assets
under $1 billion

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 How Do Banks Differ?

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 How Do Banks Differ?

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 How Do Banks Differ?
 Bank Holding Companies
 Owns controlling interest in one or
more commercial banks
 Parent Organization versus
Subsidiaries
 One-Bank Holding Companies

 Multibank Holding Companies

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 How Do Banks Differ?

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 How Do Banks Differ?
 Financial Holding Companies
 The primary advantage to forming an FHC is
that the entity can engage in a wide range of
financial activities not permitted in the bank or
in a BHC
 Authorized to engage in:
 Underwriting and selling insurance and

securities
 Commercial banking

 Merchant banking

 Insurance company portfolio investment

activities
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 How Do Banks Differ?
 Financial Holding Companies
 Fed may not permit forming an FHC (or
converting a BHC to an FHC) if any of
its insured depository institution
subsidiaries are:
 not well capitalized,

 not well managed,

 did not receive at least a “Satisfactory”

rating in its most recent CRA exam

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 How Do Banks Differ?
 Financial Holding Companies
 An FHC can own a bank or BHC or a
thrift or thrift holding company
 Each of these companies owns

subsidiaries, while the parent financial

holding company also owns other
subsidiaries directly

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 How Do Banks Differ?

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 How Do Banks Differ?
 Holding Company Financial
Statements
 The consolidated financial statements
of a holding company and its
subsidiaries reflect aggregate or
consolidate performance

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 How Do Banks Differ?
 Holding Company Financial
Statements
 While the consolidated financial
statements of a holding company and
its subsidiaries reflect aggregate
performance, it is useful to examine
the parent company’s statements alone

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 How Do Banks Differ?
 Holding Company Financial Statements
 The parent typically pays very little in
income tax because 80 percent of the
dividends from subsidiaries is exempt
 Taxable income from the remaining 20

percent and interest income is small relative

to deductible expenses
 Under IRS provisions, each subsidiary actually
pays taxes quarterly on its taxable income
 With a consolidated tax return, however, the
parent company can use taxable income from its
subsidiaries to offset its loss

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 Organizational Structure and Financial Services Business
Model

 S-Corporation Banks
 Have favorable tax treatment because a qualifying
firm does not pay corporate income tax
 The firm allocates income to shareholders on a pro

rata basis and each individual pays tax at personal

tax rates on the income allocated to them
 Given the opportunity to avoid double taxation at the firm
and individual level, many closely held banks have
chosen S-corporation status
 The primary limitation to qualifying for S-
corporation status is a requirement that the bank
must have no more than 100 shareholders

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 Organizational Structure and Financial Services Business
Model

 Financial Services Business Models

 The principal advantage of being a depository
institution is access to FDIC deposit insurance
 The FDIC charges banks a premium for the
insurance, which ensures qualifying deposit
holders that the FDIC will guarantee the
principal amount of each deposit up to the
maximum allowed
 The existence of deposit insurance allows

depository institutions to pay low rates on

insured deposits and ensures that such
deposits are relatively stable in times of crisis

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 Organizational Structure and Financial Services Business
Model

 Financial Services Business Models

 The primary disadvantage of operating as a bank
(or BHC) is that the firm is subject to regulation
as a bank
 Prior to 2008, investment banks avoided
regulation as banks, which allowed them to
operate with substantially lower equity capital per
dollar of risk assets and enter lines of business
not generally available to commercial banks
 The combined effect was greater financial
leverage and business operations in many high-
risk areas such as proprietary trading

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 Organizational Structure and Financial Services Business
Model

 Transactions Banking Versus

Relationship Banking
 Transactions Banking
 Involves the provision of transactions
services such as checking accounts, credit
card loans, and mortgage loans that occur
with high frequency and exhibit
standardized features
 Because the products are highly

standardized, they require little human

input to manage
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 Organizational Structure and Financial Services Business
Model

 Transactions Banking Versus Relationship

Banking
 Relationship Banking
 Emphasizes the personal relationship
between the banker and customer
 For example, the key feature of a loan that is
relationship driven is that the lender adds real
value to the borrower during the credit granting
process
 In addition to the provision of funds, the lender
may provide expertise in accounting, business,
and tax planning

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 Organizational Structure and Financial Services Business
Model

 Transactions Banking Versus

Relationship Banking
 Relationship Banking
 Lending institutions generally charge
higher rates and often hold the loans in
portfolio
 Aggressively market noncredit

products and services to such

customers in order to lock in the
relationship

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 Organizational Structure and Financial Services Business
Model

 Transactions Banking Versus Relationship

Banking
 Securitization
 The process of pooling a group of assets with
similar features—for example, credit card loans or
mortgages—and issuing securities that are
collateralized by the assets
 The securities are sold to investors who receive the cash
flows from the loans net of servicing, guarantee, and
trust fees
 The entire process adds liquidity to the market because
the loan originators regularly repeat the process
knowing that investors will demand the securities

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 Organizational Structure and Financial Services Business
Model

 Transactions Banking Versus

Relationship Banking
 Originate-to-Distribute (OTD)
 When loan origination is separated
from ownership
 The flaw is that lenders who originated the
loans knew they would not own the loans
long term
 They were, therefore, less concerned about
the quality of the assets originated

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 Organizational Structure and Financial Services Business
Model

 Transactions Banking Versus

Relationship Banking
 Originate-to-Distribute (OTD)
 In order to grow their business and continue
originating loans, they increasingly made
loans to less qualified borrowers
 When the underlying assets defaulted at
higher-than-expected rates, investors in the
securities did not receive the promised
payments
 The net result is that liquidity largely dried up
for most securitizations

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 Organizational Structure and Financial Services Business
Model

 Universal Banking
 Refers to a structure for a financial services
company in which the company offers a broad
range of financial products and services
 Combined traditional commercial banking that

focused on loans and deposit gathering with

investment banking
 Underwrote securities, advised on mergers and

acquisitions, managed investment assets for

customers, took equity positions in companies,
bought and sold assets for a speculative profit,
offered brokerage services, and made loans and
accepted deposits

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 Organizational Structure and Financial Services Business
Model

 Universal Banking
 The presumed advantage of universal
banking is the ability to cross-sell
services among customers
 Participation in diverse products and
services would presumably increase
the information advantage and allow
the bank to serve customers more
efficiently and at better prices

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 Organizational Structure and Financial Services Business
Model

 Universal Banking
 There is no consensus on whether
universal banking is successful
 U.S. firms that tried to achieve this goal
of a “one-stop financial supermarket”
have not outperformed more traditional
competitors

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 Different Channels for Delivering Banking Services

 Branch Banking
 Automated Teller Machines
 Internet (Online) Banking
 Call Centers
 Mobile Banking

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
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 Chapter 1

Banking and the

Financial Services
Industry

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in
whole or in part.