The Future of the Financial

System and the Money and

Capital Markets
• To explore the economic, demographic, social,
and technological forces reshaping the financial
system today.
• To learn about recent trends in the financial
system and how they may affect us in the future.
• To learn about how your behavior and
decisions, along with millions of others, may
plan an important role in shaping the future of
the financial system

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• Powerful forces are reshaping today’s
financial marketplace
• Forces for change
• Powerful new trends within the financial
marketplace itself ex: internet banking
• Major changes in the structure and functioning of
the economy ex: digital economic
• New social and demographic trends ex: social
media
• Altering the public’s need for new financial
services
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• Financial innovation - the development of many new financial
services and instruments
• Service proliferation - the expansion of the menu of financial
services offered
• Competition - the intense struggle for the customer’s business
• Consolidation - mergers and acquisitions have created
financial giants out of numerous smaller financial-service
providers

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• Deregulation - the lightening or elimination of government
rules brought about by a strategy of privatization of the
financial sector
• Convergence - the blurring of the traditional distinctions
among different types of financial-service institutions
• Homogenization - the growing similarity in the service menus
offered by financial institutions

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• Globalization - the global expansion of operations and the
falling of geographical barriers
• Market broadening - the expansion of traditionally local
markets to become regional, national, or even international in
scope
• Securitization - the pooling of loans and the issuance of
securities as claims against the loan pool

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• Aging population has greater needs
• Retirement
• Tax and estate planning
• Changing basic family unit
• Rise in proportion of nontraditional households
(single-parent, well-educated working women,
parents and children living apart, immigrants)
• Increases demand (new forms housing, daycare
facilities, flexible work schedule, less expensive
medical care)

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• Life cycle hypothesis
• Aging individuals reduce expectations of lifetime
income
• As retirement approaches, consumption declines
to match
• As US population ages
• Tend to consume less
• Tend to save more
• Challenge
• Provide for older savers
• Including retirement and estate planning
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• Displacement of manufacturing industries by
service industries in more developed
economies
• Technological innovation - the dissemination
and storage of information today is broader,
cheaper, faster, and more accurate
• Internationalization of markets - such as the
emergence of the European Union

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• The financial marketplaces depends on public
confidence
• Induces parties to provide credit to the market
• Honesty and reliability often as important as price
• Loss of public confidence
• Produces adverse consequences for individual financial
institutions
• Damages the efficiency of market processes
• Flight of funds
• Higher costs for remaining funds
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• Public confidence can be promoted
• Government insurance systems
• Federal Deposit Insurance Corporation (FDIC)
• Pension Benefit Guaranty Corporation (PBGC)
• Regulation of capital – equity requirements
• Private responses - market discipline
• Developing better risk-management tools
• Derivatives
• Stress testing

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• Government actions limited by problems
• Government-provided insurance can distort risk-taking
• Excess restrictions can reduce international
competitiveness
• Private response limited
• Limited information disclosure
• Market investors can only
approximately price these securities

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• Financial information
• Essential to provision of financial services
• Technological revolution – analysis,
storage, and transfer
• Electronic-based communications systems
annually improving at accelerating pace

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• Global integrated electronic networks
• Changing financial services design and delivery
• Internet
• Cellular phones and smart phones
• Pocket and hand-held computers
• Smart cards

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• Advertising
• Transaction
• Internet banking
• Internet investment
• Purchases
• Financial transfers
• Information

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• Adjustment to technology lags the technological
revolution
• Many still prefer paper transactions
• Preference for direct interaction
• Challenges
• Maximize friendliness of user interface
• Minimize operating costs and service prices
• Ensure ease of technological upgrades
• Strengthen data integrity and system security
• Manage greater level of external information
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• Who will offer financial services
• Erosion of traditional area separation
• Greater competition
• Price competition
• Nonprice features
• Likely remainder of differentiation will disappear
• Better-informed customers likely to be willing to
move business

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• Extensive delivery system
• Cost advantage
• Productivity advantage
• Emerging financial service needs
• Need for new financial institutions
• Develop to manage evolution in financial
instruments
• Loans to remodel residential
• Small business loans
• Credit risk derivatives 4-19
• Securitization
• Mortgage-backed securities very successful
• Spawned other markets
• Credit card receivables
• Auto and boat loans
• Equipment leases, among others

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• Merger and acquisition activity
• Consolidation
• Convergence

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• Advantages
• Elimination of duplication brings about substantial
operating costs savings
• Broadening of services and customer segments
accelerate revenue growth
• Greater diversification reduces overall risk
• Combination of expertise results in higher-quality
products and services
• Greater economies of scale increases the affordability of technologies
• Greater efficiency in joint marketing and cross-selling

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• Disadvantage
• Greater complexities of managing the firm may
increase operating costs
• May have overestimated public’s demand for “one
stop” financial shopping
• Smaller financial firms may provide more
personalized services
• Smaller financial firms may compete effectively
by outsourcing

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• Consolidation and convergence
• Major challenges for the regulatory agencies
• Safe financial system
• Stable financial system
• Regulators cannot stop the market evolution
• Challenge to merge safety and stability with
market forces

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• Different regulatory approaches
• Holding company
• Single regulator
• Functional regulation
• Harmonization

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• Difficulty of coordination and control in larger
and more diversified financial institutions
require,
• Employees who are well trained in coordination
and control skills
• Strong internal auditing procedures and
management information systems, and
• Continual evaluation of subsidiary firms, profit
centers, and service functions for their
contributions to the firm’s goals
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• Retail
• Small payments
• Largely between individuals and firms
• Wholesale
• Large payments
• Mainly banks, business firms, and government
agencies
• Typically pass through automatic
clearinghouses, fedwire and other
clearinghouses
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• Retail payments system lags behind the
wholesale payments system in
converting from expensive paper
transactions to electronic systems

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• Recent deregulatory trend likely to continue
• reduced barriers to geographic expansion
• reduced restrictions on the portfolio choices by
financial institutions,
• reorganization of regulatory agencies,
• reduced barriers to the development and offering of
new services to the public
• Contentious debate on new services from
depository institutions
• The pace of government deregulation appears to
be accelerating (GATT, NAFTA)
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• Not all government regulations will disappear
• Concern over safety
• Concern over confidence
• Shifting regulation
• Financial disclosure
• Consumer privacy protection
• Social responsibility
• Promote a level playing field

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• Require more release of information
• Potential risk
• Potential public disfavor
• Discipline of the market
• Potential gain
• Greater confidence
• More intelligent decisions
• Most economical use of resources

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• Privacy protection
• Many regulations on release of information
• Fight identity theft
• Each year thousands become victim of fraud
• Information stolen to access accounts and assets
• Has been used by terrorist groups

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• More customer privacy protection
• Require customer permission
• More security
• Federal Financial Institutions Examination
Council
• Depository institutions beginning to require
more than name and password to access
information

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• Greater scrutiny of fairness
• Resources used
• Service distribution
• Nondiscrimination
• Serving all neighborhoods
• Pressure will grow
• Have all institutions
• Serve all customers

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• Fair and equal regulatory treatment
• Important issue for bankers
• Various institutions have differential treatment
• Taxation
• Instruments
• Services
• Differential treatment may lead to differential
competitiveness
• Pressure for convergence across different
types of institutions
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• Accuity at www.bankinfo.com
• American Bankers Association at
www.aba.com/Industry+Issues
• Australian Prudential Regulatory Authority at
www.apra.gov.au
• Citi Identity Theft Solutions at
citibank.com/us/cards/cardserv/advice/victim.htm
• Consumer Law at www.consumerlaw.org
• Federal Deposit Insurance Corporation at
http://www.fdic.gov/consumers
• Federal Reserve System at www.federalreserve.gov

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