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

1995 1997 1999 2001 2003 2004 Number of Banks 10,242 9,451 8,580 8,080 7,769 7,630 < $100 M 7,123 (69.55%) 6,147 (65.04%) 5,157 (60.10%) 4,486 (55.52%) 3,911 50.34% 3,655 (47.90%) Assets Size $100M - $1B $1B - $10B 2,741 331 (26.76%) (3.23%) 2,900 331 (30.68%) (3.50%) 3,029 318 (35.30%) (3.71%) 3,194 320 (39.53%) (3.96%) 3,434 341 44.20% 4.39% 3,530 360 (46.26%) (4.72%) Asset Size $100M - $1B $1B - $10B $668 $1,077 (16.22%) (26.17%) $711 $995 (15.32%) (21.45%) $755 $915 (13.16%) (15.96%) $819 $915 (12.47%) (13.93%) $910 $947 (11.97%) (12.46%) $953 $973 (11.33%) (11.57%) > $10B 63 (0.62%) 73 (0.77%) 76 (0.89%) 80 (0.99%) 83 1.07% 85 (1.11%)

1995 1997 1999 2001 2003 2004

Total Assets $4,116 $4,642 $5,735 $6,569 $7,603 $8,413

< $100 M $310 (7.54%) $277 (5.97%) $243 (4.23%) $222 (3.37%) $201 (2.64%) $189 (2.25%)

> $10B $2,061 (50.07%) $2,658 (57.27%) $3,823 (66.65%) $4,613 (70.22%) $5,545 (72.93%) $6,297 (74.85%)

I. Recent Bank Performance

I. Recent Bank Performance

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

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

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

I. Recent Bank Performance

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 Competition Competition Competition

for for for for

deposits loans payment services 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.
Commercial paper Captive automobile finance companies Other finance companies Junk bonds

Competition for loans comes in many forms:

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 feebased 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

II. Recent Banking Trends

II. Recent Banking Trends

Securitization
Securitization is the process of converting assets into marketable securities. It enables banks to move assets off-balancesheet and increase fee income. It increases competition for standardized produces such as mortgages and other cerditscored 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 doubleedged 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

Country Japan United States Switzerland France United Kingdom Total Assets ($M) $1,285,471 1,264,032 1,120,543 1,105,378 1,034,216

Bank 1. Mizuho Financial Group 2. Citigroup 3. UBS Group 4. Credit Agricole Mutual 5. HSBC Holdings

6. Deutsche Bank
7. BNP paribus 8. Mitibush Tokyo Financial Group 9. Sumitomo Mitsui Financial Group 10. Royal Bank of Scotland

Germany
France Japan Japan United Kingdom

1,014,845
988,982 974.950 950,448 806,207

II. Recent Banking Trends

The 20 largest banks in the world, July 1, 2004

Country United Kingdom Switzerland United States Japan United Statements Total Assets ($M) $791,292 777,849 770,912 753,631 736,445

Bank 11. Barclays Bank 12. Credit Suisse Group 13. J.P. Morgan Chase 14. UFJ Holdings 15. Bank of America

16. ING Bank

17. Societe Generake 18. ABN-AMRO Bank 19. HSBC Industrial and Commercial Bank of China

Netherlands
France Netherlands United Kingdom China

684,004
681,218 667,636 650,721 637,829