Introduction to the Business of Banking and Financial-Services (1)

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P A R T O N E

Introduction to the Business of Banking and Financial-Services Management

Opening this book launches us on an adventure, exploring one of the oldest and mostimportant industries in the world. Banking and the financial-services industry encom-passes some of the largest business firms ever created—behemoths such as Citibank, J. P.Morgan Chase, and Bank of America in the United States, Toronto-Dominion Bank inCanada, Deutsche Bank in Germany, and Barclays PLC in Great Britain. And let’s notforget banking’s huge nonbank competitors, including AXA, ING, Prudential, MetLife,GE Capital, GMAC, Fannie Mae, Freddie Mac, and scores of other financial-servicegiants that serve every major market around the globe. Yet, astonishingly, this industryalso contains some of the smallest businesses to ever open their doors, such as HeritageBank in Bozeman, Montana.

Whether big or small, however, banking and the financial-services industry has a pro-found effect on our lives, influencing the availability of jobs, the cost of living, the ade-quacy of our savings, and the quality of our existence.

However, banking and the financial-services industry as we know it today is rapidlybecoming a quite different industry than in the past. For example, bank and nonbankfinancial firms are declining in numbers, consolidating into fewer but also much larger com-panies that may be more efficient and failure resistant. At the same time banks, insurancecompanies, security dealers, finance companies, and other financial firms are convergingtoward each other, each proliferating the number of services they offer to capture new mar-kets. The result is that the boundaries between banking, insurance, security firms, financecompanies, and other financial-service providers are becoming hopelessly blurred—customers, employees, and industry regulators often cannot tell the difference betweenthem. Financial-service providers are aggressively invading each other’s territories.

For example, if you are looking for a credit card today you can probably find what youare looking for not only at the neighborhood bank, but also from retailers such as Targetand Wal-Mart, from leading security firms such as Fidelity and Merrill Lynch, and frommajor insurance companies such as Prudential and State Farm. If you are seeking a per-sonal loan and your credit is good you likely have thousands of options, from credit cardcompanies and credit unions to finance companies and security brokers, not to mentionyour friendly neighborhood bank. If you are computer oriented and want to access finan-cial services over the Internet, virtual banks and scores of other financial-service vendorsare waiting there for you, reflecting the fact that the entire financial-services sector is

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undergoing a vast wave of technological change. Instead of focusing just on bankingtoday, as we used to do in the past, we must continually expand our focus to view bank-ing within a far broader financial-services industry. Instead of using only a microscope wealso need a telescope or we may miss something really important!

Hang on, then, because this rapidly changing industry is about to unfold before us. Inthis opening part of the text we explore the origins of financial-service providers, exam-ine their range of services, tally up who the key competitors are, and see what careeropportunities may be waiting out there for you if you find enjoyment and satisfaction inlearning about the financial-services industry. We also explore the important roles playedby government in regulating and supervising financial firms and discover how these firmsare organized today and the service-delivery vehicles (such as branches, ATMs, cellphones, the Internet, etc.) they employ to attract and hold their customers.

We welcome you on this important journey and hope you find it fascinating and useful as you live for the present and plan for the future.

2 Part One Introduction to the Business of Banking and Financial-Services Management


C H A P T E R O N E

An Overview of Banksand the Financial-Services SectorKey Topics in This Chapter

• Powerful Forces Reshaping the Industry

• What Is a Bank?

• The Financial System and Competing Financial-Service Institutions

• Old and New Services Offered to the Public

• Key Trends affecting All Financial-Service Firms

• Appendix: Career Opportunities in Financial Services

1–1 IntroductionThere is an old joke attributed to comedian Bob Hope that says “a bank is a financial insti-tution where you can borrow money only if you can prove you don’t need it.” Althoughmany of a bank’s borrowing customers may get the impression that old joke is more truththan fiction, the real story is that banks today readily provide hundreds of different servicesto millions of people, businesses, and governments all over the world. And many of thesefinancial services are vital to our personal well-being and the well-being of the communi-ties and nations where we live.

Banks are the principal source of credit (loanable funds) for millions of individuals andfamilies and for many units of government (school districts, cities, counties, etc.). More-over, for small businesses ranging from grocery stores to automobile dealers, banks areoften the major source of credit to stock shelves with merchandise or to fill a dealer’s lotwith new cars. When businesses and consumers must make payments for purchases ofgoods and services, more often than not they use bank-supplied checks, credit or debitcards, or electronic accounts accessible through a Web site. And when they need financialinformation and financial advice, it is the banker to whom they turn most frequently foradvice and counsel. More than any other financial-service firm, banks have a reputationfor public trust.

Worldwide, banks grant more installment loans to consumers (individuals and families)than any other financial-service provider. In most years, they are among the leading buy-ers of bonds and notes governments issue to finance public facilities, ranging from audito-riums and football stadiums to airports and highways. Banks are among the most importantsources of short-term working capital for businesses and have become increasingly active

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in recent years in making long-term business loans to fund the purchase of new plant andequipment. The assets held by U.S. banks represent about one-fifth of the total assets andan even larger proportion of the earnings of all U.S.-based financial-service institutions.In other nations—for example, in Japan—banks hold half or more of all assets in thefinancial system. The difference is because in the United States, many important non-bank financial-service providers can and do compete to meet the needs of businesses,consumers, and governments.

Powerful Forces Are Reshaping Banking and Financial Services TodayAs we begin our study of this important industry, we should keep in mind the great forcesreshaping the whole financial-services sector. For example, most banks today are profitable—and, in fact, in several recent quarters they have posted record earnings—but their marketshare of the financial-services marketplace is falling significantly. As the former chairman ofthe Federal Deposit Insurance Corporation (FOIC) noted recently, in 1980 insured com-mercial banks and other depository financial institutions held more than 90 percent ofAmericans’ money—a share that had dropped to only about 45 percent as the 21st centuryopened. Over the same time span, banks’ and other depositories’ share of U.S. credit marketliabilities fell from about 45 percent of the grand total to only about 25 percent (as reportedby Powell [6]).

The industry is also consolidating rapidly with substantially fewer, but much larger, banksand other financial firms. For example, the number of U.S. commercial banks fell fromabout 14,000 to fewer than 8,000 between 1980 and 2006. The number of separatelyincorporated commercial banks in the United States has now reached the lowest level inmore than a century, and much the same pattern of industry consolidation appears aroundthe globe in most financial-service industries.

Moreover, banking and the financial-services industry are rapidly globalizing and expe-riencing intense competition in marketplace after marketplace around the planet, not justbetween banks, but also with security dealers, insurance companies, credit unions, financecompanies, and thousands of other financial-service competitors. These financial heavy-weights are all converging toward each other, offering parallel services and slugging it outfor the public’s attention. If consolidation, globalization, convergence, and competitionwere not enough to keep an industry in turmoil, banking and its financial-service neigh-bors are also undergoing a technological revolution as the management of information andthe production and distribution of financial services become increasingly electronic. Forexample, thanks to the Check 21 Act passed in the United States in 2004, even the famil-iar “paper check” is gradually being replaced with electronic images. People increasinglyare managing their deposit accounts through the use of personal computers, cell phones,and debit cards, and there are virtual banks around the world that offer their services exclu-sively through the Internet.

Clearly, if we are to understand bank’s and their financial-service competitors and seewhere they all are headed, we have our work cut out for us. But, then, you always wantedto tackle a big challenge, right?

1–2 What Is a Bank?As important as banks are to the economy as a whole and to the local communities theycall home, there is still much confusion about what exactly a bank is. A bank can bedefined in terms of (1) the economic functions it serves, (2) the services it offers its cus-tomers, or (3) the legal basis for its existence.


FactoidWhat nation has thegreatest number ofcommercial banks?Answer: The UnitedStates with about 7,800commercial banks,followed by Germanywith close to 2,500.


Certainly banks can be identified by the functions they perform in the economy. Theyare involved in transferring funds from savers to borrowers (financial intermediation) andin paying for goods and services.

Historically, banks have been recognized for the great range of financial services theyoffer—from checking accounts and savings plans to loans for businesses, consumers, andgovernments. However, bank service menus are expanding rapidly today to include invest-ment banking (security underwriting), insurance protection, financial planning, advice formerging companies the sale of risk-management services to businesses and consumers, andnumerous other innovative services. Banks no longer limit their service offerings to tradi-tional services but have increasingly become general financial-service providers.

Unfortunately in our quest to identify what a bank is, we will soon discover that not onlyare the functions and services of banks changing within the global financial system, buttheir principal competitors are going through great changes as well. Indeed, many financial-service institutions—including leading security dealers, investment bankers, brokerage firms,credit unions, thrift institutions, mutual funds, and insurance companies—are trying to be assimilar to banks as possible in the services they offer. Examples include Merrill Lynch, DreyfusCorporation, and Prudential Insurance—all of which own banks or banklike firms. Moreover,if this were not confusing enough, several industrial companies have stepped forward in recentdecades in an effort to control a bank and offer loans, credit cards, savings plans, and other tra-ditional banking services. Examples of these giant banking-market invaders include GeneralMotors Acceptance Corporation (GMAC), GE Capital, and Ford Motor Credit, to nameonly a few. Even Wal-Mart, the world’s largest retailer, recently has explored the possibilityof acquiring an industrial bank in Utah in an effort to expand its financial-service offerings!American Express and Target already control bank-like institutions.

Bankers have not taken this invasion of their turf lying down. They are demandingrelief from traditional rules and lobbying for expanded authority to reach into new marketsall around the globe. For example, with large U.S. banks lobbying heavily, the UnitedStates Congress passed the Financial Services Modernization Act of 1999 (known morepopularly as the Gramm-Leach-Bliley or GLB Act after its Congressional sponsors), allow-ing U.S. banks to enter the securities and insurance industries and permitting nonbankfinancial holding companies to acquire and control banking firms.

To add to the prevailing uncertainty about what a bank is, over the years literallydozens of organizations have emerged from the competitive financial marketplace proudlybearing the label of bank. As Exhibit 1–1 shows, for example, there are savings banks, invest-ment banks, mortgage banks, merchant banks, universal banks, and so on. In this text wewill spend most of our time focused upon the most important of all banking institutions—the commercial bank—which serves both business and household customers all over theworld. However, the management principles and concepts we will explore in the chaptersthat follow apply to many different kinds of “banks” as well as to other financial-serviceinstitutions that provide similar services.

While we are discussing the many different kinds of banks, we should mention an impor-tant distinction between banking types that will surface over and over again as we make ourway through this text—community banks versus money-center banks. Money-center banksare giant industry leaders, spanning whole regions, nations, and continents, offering thewidest possible menu of financial services, gobbling up smaller businesses, and facing toughcompetition from other giant financial firms around the globe. Community banks, on theother hand, are usually much smaller and service local communities, towns, and cities,offering a significantly narrower, but often more personalized, menu of financial services tothe public. As we will see, community banks are declining in numbers, but they also areproving to be tough competitors in the local areas they choose to serve.

Chapter 1 An Overview of Banks and the Financial-Services Sector 5


One final note in our search for the definition of banks concerns the legal basis for theirexistence. When the federal government of the United States decided that it would regu-late and supervise banks more than a century ago, it had to define what was and what wasnot a bank for purposes of enforcing its rules. After all, if you plan to regulate banks youhave to write down a specific description of what they are—otherwise, the regulated firmscan easily escape their regulators, claiming they aren’t really banks at all!

The government finally settled on the definition still used by many nations today:A bank is any business offering deposits subject to withdrawal on demand (such as by writ-ing a check or making an electronic transfer of funds) and making loans of a commercialor business nature (such as granting credit to private businesses seeking to expand theinventory of goods on their shelves or purchase new equipment). Over a century later,during the 1980s, when hundreds of financial and nonfinancial institutions (such as J. C.Penney and Sears) were offering either, but not both, of these two key services and, there-fore, were claiming exemption from being regulated as a bank, the U.S. Congress decidedto take another swing at the challenge of defining banking. Congress then defined a bankas any institution that could qualify for deposit insurance administered by the Federal DepositInsurance Corporation (FDIC).

A clever move indeed! Under federal law in the United States a bank had come to bedefined, not so much by its array of service offerings, but by the government agency insur-ing its deposits! Please stay tuned—this convoluted and complicated story undoubtedlywill develop even more bizarre twists as the 21st century unfolds.


Name of Banking-Type Firm Definition or Description

Commercial banks: Sell deposits and make loans to businesses and individualsMoney center banks: Are large commercial banks based in leading financial centersCommunity banks: Are smaller, locally focused commercial and savings banksSavings banks: Attract savings deposits and make loans to individuals and familiesCooperative banks: Help farmers, ranchers, and consumers acquire goods and servicesMortgage banks: Provide mortgage loans on new homes but do not sell depositsInvestment banks: Underwrite issues of new securities by their corporate customersMerchant banks: Supply both debt and equity capital to businessesIndustrial banks: State-chartered loan companies owned by financial or non financial

corporationsInternational banks: Are commercial banks present in more than one nationWholesale banks: Are larger commercial banks serving corporations and governmentsRetail banks: Are smaller banks serving primarily households and small businessesLimited-purpose banks: Offer a narrow menu of services, such as credit card companies and

subprime lendersBankers banks: Supply services (e.g., check clearing and security trading) to banksMinority banks: Focus primarily on customers belonging to minority groupsNational banks: Function under a federal charter through the Comptroller of the

CurrencyState banks: Function under charters issued by banking commissions in the various

statesInsured banks: Maintain deposits backed by federal deposit insurance plans (e.g., the

FDIC)Member banks: Belong to the Federal Reserve SystemAffiliated banks: Are wholly or partially owned by a holding companyVirtual banks: Offer their services only over the Internet.Fringe banks: Offer payday and title loans, cash checks, or operate as pawn shops

and rent-to own firmsUniversal banks: Offer virtually all financial services available in today’s marketplace.

EXHIBIT 1–1The Different Kindsof Financial-ServiceFirms CallingThemselves Banks

Key URLsThe Federal DepositInsurance Corporationnot only insuresdeposits, but provideslarge amounts of dataon individual banks.See especiallywww.fdic.gov andwww.fdic.gov/bank/index.html.


Insights and Issues

A BRIEF HISTORY OF BANKING AND OTHERFINANCIAL-SERVICE FIRMSAs best we can tell from historical records, banking is the oldest ofall financial-service professions. Where did these powerful finan-cial institutions come from?

Linguistics (the science of language) and etymology (the studyof word origins) tell us that the French word banque and the Ital-ian banca were used centuries ago to refer to a “bench” or“money changer’s table.” This describes quite well what histori-ans have observed about the first bankers offering their servicesmore than 2,000 years ago. They were money changers, situatedusually at a table in the commercial district, aiding travelers byexchanging foreign coins for local money or discounting commer-cial notes for a fee.

The earliest bankers pledged a lot of their own money to sup-port these early ventures, but it wasn’t long before the idea ofattracting deposits and loaning out those same funds emerged.Loans were granted to shippers, landowners, and others at inter-est rates as low as 6 percent to as high as 48 percent a month forthe riskiest ventures! Most of the early banks were Greek in origin.

The banking industry gradually spread from the classical civi-lizations of Greece and Rome into Europe. It encountered religiousopposition during the Middle Ages primarily because loans to thepoor often carried high interest rates. However, as the MiddleAges drew to a close and the Renaissance began in Europe, thebulk of loans and deposits involved wealthy customers, whichhelped to reduce religious objections.

The development of overland trade routes and improvementsin navigation in the 15th, 16th, and 17th centuries gradually shiftedthe center of world commerce from the Mediterranean towardEurope and the British Isles. During this period, the seeds of theIndustrial Revolution, which demanded a welldeveloped financialsystem, were planted. The adoption of mass production requiredan expansion in global trade to absorb industrial output, which inturn required new methods for making payments and obtainingcredit. Banks that could deliver on these needs grew rapidly, ledby such institutions as the Medici Bank in Italy and the Hochstet-ter Bank in Germany.

The early banks in Europe were places for the safekeeping ofwealth (such as gold and silver) for a fee as people came to fearloss of their assets due to war, theft, or expropriation by govern-ment. Merchants shipping goods found it safer to place theirpayments of gold and silver in the nearest bank rather than risk-ing loss to pirates or storms at sea. In England governmentefforts to seize private holdings resulted in people depositingtheir valuables in goldsmiths’ shops, which issued tokens or cer-tificates indicating the customer had made a deposit. Soon,

goldsmith certificates began to circulate as money because theywere more convenient and less risky to carry around than goldor other valuables. The goldsmiths also offered certification ofvalue services—what we today call property appraisal. Cus-tomers would bring in their valuables to have an expert certifythese items were real and not fakes.

When colonies were established in North and South America,Old World banking practices entered the New World. At first thecolonists dealt primarily with established banks in the countriesfrom which they had come. Later, state governments in the UnitedStates began chartering banking companies. The U.S. federalgovernment became a major force in banking during the CivilWar. The Office of the Comptroller of the Currency (OCC) wasestablished in 1864, created by the U.S. Congress to charternational banks. This divided bank regulatory system, in whichboth the federal government and the states play key roles in thesupervision of banking activity, has persisted in the United Statesto the present day.

Despite banking’s long history and success, tough financial-service competitors have emerged over the past century or two,mostly from Europe, to challenge bankers at every turn. Among theoldest were life insurance companies—the first American com-pany was chartered in Philadelphia in 1759. Property-casualtyinsurers emerged at roughly the same time, led by Lloyds of Lon-don in 1688, underwriting a wide range of risks to persons andproperty.

The 19th century ushered in a rash of new financial competi-tors, led by savings banks in Scotland in 1810. These institutionsoffered small savings deposits to individuals at a time when mostcommercial banks largely ignored this market segment. A similarfirm, the savings and loan association, appeared in the midwest-ern United States during the 1830s, encouraging household savingand financing the construction of new homes. Credit unions werefirst chartered in Germany during the same era, providing savingsaccounts and low-cost credit to industrial workers.

Mutual funds—one of banking’s most successful competitors—appeared in Belgium in 1822. These investment firms enteredthe United States in significant numbers during the 1920s, weredevastated by the Great Depression of the 1930s, and rose againto grow rapidly. A closely related institution—the money marketfund—surfaced in the 1970s to offer professional cash manage-ment services to households and institutions. These aggressivecompetitors attracted a huge volume of deposits away frombanks and ultimately helped to bring about government deregu-lation of the banking industry. Finally, hedge funds appeared tooffer investors a less regulated, more risky alternative to mutualfunds. They grew explosively into the new century.


1–3 The Financial System and Competing Financial-Service Institutions

Roles of the Financial SystemAs we noted at the opening of this chapter, bankers face challenges from all sides today asthey reach out to their financial-service customers. Banks are only one part of a vast finan-cial system of markets and institutions that circles the globe. The primary purpose of thisever-changing financial system is to encourage individuals and institutions to save and to trans-fer those savings to those individuals and institutions planning to invest in new projects. Thisprocess of encouraging savings and transforming savings into investment spending causesthe economy to grow, new jobs to be created, and living standards to rise.

But the financial system does more than simply transform savings into investment. Italso provides a variety of supporting services essential to modern living. These include pay-ment services that make commerce and markets possible (such as checks, credit cards, andinteractive Web sites), risk protection services for those who save and venture to invest(including insurance policies and derivative contracts), liquidity services (making it possi-ble to convert property into immediately available spending power), and credit services forthose who need loans to supplement their income.

The Competitive Challenge for BanksFor many centuries banks were way out in front of other financial-service institutions insupplying savings and investment services, payment and risk protection services, liquidity,and loans. They dominated the financial system of decades past. But this is no longer astrue today. Banking’s financial market share generally has fallen as other financial institu-tions have moved in to fight for the same turf. In the United States of a century ago, forexample, banks accounted for more than two-thirds of the assets of all financial-serviceproviders. However, as Exhibit 1–2 illustrates, that share has fallen to only about one-fifthof the assets of the U.S. financial marketplace.

Some authorities in the financial-services field suggest this apparent loss of marketshare may imply that traditional banking is dying. (See, for example, Beim [2] and thecounterargument by Kaufman and Mote [3].) Certainly as financial markets become moreefficient and the largest customers find ways around banks to obtain the funds they need(such as by borrowing in the open market), traditional banks may become less necessary.Some experts argue that the reason we still have thousands of banks scattered around theglobe—perhaps many more than we need—is that governments often subsidize the indus-try through cheap deposit insurance and low-cost loans. Still others argue that banking’smarket share is falling due to excessive government regulation, restricting the industry’sability to compete. Perhaps banking is being “regulated to death,” which may hurt thosecustomers who most heavily depend on banks for critical services—individuals and smallbusinesses. Other experts counter that banking is not dying, but only changing—offeringnew services and changing its form—to reflect what today’s market demands. Perhaps thetraditional measures of the industry’s importance (like total assets) no longer reflect howtruly diverse and competitive bankers have become in the modern world.

Leading Competitors with BanksAmong the leading competitors with banks in wrestling for the loyalty of financial-servicecustomers are such nonbank financial-service institutions as:

Savings associations: Specialize in selling savings deposits and granting homemortgage loans and other forms of credit to individuals and families, illustrated bysuch financial firms as Atlas Savings and Loan Association (www.atlasbank.com),


FactoidDid you know that thenumber of banksoperating in the U.S.today represents lessthan a third of thenumber operating 100years ago? Why do youthink this is so?

Key URLsWant to know moreabout savingsassociations? Seeespecially the Office ofThrift Supervision atwww.ots.treas.gov andthe Federal DepositInsurance Corporationat www.fdic.gov.


Flatbush Savings and Loan Association (www.flatbush.com) of Brooklyn, New York,Washington Mutual (www.wamu.com), and American Federal Savings Bank(www.americanfsb.com).Credit unions: Collect deposits from and make loans to their members as nonprofitassociations of individuals sharing a common bond (such as the same employer),including such firms as American Credit Union of Milwaukee (www.americancu.org)and Chicago Post Office Employees Credit Union (www.my-creditunion.com).Money market funds: Collect short-term, liquid funds from individuals andinstitutions and invest these monies in quality securities of short duration, includingsuch firms as Franklin Templeton Tax-Free Money Fund (www.franklintempleton.com) and Scudder Tax-Free Money Fund (www.scudder.com).Mutual funds (investment companies): Sell shares to the public representing aninterest in a professionally managed pool of stocks, bonds, and other securities,including such financial firms as Fidelity (www.fidelity.com) and The VanguardGroup (www.vanguard.com).Hedge funds: Sell shares mainly to upscale investors in a broad group of differentkinds of assets (including nontraditional investments in commodities, real estate,loans to ailines companies, and other risky assets); for additional information see suchfirms as Magnum Group (www.magnum.com) and Turn Key Hedge Funds(www.turnkeyhedgefunds.com).Security brokers and dealers: Buy and sell securities on behalf of their customers andfor their own accounts, such as Merrill Lynch (www.ml.com) and Charles Schwab(www.Schwab.com).


Total Financial Assets Percent of All Financial Financial-Service Institutions Held in 2005 (bill.)* Assets Held in 2005

Depository Institutions:Commercial banks** 8,713 20.1%Savings institutions*** 1,693 3.9Credit unions 670 1.5

Nondeposit Financial Institutions:Life insurance companies 4,166 9.6Property/casualty and other insurers 1,197 2.8Private pension funds 4,286 9.9State and local government retirement funds 2,040 4.7Federal government retirement funds 71 0.2Money market funds 1,841 4.2Investment companies (mutual funds) 5,443 12.5Finance companies 1,424 3.3Mortgage companies 32 ****Real estate investment trusts 259 0.6Security brokers and dealers 1,941 4.5Other financial service providers (including government-sponsored enterprises, mortgage pools, payday lenders, etc.) 9,670 22.3

Totals 43,446 100.0%

EXHIBIT 1–2Comparative Size byIndustry ofCommercial Banksand Their PrincipalFinancial-ServiceCompetitors

Source: Board of Governors ofthe Federal Reserve System,Flow of Funds Accounts of theUnited States. First Quarter2005, June 2005.

Notes: Columns may not add to totals due to rounding error.*Figures are for the first quarter of 2005.**Commercial banking as recorded here includes U.S. chartered commercial banks, foreign banking offices in the United States, bankholding companies, and banks operating in United States affiliated areas.***Savings institutions include savings and loan associations, mutual and federal savings banks, and cooperative banks.****Figure is less than one-tenth of one percent.

Key URLsThe nature andcharacteristics of moneymarket funds and othermutual funds areexplained at length insuch sources aswww.smartmoney.com,www.ici.org,www.morningstar.com,and market watch.com.

Key URLsTo explore thecharacter of the creditunion industry seewww.cuna.org andwoccu.org.

Key URLsTo learn more aboutsecurity brokers anddealers see www.sec.govor www.investorguide.com.


Investment banks: Provide professional advice to corporations and governmentsraising funds in the financial marketplace or seeking to make business acquisitions,including such prominent investment banking houses as Bear Sterns(www.bearsterns.com) and Morgan Stanley (www.morganstanley.com).Finance companies: Offer loans to commercial enterprises (such as auto andappliance dealers) and to individuals and families using funds borrowed in the openmarket or from other financial institutions, including such well-known financial firmsas Household Finance (www.household.com) and GMAC Financial Services(www.gmacfs.com).Financial holding companies: (FHCs) Often include credit card companies,insurance and finance companies, and security broker/dealer firms under onecorporate umbrella as highly diversified financial-service providers, including suchleading financial conglomerates as GE Capital (www.gecapital.com) and UBSWarburg AG (www.ubswarburg.com).Life and property/casualty insurance companies: Protect against risks to persons orproperty and manage the pension plans of businesses and the retirement funds ofindividuals, including such industry leaders as Prudential Insurance (www.prudential.com) and State Farm Insurance Companies (www.statefarm.com).

As suggested by Exhibit 1–3, all of these financial-service providers are converging interms of the services they offer—rushing toward each other like colliding trains—andembracing each other’s innovations. Moreover, recent changes in government rules, suchas the U.S. Financial Services Modernization (Gramm-Leach-Bliley) Act of 1999, haveallowed many of the financial firms listed above to offer the public one-stop shopping forfinancial services. To bankers the financial-services marketplace appears to be closing infrom all sides as the list of aggressive competitors grows.

Thanks to more liberal government regulations, banks with quality management andadequate capital can now truly become conglomerate financial-service providers. Thesame is true for security firms, insurers, and other financially oriented companies that wishto acquire bank affiliates.

Thus, the historic legal barriers in the United States separating banking from other financial-service businesses have, like the walls of ancient Jericho, “come tumbling down.” The challengeof differentiating banks from other financial-service providers is greater than ever before. How-ever, inside the United States, Congress (like the governments of many other nations aroundthe globe) has chosen to limit severely banks’ association with industrial and manufacturingfirms, fearing that allowing banking–industrial combinations of companies might snuff out com-petition, threaten bankers with new risks, and possibly weaken the safety net that protectsdepositors from loss when the banking system gets into trouble.


Key URLsYou can explore theworld of investmentbanking more fully atwww.wallstreetprep.com.

Key URLsTo discover more abouthedge funds see theSecurity and ExchangeCommission’s Web siteat www.sec.gov/answers/hedge.htm.

Key URLsTo explore the lifeinsurance andproperty/casualtyinsurance industries seeespecially www.acli.comand www.iii.org.

Key URLsTo learn more aboutfinance companies seewww.nacm.org,www.hsbcusa.com, andwww.capitalone.com.

Concept Check

1-1. What is a bank? How does a bank differ from mostother financial-service providers?

1-2. Under U.S. law what must a corporation do to qual-ify and be regulated as a commercial bank?

1-3. Why are some banks reaching out to becomeonestop financial-service conglomerates? Is this agood idea, in your opinion?

1-4. Which businesses are banking’s closest and tough-est competitors? What services do they offer thatcompete directly with banks’ services?

1-5. What is happening to banking’s share of the finan-cial marketplace and why? What kind of bankingand financial system do you foresee for the future ifpresent trends continue?



Offering customers credit,payments, and savings depositservices often fullycomparable to what banksoffer

Providing customerswith long-term savingsplans, risk protection,and credit

Credit Unions and Other Thrift Institutions

Security Brokersand Dealers

Insurance Companiesand Pension Plans

Providing investment and savingsplanning, executing securitypurchases and sales, and providingcredit cards to their customers

Supplying customers withaccess to cash (liquidity) andshort- to medium-term loansfor everything from dailyhousehold and operating expenses to the purchase of appliances and equipment

FinanceCompanies

Supplying professionalcash management andinvesting services for longer-term savers

Mutual Funds

Highlydiversifiedfinancial-serviceproviders

that controlmultiplefinancialfirms

offeringmany different services

FinancialConglomerates

Modern

B ank

Bankers feel the impact of their fiercest nonbankcompetitors coming in from all directions

InvestmentBanks

Advising corporations and Governments on raising funds,entering new markets, and planningacquisitions and mergers

EXHIBIT 1–3 The Most Important Nonbank Competitors for Banks

The result of all these recent legal maneuverings is a state of confusion in the public’smind today over what is or is not a bank. The safest approach is probably to view these his-toric financial institutions in terms of the many key services—especially credit, savings,payments, financial advising, and risk protection services—they offer to the public. Thismultiplicity of services and functions has led to banks and their nearest competitors beinglabeled “financial department stores” and to such familiar advertising slogans as “YourBank—a Full-Service Financial Institution”.


1–4 Services Banks and Many of Their Closest Competitors Offer the PublicBanks, like their neighboring competitors, are financial-service providers. As such, theyplay a number of important roles in the economy. (See Table 1–1.) Their success hinges ontheir ability to identify the financial services the public demands, produce those servicesefficiently, and sell them at a competitive price. What services does the public demandfrom banks and their financial-service competitors today? In this section, we present anoverview of both banking’s traditional and its modern service menu.

Services Banks Have Offered Throughout HistoryCarrying Out Currency ExchangesHistory reveals that one of the first services banks offered was currency exchange. A bankerstood ready to trade one form of coin or currency (such as dollars) for another (such asfrancs or pesos) in return for a service fee. Such exchanges have been important to travelersover the centuries, because the traveler’s survival and comfort may depend on gaining accessto local funds. In today’s financial marketplace, trading in foreign currency is conductedprimarily by the largest financial-service firms due to the risks involved and the expenserequired to carry out these transactions.

Discounting Commercial Notes and Making Business LoansEarly in history, bankers began discounting commercial notes—in effect, making loans tolocal merchants who sold the debts (accounts receivable) they held against their cus-tomers to a bank to raise cash quickly. It was a short step from discounting commercialnotes to making direct loans for purchasing inventories of goods or for constructing newfacilities—a service that today is provided by banks, finance companies, insurance firms,and other financial-service competitors.

Offering Savings DepositsMaking loans proved so profitable that banks began searching for ways to raise addi-tional loanable funds. One of the earliest sources of these funds consisted of offering


The modern bank has had to adopt many roles to remain competitive and responsive to public needs.Banking’s principal roles (and the roles performed by many of its competitors) today include:

The intermediation role Transforming savings received primarily from households into credit(loans) for business firms and others in order to make investments innew buildings, equipment, and other goods.

The payments role Carrying out payments for goods and services on behalf of customers(such as by issuing and clearing checks and providing a conduit forelectronic payments.

The guarantor role Standing behind their customers to pay off customer debts when thosecustomers are unable to pay (such as by issuing letters of credit).

The risk management role Assisting customers in preparing financially for the risk of loss toproperty, persons, and financial assets.

The investment banking role Assisting corporations and governments in marketing securities andraising new funds.

The savings/investment Aiding customers in fulfilling their long-range goals for a better life by advisor role building and investing savings.The safekeeping/certification Safeguarding a customer’s valuables and certifying their true value.of value roleThe agency role Acting on behalf of customers to manage and protect their property.The policy role Serving as a conduit for government policy in attempting to regulate

the growth of the economy and pursue social goals.

TABLE 1–1The Many DifferentRoles Banks andTheir ClosestCompetitors Play in the Economy


Insights and Issues

THE ROLE OF BANKS AND OTHER FINANCIALINTERMEDIARIES IN THEORYBanks, along with insurance companies, mutual funds, financecompanies, and similar financial-service providers, are financialintermediaries. The term financial intermediary simply means abusiness that interacts with two types of individuals and institu-tions in the economy: (1) deficit-spending individuals and institu-tions, whose current expenditures for consumption and investmentexceed their current receipts of income and who, therefore, needto raise funds externally through borrowing or issuing stock; and (2)surplus-spending individuals and institutions whose currentreceipts of income exceed their current expenditures on goods andservices so they have surplus funds that can be saved andinvested. Intermediaries perform the indispensable task of actingas a bridge between these two groups, offering convenient finan-cial services to surplus-spending units in order to attract funds andthen allocating those funds to deficit spenders. In so doing, inter-mediaries accelerate economic growth by expanding the availablepool of savings, lowering the risk of investments through diversifi-cation, and increasing the productivity of savings and investment.

Intermediation activities will take place (1) if there is a positivespread between the expected yields on loans that financial inter-mediaries make to deficit spenders and the expected cost of thefunds intermediaries attract from surplus spenders; and (2) if thereis a positive correlation between the yields on loans and otherassets and the attracting funds. If an Intermediary’s asset yieldsand its fund-raising costs are positively correlated, this will reduceuncertainty about its expected profits and allow it to expand.

An ongoing debate in finance concerns why financial interme-diaries exist at all. What services do they provide that other busi-nesses and individuals cannot provide for themselves?

This question has proven difficult to answer. Research evi-dence showing that our financial markets are reasonably efficienthas accumulated in recent years. Funds and information flowreadily to market participants, and the prices of assets seem to bedetermined in highly competitive markets. In a perfectly competi-tive and efficient financial system, in which all participants haveequal and open access to the financial marketplace, no one par-ticipant can exercise control over prices, all pertinent informationaffecting the value of various assets is available to all, transac-tions costs are not significant impediments to trading, and allassets are available in denominations anyone can afford, whywould banks and other financial-service firms be needed at all?

Most current theories explain the existence of financial inter-mediaries by pointing to imperfections in our financial system. Forexample, all assets are not perfectly divisible into small denomina-tions that everyone can afford. To illustrate, marketable U.S. Trea-sury bonds—one of the most popular securities in the world—haveminimum denominations of $1,000, which is beyond the reach of

many small savers and investors. Financial intermediaries providea valuable service in dividing up such instruments into smaller unitsthat are readily affordable for millions of people.

Another contribution that intermediaries make is their willing-ness to accept risky loans from borrowers, while issuing low-risksecurities to their depositors and other funds providers. Theseservice providers engage in risky arbitrage across the financialmarkets and sell risk-management services as well.

Financial intermediaries satisfy the need for liquidity. Financialinstruments are liquid if they can be sold quickly in a ready marketwith little risk of loss to the seller. Many households and busi-nesses, for example, demand large precautionary balances of liq-uid funds to cover future cash needs. Intermediaries satisfy thiscustomer need by offering high liquidity in the financial assetsthey provide, giving customers access to liquid funds preciselywhen they are needed.

Still another reason intermediaries have prospered is theirsuperior ability to evaluate information. Pertinent data on financialinvestments is limited and costly. Some institutions know morethan others or possess inside information that allows them tochoose profitable investments while avoiding the losers. Thisuneven distribution of information and the talent to analyze it isknown as informational asymmetry. Asymmetries reduce the effi-ciency of markets, but provide a profitable role for intermediariesthat have the expertise to evaluate potential investments.

Yet another view of why financial institutions exist in modernsociety is called delegated monitoring. Most borrowers prefer tokeep their financial records confidential. Lending institutions areable to attract borrowing customers because they pledge confi-dentiality. For example, a bank’s depositors are not privileged toreview the records of its borrowing customers. Depositors oftenhave neither the time nor the skill to choose good loans over bad.They turn the monitoring process over to a financial intermediary.Thus a depository institution serves as an agent on behalf of itsdepositors, monitoring the financial condition of those customerswho do receive loans to ensure that depositors will recover theirfunds. In return for monitoring, depositors pay a fee to the lenderthat is probably less than the cost they would incur if they moni-tored borrowers themselves.

By making a large volume of loans, lending institutions actingas delegated monitors can diversify and reduce their risk expo-sure, resulting in increased safety for savers’ funds. Moreover,when a borrowing customer has received the stamp of approvalof a lending institution it is easier and less costly for that cus-tomer to raise funds elsewhere. This signals the financial market-place that the borrower is likely to repay his or her loans. Thissignaling effect seems to be strongest, not when a lending insti-tution makes the first loan to a borrower, but when it renews amaturing loan.


savings deposits—interest-bearing funds left with depository institutions for a period oftime. According to some historical records, banks in ancient Greece paid as high as 16 per-cent in annual interest to attract savings deposits from wealthy patrons and then madeloans to ship owners sailing the Mediterranean Sea at loan rates double or triple the ratebankers were paying to their savings deposit customers. How’s that for a nice profit spread?

Safekeeping of Valuables and Certification of ValueDuring the Middle Ages, banks and other merchants (often called “goldsmiths”) began thepractice of holding gold and other valuables owned by their customers inside secure vaults,thus reassuring customers of their safekeeping. These financial firms would assay the mar-ket value of their customer’s valuables, especially gold and jewelry, and certify whether ornot these “valuables” were worth what others had claimed.

Supporting Government Activities with CreditDuring the Middle Ages and the early years of the Industrial Revolution, governments inEurope noted bankers’ ability to mobilize large amounts of funds. Frequently banks werechartered under the proviso that they would purchase government bonds with a portion ofthe deposits they received. This lesson was not lost on the fledgling American governmentduring the Revolutionary War. The Bank of North America, chartered by the Continen-tal Congress in 1781, was set up to help fund the struggle to throw off British rule andmake the United States a sovereign nation. Similarly, during the Civil War the U.S. Con-gress created a whole new federal banking system, agreeing to charter national banks pro-vided these institutions purchased government bonds to help fund the war.

Offering Checking Accounts (Demand Deposits)The Industrial Revolution ushered in new financial services, and new service providers.Probably the most important of the new services developed during this period was thedemand deposit—a checking account that permitted the depositor to write drafts in pay-ment for goods and services that the bank or other service provider had to honor immedi-ately. Demand deposit services proved to be one of the financial-service industry’s mostimportant offerings because it significantly improved the efficiency of the paymentsprocess, making transactions easier, faster, and safer. Today the checking account concepthas been extended to the Internet, to the use of plastic debit cards that tap your checkingaccount electronically, and to “smart cards” that electronically store spending power.Today payment-on-demand accounts are offered not only by banks, but also by savingsassociations, credit unions, securities firms, and other financial-service providers.

Offering Trust ServicesFor many years banks and a few of their competitors (such as insurance and trust compa-nies) have managed the financial affairs and property of individuals and business firms inreturn for a fee. This property management function is known as trust services. Providersof this service typically act as trustees for wills, managing a deceased customer’s estate bypaying claims against that estate, keeping valuable assets safe, and seeing to it that legalheirs receive their rightful inheritance. In commercial trust departments, trust-serviceproviders manage security portfolios and pension plans for businesses and act as agents forcorporations issuing stocks and bonds.

Services Banks and Many of Their Financial-Service Competitors Have Offered More RecentlyGranting Consumer LoansHistorically, banks did not actively pursue loan accounts from individuals and families,believing that the relatively small size of most consumer loans and their relatively high


FactoidWhat region of theUnited States containsthe largest number ofbanks? The Midwest.The smallest number ofbanks? The Northeast.Why do you think thisis so?


default rate would make such lending unprofitable. Accordingly, other financial-serviceproviders—especially credit unions, savings and loans, and finance companies—soonmoved in to focus on the consumer. Early in this century, however, bankers began to relymore heavily on consumers for deposits to help fund their large corporate loans. In addi-tion, heavy competition for business deposits and loans caused bankers increasingly to turnto the consumer as a potentially more loyal customer. By the 1920s and 1930s severalmajor banks, led by one of the forerunners of New York’s Citibank and by the Bank ofAmerica, had established strong consumer loan departments. Following World War II,consumer loans were among the fastest-growing forms of bank credit. Their rate of growthhas slowed recently, though, as bankers have run into stiff competition for consumer creditaccounts from nonbank service providers.

Financial AdvisingCustomers have long asked financial institutions for advice, particularly when it comes tothe use of credit and the saving or investing of funds. Many service providers today offer awide range of financial advisory services, from helping to prepare tax returns and finan-cial plans for individuals to consulting about marketing opportunities at home and abroadfor business customers.

Managing CashOver the years, financial institutions have found that some of the services they providefor themselves are also valuable for their customers. One of the most prominent is cashmanagement services, in which a financial intermediary agrees to handle cash collectionsand disbursements for a business firm and to invest any temporary cash surpluses in interest-bearing assets until cash is needed to pay bills. Although banks tend to specialize mainly inbusiness cash management services, many financial institutions are offering similar servicesto consumers.

Offering Equipment LeasingMany banks and finance companies have moved aggressively to offer their business cus-tomers the option to purchase equipment through a lease arrangement in which the lend-ing institution buys the equipment and rents it to the customer. These equipment leasingservices benefit leasing institutions as well as their customers because, as the real owner ofthe leased equipment, the lessor can depreciate it for additional tax benefits.

Making Venture Capital LoansIncreasingly, banks, security dealers, and other financial conglomerates have becomeactive in financing the start-up costs of new companies. Because of the added risk involvedin such loans, this is generally done through a separate venture capital firm that raisesmoney from investors to support young businesses in the hope of turning a profit whenthose firms are sold org. public.

Selling Insurance PoliciesFor many years bankers have sold credit life insurance to their customers receiving loans,guaranteeing repayment if borrowers die or become disabled. Moreover, during the 19thand early 20th centuries, many bankers sold insurance and provided financial advice totheir customers, literally serving as the local community’s all-around financial-servicestore. However, beginning with the Great Depression of the 1930s, U.S. banks were pro-hibited from acting as insurance agents or underwriting insurance policies. For example,banks in most cases couldn’t provide automobile or homeowners’ coverage or general lifeand health insurance protection. Congress acted out of fear that selling insurance wouldincrease bank risk and lead to conflicts of interest in which customers asking for one ser-vice would be compelled to buy other services as well.


FilmtoidWhat 2001documentary recountsthe creation of anInternet company,GovWorks.com, usingmore than $50 millionin funds provided byventure capitalists?Answer: Startup.com.

Key URLsFor more informationon the venture capitalindustry seewww.nvca.org


Leading Nonbank Financial Firms That Have Reached into Traditional Bank Service Markets

For several decades now bankers have watched as some of the world’s most aggressive nonbankinstitutions have invaded banking’s traditional marketplace. Among the most successful and aggres-sive of such companies are these:

Merrill Lynch & Co. (www.ml.com).* Merrill is one of the largest security trading and underwritingfirms on the planet and serves as an adviser to corporations and governments on every continent.Beginning as an investment firm in 1885, Merrill now competes directly with banks in offering moneymarket accounts and online banking services to both businesses and households. It was one of thefirst nonbank firms to adopt the holding company form and acquire or establish affiliates dealing ingovernment securities, asset management, and the management of mutual funds. During the 1970sMerrill Lynch organized one of the largest of all money market funds and today also controls onindustrial bank.American Express Company (http://home.americanexpress.com).* American Express was one ofthe first credit card companies in the United States and now serves millions of households andbusiness firms. It also owns an FDIC-insured industrial bank (American Express Centurion Bank)through which it offers home mortgage and home equity loans, savings deposits, checking andretirement accounts, and online bill paying. AEX is registered with the Federal Reserve Board as afinancial holding company.Household International (www.household.com).* Household is the largest finance company in theworld, offering personal loans as well as financial assistance to businesses requiring inventoryfinancing. Reaching over 50 million customers in Canada, the United States, and Great Britain,Household competes directly with banks in offering credit cards, auto financing, home mortgages, andcredit life insurance. It also operates a joint venture with an insurance company to offer term life andauto insurance coverage. During 2002, Household International announced its acquisition by HSBC ofLondon, one of the world’s largest banks.Countrywide Financial Corp. (www.countrywide.com). Countrywide is the largest home mortgagelender in the United States. Founded in New York in 1969, the company pioneered banklike branches(known as “country stores”), based initially in California and then spreading nationwide, subsequentlyforming a broker–dealer subsidiary, an insurance agency, and an online lending unit. SubsequentlyCountrywide bought Treasury Bank, NA, in Alexandria, Virginia.

*Indicates this financial firm is included in the Educational Version of S&P’s Market Insight.

Many bankers arranged to have insurance companies sell policies to customers by rentingspace in bank lobbies. This picture of extreme separation between banking and insurancechanged dramatically in 1999 when the U.S. Congress passed the Gramm-Leach-Bliley(GLB) Act and tore down the legal barriers between the two industries, allowing bank hold-ing companies to acquire control of insurance companies and, conversely, permitting insur-ance companies to acquire banks. Today, these two industries are competing aggressivelywith each other, pursuing cross-industry mergers and acquisitions.

Selling Retirement PlansBanks, trust departments, mutual funds, and insurance companies are active in managingthe retirement plans that most businesses make available to their employees, investingincoming funds and dispensing payments to qualified recipients who have reached retire-ment or become disabled. Banks and other depository institutions sell retirement plans(known as IRAs and Keoghs) to individuals holding these deposits until the funds areneeded for income after retirement.


Dealing in Securities: Offering Security Brokerage and Investment Banking ServicesOne of the biggest of all banking service targets in recent years, particularly in the UnitedStates, has been dealing in securities, executing buy and sell orders for security trading cus-tomers (referred to as security brokerage services) and marketing new securities to raisefunds for corporations and other institutions (referred to as security underwriting or invest-ment banking services). However, much of this security brokerage and security underwritingactivity was prohibited in the United States due to the separation of commercial andinvestment banking by the Glass-Steagall Act, passed in 1933. With the passage of theGramm-Leach-Bliley Act in the fall of 1999, however, banks are now permitted to affiliatewith securities firms and security firms can acquire banks. Two venerable old industries, longseparated by law, especially in the United States and Japan, are now like two out-of-controllocomotives rushing toward each other, pursuing many of the same customers.

Offering Mutual Funds and AnnuitiesMany customers have come to demand investment products from their financial-serviceproviders. Mutual fund investments and annuities that offer the prospect of higher yieldsthan the returns often available on conventional bank deposits are among the mostsought-after investment products. However, these product lines also tend to carry morerisk than do bank deposits.

Annuities consist of long-term savings plans that promise the payment of a stream ofincome to the annuity holder beginning on a designated future date (e.g., at retirement).In contrast, mutual funds are professionally managed investment programs that acquirestocks, bonds, and other assets that appear to “fit” the funds’ announced goals (such as tomaximize current income or to achieve long-term capital appreciation). Recently manybanking firms have organized special subsidiary organizations to market these services orentered into joint ventures with security brokers and insurance companies. In turn, manyof bankers’ key competitors, including insurance companies and security firms, havemoved aggressively to expand their public offerings of fixed and variable annuity plans andbroaden their menu of investment services in order to attract customers away from banks.

Offering Merchant Banking ServicesU.S. financial-service providers are following in the footsteps of leading financial institu-tions all over the globe (for example, Barclays Bank of Great Britain and Deutsche Bankof Germany) in offering merchant banking services to larger corporations. These consistof the temporary purchase of corporate stock to aid the launching of a new business ven-ture or to support the expansion of an existing company. Hence, a merchant bankerbecomes a temporary stockholder and bears the risk that the stock purchased may declinein value. In practice, merchant banking services often encompass the identification of pos-sible merger targets for a corporate customer, providing that customer with strategic mar-keting advice.

Offering Risk Management and Hedging ServicesMany observers see fundamental changes going on in the banking sector with largerbanks (such as J. P. Morgan Chase and Citibank) moving away from a traditionally heavyemphasis on deposit-taking and loan-making toward risk intermediation—providing theircustomers with financial tools to combat risk exposure in return for substantial fees.The largest banks around the globe now dominate the risk-hedging field, either actingas dealers (i.e., serving as “market makers”) in arranging for risk protection for thebanks’ customers from third parties or directly selling their customers the bank’s own



Some Leading Retailing and Industrial Firms Reachinginto the Banking and Financial-Services Sector

Banks and other financial-service firms have experienced a rising tide of competition from leadingmanufacturing, retailing, and other businesses in recent decades. These companies based outsidethe financial sector nevertheless have often been successful in capturing financial-service cus-tomers. Among the best known of such nonfinancial-based entities are these:

GE Capital (www.gecapital.com).* The predecessor of GE Capital was set up during the 1930s as acaptive finance company of its parent, General Electric, to provide financing so that consumers andappliance and equipment dealers could afford GE products. The firm branched out as it grew tofinance more than just GE products. Today it offers such diverse services as leasing airplanes, autos,and oil tankers; credit cards; equity investments; and insurance. If GE Capital were a bank it wouldrank in the top 10 of all U.S. banks. In 2002 GE announced that GE Capital would become four separatebusinesses—GE Commercial Finance, GE Consumer Finance, GE Equipment Management, and GEInsurance. General Electric also owns monogram credit card Bank.GMAC Financial Services (www.gmacfs.com). GMAC began in 1919 as a captive finance company,financing the vehicles produced by General Motors by lending to both dealers and consumers. TodayGMAC Financial Services is a family of financial-service companies that not only finance purchases ofmotor vehicles, but extend home mortgage loans, provide real estate brokerage services, makecommercial loans, sell insurance on homes and autos, and provide banking services through GMACbank and a thrift institution.Wal-Mart (www.wal-mart.com/financial-services)* The largest consumer retailer on the planettoday, offering several financial services through its more than 3,500 stores, is Wal-Mart. Workinglargely through cooperative ventures with such companies as MoneyGram, Discover Card, andSunTrust, Wal-Mart cashes payroll checks, sells money orders, and provides wire transfers of funds toMexico. It has allocated space to allow some banks to set up bank branch offices in nearly 1,000 of itssuperstores and applied for or industrial bank charter.

*Indicates this firm is included in the Educational Version of S&ampersand;P’s Market Insight.

risk-protection contracts (i.e., acting as “matched traders”) in which bankers takeon their customer’s risk exposure and find creative ways to protect their own insti-tutions from that exposure. As we will see later on, this popular financial service hasled to phenomenal growth in such risk-hedging tools as swaps, options, and futurescontracts.

Convenience: The Sum Total of All Banking and Financial ServicesIt should be clear from the list of services we have described that not only are banks andtheir financial-service competitors offering a wide array of comparable services today, butthat service menu is growing rapidly. New service delivery methods like the Internet, cellphones, and smart cards with digital cash are expanding and whole new service lines arebeing launched every year. Viewed as a whole, the impressive array of services offered andthe service delivery channels used by modern financial institutions add up to greater con-venience for their cusomers, who can satisfy virtually all their financial-service needs atone location. Banks and some of their competitors have become the financial departmentstores of the modern era, working to unify banking, fiduciary, insurance, and security bro-kerage services under one roof—a trend often referred to as universal banking in theUnited States and Great Britain, as allfinanz in Germany, and as bancassurance in France.


Table 1–2 lists some of these financial department stores, including some of the verylargest banks and competing nonbank financial firms in the world, while Table 1–3 liststhe largest banks operating in the United States.


Leading Banking-Oriented Firms Leading Global Nonbank Service Providers, Security Around the Globe Dealers, Brokers, and Investment Bankers

Mizuho Financial Group Ltd., Japan* Merrill Lynch, USA*Mitsubishi Banking Corp, Japan* Goldman Sachs, USA*Deutsche Bank AG, Germany Nomura Securities, JapanUBS AG, Switzerland Daiwa Securities, JapanCitigroup, Inc., USA*HSBC Holdings PLC, Great Britain*Lloyds TSB, Great BritainIndustrial and Commercial Bank of China Insurance CompaniesBNP Paribus Group, France Nippon Life InsuranceBarclays PLC, London, Great Britain* Axa/Equitable, Paris, FranceBank of Montreal, Canada Metropolitan Life Insurance, USA*Canadian Imperial Bank of Commerce Prudential Insurance, USAJ. P. Morgan Chase & Company, USA*

Bank of America Corp., USA*Agricultural Bank of China Finance CompaniesAustralian & N.Z. Banking Group Household International, USA*

GE Capital, USA*

TABLE 1–2Some of the LeadingFinancial-ServiceFirms around theGlobe

Sources: Bank for InternationalSettlements, Bank of England,Bank of Japan, and Board ofGovernors of the FederalReserve System.

*This financial firm appears in the Educational Version of S&P’s Market Insight.

Bank Name ($ bill.) Location of Headquarters Total Assets

J. P. Morgan Chase Bank, N.A. Columbus, Ohio $983Bank of America, NA Charlotte, North Carolina 838Citibank, N.A. New York City, New York 685Wachovia Bank, N.A. Charlotte, North Carolina 455Wells Fargo Bank, N.A. Sioux Falls, South Dakota 367Fleet National Bank Providence, Rhode Island 213U.S. Bank, N.A. Cincinnati, Ohio 198HSBC Bank USA, N.A. Wilmington, Delaware 139SunTrust Bank Atlanta, Georgia 136Chase Bank USA, N.A. Newark, Delaware 89State Street Bank and Trust Company Boston, Massachusetts 88KeyBank, N.A. Cleveland, Ohio 85

TABLE 1-3The Largest BanksOperating in theUnited States(Total assets asreported for March31, 2005)

Source: National InformationCenter, Federal ReserveSystem, Washington, D.C.

Notes: The designation N.A. means National Association, indicating that the bank carrying this designation is a national bankchartered by the Office of the Comptroller of the Currency in Washington, D.C. as opposed to most other banks, which are chartered bytheir home states.

Concept Check

1-6. What different kinds of services do banks offer thepublic today? What services do their closest com-petitors offer?

1-7. What is a financial department store? A universalbank? Why do you think these institutions have

become so important in the modern financial system?

1-8. Why do banks and other financial intermediariesexist in modern society, according to the theory offinance?


1–5 Key Trends Affecting All Financial-Service FirmsThe foregoing survey of financial services suggests that banks and many of their financial-service competitors are currently undergoing sweeping changes in function and form. Infact, the changes affecting the financial-services business today are so important that manyindustry analysts refer to these trends as a revolution, one that may well leave financialinstitutions of the next generation almost unrecognizable. What are the key trends reshap-ing banking and financial services today?

Service ProliferationLeading financial firms have been rapidly expanding the menu of services they offer totheir customers. This trend toward service proliferation has accelerated in recent yearsunder the pressure of increasing competition from other financial firms, more knowledge-able and demanding customers, and shifting technology. The new services have opened upnew sources of revenue—service fees (called fee income), which are likely to continue togrow relative to more traditional sources of financial-service revenue (such as the interestearned on loans).

Rising CompetitionThe level and intensity of competition in the financial-services field have grown as finan-cial institutions have proliferated their service offerings. For example, the local bank offer-ing business and consumer credit, savings and retirement plans, and financial counselingfaces direct competition for all of these services today from other banks, thrift institutionslike Washington Mutual, securities firms like Merrill Lynch, finance companies like GECapital, and insurance companies and agencies like Prudential. This trend toward risingcompetition has acted as a spur to develop still more services for the future and to reduceoperating costs.

Government DeregulationRising competition and the proliferation of financial services have been spurred on bygovernment deregulation—a loosening of government control—of the financial servicesindustry that began more than two decades ago and has spread around the globe. As wewill see more fully in the chapters ahead, U.S. deregulation began with the lifting ofgovernment-imposed interest rate ceilings on savings deposits in an effort to give thepublic a fairer return on their savings. Almost simultaneously, the services many of bank-ing’s key competitors, such as savings and loans and credit unions, could offer were sharplyexpanded by legislation so they could remain competitive with banks. Such leadingnations as Australia, Canada, Great Britain, and Japan have recently joined the deregula-tion movement, broadening the legal playing field for banks, security dealers, and otherfinancial-service companies operating in a freer and more competitive marketplace.

An Increasingly Interest-Sensitive Mix of FundsGovernment deregulation of the financial sector has made it possible for customers to earnhigher and more flexible rates of return on their savings and payments accounts. Massiveamounts of funds have flowed from older, low-yielding savings instruments and noninterest-bearing checking accounts into newer high-yielding accounts whose rates of return couldbe changed with market conditions. Thus, bankers and their closest competitors foundthemselves with an increasingly interest-sensitive mix of funds.

Financial-service managers have discovered that they are facing a better-educated, aswell as more interest-sensitive, customer today, whose loyalty can more easily be luredaway by aggressive competitors. Financial-service providers must now strive to be more



competitive in the returns they offer on the public’s money and more sensitive to chang-ing public preferences with regard to how savings are allocated.

Technological Change and AutomotionBanks and many of their most serious competitors (for example, insurance companies)have been faced with higher operating costs in recent years and, therefore, have turnedincreasingly to automation and the installation of sophisticated electronic systems toreplace older, labor-based production and delivery systems. This move toward greater tech-nological change is especially evident in the delivery of such services as dispensing pay-ments and making credit available to qualified customers.

The most prominent examples of major technological innovations in financial servicesinclude automated teller machines (ATMs), cell phones, point of sale (POS) terminals, anddebit cards. There are well over 300,000 ATMs in the United States today and a compara-ble number in Europe, giving customers 24-hour access to their accounts for cash with-drawals and deposits and to a widening menu of other services. Also accessible well beyond“bankers’ hours” are POS terminals in stores and shopping centers that replace paper-basedmeans of paying for goods and services with rapid computer entries. Even more rapidlygrowing are encoded debit cards that permit a customer to pay for purchases of goods andservices with the swipe of a card through an electronic card reader, while in some parts ofthe world customers can pay for purchases simply by waving their cell phones, which con-tain embedded chips, over an electronic sensor at some merchants’ cash registers.

Thus, banking and financial services now comprise a more capital-intensive, fixed-costindustry and a less labor-intensive, variable-cost industry than in the past. Some expertsbelieve that traditional brick-and-mortar buildings and face-to-face meetings with cus-tomers eventually will become relics of the past, replaced almost entirely by electroniccommunication. Service production and delivery would then be fully automated. Techno-logical advances such as these will significantly lower the per-unit costs associated withhigh-volume transactions, but they will tend to depersonalize financial services and resultin further loss of jobs as capital equipment is substituted for labor. Recent experience sug-gests, however, that fully automated financial services for all customers may be a long timecoming. A substantial proportion of customers still prefer personalized service and theopportunity to consult personally, one to one, with their financial advisor.

Consolidation and Geographic ExpansionMaking efficient use of automation and other technological innovations requires a highvolume of sales. So financial-service providers have had to expand their customer base byreaching into new and more distant markets and by increasing the number of service unitssold. The result has been a dramatic increase in branching activity in order to providemultiple offices (i.e., points of contact) for customers, the formation of financial holdingcompanies that bring smaller institutions into larger conglomerates offering multiple ser-vices in multiple markets, and mergers between some of the largest bank and nonbankfinancial firms, such as J. P. Morgon Chase with Bank One, Bank of America with FleetBoston Financial Group and MBNA and Deutsche Bank of Germany with Bankers TrustCompany of New York.

The number of small, independently owned financial institutions is declining and theaverage size of individual banks, as well as securities firms, credit unions, finance compa-nies, and insurance firms, has risen significantly. This consolidation of financial institutionshas resulted in a decline in employment in the financial-services sector.

ConvergenceService proliferation and greater competitive rivalry among financial firms have led toa powerful trend, toward convergence, particularly on the part of the largest financial



institutions. Convergence refers to the movement of businesses across industry lines sothat a firm formerly offering only one product line ventures into other product lines tobroaden its sales base. This phenomenon has been most evident among larger banks,insurance companies, and security broker/dealer firms that have eagerly climbed intoeach other’s backyard. Clearly, competition intensifies in the wake of convergence asbusinesses previously separated into different industries now find their former industryboundaries no longer discourage new competitors, Under these more intense competi-tive pressures, weaker firms will fail or be merged into companies that are ever largerand offer more diverse services.

GlobalizationThe geographic expansion and consolidation of financial-service units have reached wellbeyond the boundaries of a single nation to encompass the whole planet—a trend calledglobalization. The largest financial firms in the world compete with each other for businesson every continent. For example, huge banks headquartered in France (led by BNPParibus), Germany (led by Deutsche Bank), Great Britain (led by HSBC), and the UnitedStates (led by Citigroup and J. P. Morgan Chase) have become heavyweight competitorsin the global market for corporate and government loans. Deregulation has helped allthese institutions compete more effectively and capture growing shares of the global mar-ket for financial services.

1–6 The Plan of This BookThe primary goal of this book is to provide the reader with a comprehensive understandingof the financial-services industry and the role of banking in that industry. Through its sevenmajor parts we pursue this goal both by presenting an overview of the financial-servicesindustry as a whole and by pointing the reader toward specific questions and issues thatbankers and their principal competitors must resolve every day.

Part One, consisting of Chapters 1 through 4, provides an introduction to the world ofbanking and financial services and their functions in the global economy. We explore theprincipal services offered by banks and many of their closest competitors, and we examinethe many ways financial firms are organized to bring together human skill, capital equip-ment, and natural resources to produce and deliver their services. Part One also explainshow and why banks and other financial-service providers are regulated and who theirprincipal regulators are. Part One concludes with an analysis of the different ways finan-cial institutions deliver their services to the public, including the chartering of new finan-cial firms, constructing branches, installing ATMs and point-of-sale terminals, expansionof call centers, and use of the Internet.

Part Two introduces readers to the financial statements of banks and their closest com-petitors. Chapter 5 explores the content of balance sheets and income/expense statements,while Chapter 6 examines measures of performance often used to gauge how well banksand their closest competitors are doing in serving their stockholders and the public.Among the most important performance indicators discussed are numerous measures offinancial firm profitability and risk.

Part Three opens up the dynamic area of asset-liability management (ALM). Chapters7, 8, and 9 describe how financial-service managers have changed their views about man-aging assets, liabilities, and capital and controlling risk in recent years. These chapters takea detailed look at the most important techniques for hedging against changing marketinterest rates, including financial futures, options, and swaps. Part Three also exploressome of the newer tools to deal with credit risk and the use of off-balance-sheet financingtechniques, including securitizations, loan sales, and credit derivatives.


FactoidWhen in Americanhistory did the greatestnumber of banks fail?Between 1929 and 1933when about one-third(approximately 9,000)of all U.S. banks failedor were merged out ofexistence.


Part Four addresses two age-old problem areas for depository institutions and their clos-est competitors: managing a portfolio of investment securities and maintaining enough liq-uidity to meet daily cash needs. We examine the different types of investment securitiestypically acquired and review the factors that an investment officer must weigh in choos-ing what investment securities to buy or sell. This part of the book also takes a critical lookat why depository institutions and their closest competitors must constantly struggle toensure that they have access to cash precisely when and where they need it.

Part Five directs our attention to the funding side of the balance sheet—raising moneyto support the acquisition of assets and to meet operating expenses. We present the prin-cipal types of deposits and nondeposit investment products and review recent trends in themix and pricing of deposits for their implications for managing banks and other financialfirms today and tomorrow. Next, we explore all the important nondeposit sources of short-term funds—federal funds, security repurchase agreements, Eurodollars, and the like—andassess their impact on profitability and risk for banks and other financial firms. This partalso examines the increasing union of commercial banking, investment banking, and

Real Banks, Real DecisionsCONVERGENCE AND CONSOLIDATION IN FINANCIAL SERVICES SLOWS DOWN

Although financial-institutions have continued to move closer to each other, heating up competitionin the financial-services sector, the pace of convergence and consolidation in financial servicesappears to have slowed somewhat. As the 21st century opened, mergers were proceeding at abouthalf the pace of the hectic 1990s. The formation of new financial holding companies, combining bank-ing, insurance, and security services under one roof, paused and leveled out.

Perhaps most dramatic of all, the leading financial firm in the world—Citigroup—divested itself ofTravelers Property and Casualty Insurance in 2001 (after acquiring the latter in 1998) and then subse-quently announced its intention to sell to MetLife Insurance its Travelers Life and Annuity Insuranceunit and to sell to GE its CitiCapital Transportation Financial Services affiliate. This was a big surprisebecause Citigroup, perhaps more than any other financial institution, has epitomized the expansion of“one-stop financial services shopping” around the world. And Citigroup is not alone. AmericanExpress recently announced plans to sell its Financial Advisers unit and move closer to being a purecredit card company, while J. P. Morgan Chase sold its life insurance and annuity underwriting busi-ness to Protective Life Corporation.

Why did these leading financial-service conglomerates take an apparent step backward from theirhighly publicized “one-stop” financial services strategies? Is the drive toward consolidation and con-vergence now reversing itself and returning to more traditional lines? After all, the financial-servicegiants named above had argued long and loud that one-stop shopping was the “wave of the future.”They had contended that multiple-service firms would achieve greater efficiency in generating rev-enues and capture ample cost savings, while their customers would not only experience greater con-venience, but also lower service fees. What customer wouldn’t relish being able to go to one locationand open a savings account, sign up for a new auto insurance policy, and purchase stocks and bondsfor their retirement plan? Was this one-stop, financial-conglomerate strategy now falling apart?

Not likely, but the pace of financial-services diversification appears to have slowed. One reason:The economies of Europe and America have been growing more slowly in the current decade. More-over, efforts to further deregulate financial-service firms slowed in the new century. Then, too, thecost savings from one-stop financial shopping have been much less than many financial firms antici-pated. Moreover, many firms that tried to combine managing the public’s assets and selling in-houseinvestment products ran into conflict-of-interest problems. And new electronic shopping channels(especially the Internet) have encouraged more customers to “shop around” in search of the best dealrather than making all their purchases from one place. One thing is clear: Change in the financial-servicesindustry often proceeds by fits and starts, due principally to the continual interaction between economicconditions, changing technology, and government regulation.


insurance industries in the United States and selected other areas of the world and the riseof bank sales of nondeposit investment products, including sales of securities, annuities,and insurance. We explore the implications of the newer product lines for financial-firmreturn and risk. The final source of funds we review is equity capital—the source of fund-ing provided by a financial firm’s owners.

Part Six takes up what many bankers and other financial-service managers regard as theessence of their business—granting credit to customers through the making of loans. Thetypes of loans made by banks and their closest competitors, regulations applicable to thelending process, and procedures for evaluating and granting loans are all discussed. Thisportion of the text includes expanded information about credit card services—one of themost successful, but challenging service areas for financial institutions today.

Finally, Part Seven tackles two of the most important strategic decisions that manyfinancial firms have to make—acquiring or merging with other financial-service providersand following their customers into international markets. As the financial-services indus-try continues to consolidate and converge into larger units, managerial decisions aboutacquisitions, mergers, and global expansion become crucial to the long-run survival ofmany financial institutions. This final section concludes with an overview of the future ofthe financial-services marketplace in the 21st century.


Concept Check

1-9. How have banking and the financial-services mar-ket changed in recent years? What powerfulforces are shaping financial markets and institu-tions today? Which of these forces do you thinkwill continue into the future?

1-10. Can you explain why many of the forces younamed in the answer to the previous question

have led to significant problems for the manage-ment of banks and other financial firms and fortheir stockholders?

1-11. What do you think the financial-services industrywill look like 20 years from now? What are theimplications of your projections for its manage-ment today?

Summary In this opening chapter we have explored many of the roles played by modern banks andtheir financial-service competitors. We have examined how and why the financial-servicesmarketplace is rapidly changing, becoming something new and different as we move for-ward into the future.

Among the most important points presented in this chapter were these:

• Banks—the oldest and most familiar of all financial institutions—have changedgreatly since their origins centuries ago, evolving from moneychangers and moneyissuers to become the most important gatherers and dispensers of financialinformation in the economy.

• Banking is being pressured on all sides by key financial-service competitors—savingsand loan associations and savings banks, credit unions, money market funds, invest-ment banks, security brokers and dealers, investment companies (mutual funds), hedgefunds, finance companies, insurance companies, and financial-service conglomerates.

• The leading nonbank businesses that compete with banks today in the financial sectoroffer many of the same services and, therefore, make it increasingly difficult to separatebanks from other financial-service providers. Nevertheless, larger banks tend to offerthe widest range of services of any financial-service firm today.

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• The principal functions (and services) offered by banks and many of their financial-service competitors today include: (1) lending and investing money (the creditfunction); (2) making payments on behalf of customers to facilitate their purchasesof goods and services (the payments function); (3) managing and protecting cus-tomers’ cash and other forms of customer property (the cash management, risk man-agement, and trust functions); and (4) assisting customers in raising new funds andinvesting those funds profitably (through the brokerage, investment banking, andsavings functions).

• Major trends affecting the performance of financial firms today include: (1) wideningservice menus (i.e., greater product-line diversification); (2) the globalization of thefinancial marketplace and the spread of services worldwide (i.e., geographic diversifica-tion); (3) the easing or elimination of government rules affecting banks and otherfinancial firms (i.e., deregulation); (4) the growing rivalry among banks themselves andwith their closest financial-service competitors (i.e., intense competition); (5) the ten-dency for all financial firms increasingly to look alike, offering similar services (i.e.,convergence); (6) the declining numbers and larger size of financial-service providers(i.e., consolidation); and (7) the increasing automation of financial-service productionand delivery (i.e., technological change) in order to offer greater convenience for cus-tomers, reach wider markets, and promote cost savings.

Key Terms banksavingsassociationscredit unionsmoney market fundsmutual fundshedge fundssecurity brokers anddealersfinance companies

financial holdingcompanieslife and property/casualtyinsurance companiescurrency exchangediscounting commercialnotessavings depositsdemand deposit servicestrust services

financial advisory servicescash management servicesequipment leasing servicesinsurance policiesretirement planssecurity brokerage servicessecurity underwritinginvestment bankingmerchant banking services

1. You have just been hired as the marketing officer for the new First National Bank ofVincent, a suburban banking institution that will soon be serving a local community of120,000 people. The town is adjacent to a major metropolitan area with a total popu-lation of well over 1 million. Opening day for the newly chartered bank is just twomonths away, and the president and the board of directors are concerned that the newbank may not be able to attract enough depositors and good-quality loan customers tomeet its growth and profit projections. (There are 18 other financial-service competi-tors in town, including two credit unions, three finance companies, four insuranceagencies, and two security broker offices.) Your task is to recommend the various ser-vices the bank should offer initially to build an adequate customer base. You are askedto do the following:a. Make a list of the services the new bank could offer, according to current regulations.b. List the types of information you will need about the local community to help you

decide which of many possible services are likely to have sufficient demand to makethem profitable.

c. Divide the possible services into two groups: those you think are essential to cus-tomers (which should be offered opening day) and those you believe can be offeredlater as the bank grows.

Problems and Projects


d. Briefly describe the kind of advertising campaign you would like to run to help thepublic see how your bank is different from all the other financial-service providers inthe local area. Which services offered by nonbank service providers would be ofmost concern to the new bank’s management?

2. Leading money center banks in the United States have accelerated their investment bankingactivities all over the globe in recent years, purchasing corporate debt securities and stockfrom their business customers and reselling those securities to investors in the open market.Is this a desirable move by banking organizations from a profit standpoint? From a risk stand-point? From the public interest point of view? How would you research there questions? Ifyou were managing a corporation that had placed large deposits with a bank engaged in suchactivities, would you be concerned about the risk to your company’s funds? Why or why not?

3. The term bank has been applied broadly over the years to include a diverse set of financial-service institutions, which offer different financial-service packages. Identify as many of thedifferent kinds of banks as you can. How do the banks you have identified compare tothe largest banking group of all—the commercial banks? Why do you think so many dif-ferent financial firms have been called banks? How might this terminology confusionaffect financial-service customers?

4. What advantages can you see to banks affiliating with insurance companies? Howmight such an affiliation benefit a bank? An insurer? Can you identify any possible dis-advantages to such an affiliation? Can you cite any real-world examples of bank–insureraffiliations? How well do they appear to have worked out in practice?

5. Explain the difference between consolidation and convergence. Are these trends in bank-ing and financial services related? Do they influence each other? How?

6. What is a financial intermediary? What are its key characteristics? Is a bank a type of finan-cial intermediary? What other financial-services companies are financial intermediaries?What important roles within the financial system do financial intermediaries play?

7. Four main types of financial-service firms—depository institutions, investment banks,insurance companies, and finance/credit card companies—are in intense competitionwith one another today. Using Standard &ampersand; Poor’s Market Insight, Educa-tional Version, available to users of this McGraw-Hill book, describe the principal sim-ilarities and differences among these four types of companies. You may find it helpful inanswering this question to examine the files on Market Insight devoted to such finan-cial firms as Bank of America (BAC), Bear Stearns Companies (BSC), American Inter-national Group (AIG), and Capital One Financial Corp (COF).

Internet Exercises1. The beginning of this chapter addresses the question, “What is a bank?” (That is a tough

question!) A number of Web sites also try to answer the very same question. Explore thefollowing Web sites and try to develop an answer from two different perspectives:http://money.howstuffworks.com/bank1.htmhttp://law.freeadvice.com/financial_law/banking_law/bank.htmhttp://www.pacb.org/banks_and_banking/a. In the broadest sense, what constitutes a bank?b. In the narrowest sense, what constitutes a bank?

2. What services does the bank you use offer? Check out its Web site, either by surfing theWeb using the bank’s name and location or by checking the Federal Deposit InsuranceCorporation’s Web site for the bank’s name, city, and state. How does your current bankseem to compare with neighboring banks in the range of services it offers? In the qual-ity of its Web site? (See especially www.fdic.gov.)

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3. In this chapter we discuss the changing character of the financial-services industry andthe role of consolidation. Visit the Web site http://www.financialservicesfacts.org/financial/ and look at consolidation for the financial-services industry. What do thenumbers tell us? How have the numbers changed since 2000?a. Specifically, which sectors of the financial-services industry have increased the dol-

lar amount of assets they control?b. In terms of market share based on the volume of assets held, which sectors have

increased their shares (percentagewise) and which have decreased their shares?4. As college students, we often want to know: How big is the job market? Visit the Web

site http://www.financialservicesfacts.org/financial/ and look at employment for thefinancial-services industry. Answer the following questions using the most recent dataon this site.a. How many employees work at depository institutions? What is the share (percent-

age) of total financial-services employees?b. How many employees work in insurance? What is the share (percentage) of total

financial-services employees?c. How many employees work in securities and commodities? What is the share (per-

centage) of total financial-services employees?5. What kinds of jobs seem most plentiful in the banking industry today? Make a brief list

of the most common job openings you find at various bank Web sites. Do any of thesejobs interest you? (See, for example, www.bankjobs.com.)

6. According to the sources mentioned earlier on the World Wide Web, how did bankingget its start and why do you think it has survived for so long? What major event occurredin 1934 that has affected banking, not only in the United States, but in many countriesaround the world ever since then? (See www.factnon-ster.com/ipka/A080/059.htmland www.fdic.gov.)

7. In what ways do the following corporations resemble banks? How are they differentfrom banks of about the same asset size?Charles Schwab Corporation (www.schwab.com)Household International (www.nsbousa.com)GMAC Financial Services (www.gmacfs.com)

S&P Market Insight Challenge 1. (www.mhhe.com/edumarketinsight). GE Capital is a financial-services affiliate of

General Electric. Reread the description of GE Capital in this chapter. Then, using theEducational Version of S&P’s Market Insight, read and print the “Long BusinessDescription” for GE. Describe any new developments concerning the company’s finan-cial-service affiliates. What is the most recent contribution of the financial-servicesaffiliates to the total revenue received by the entire company? (This would be expressedas a percentage of total revenue.)

2. Table 1–2 in this chapter provides a list of the leading banking and nonbankingfinancial-service providers around the globe. The left-hand column lists banks andthe right-hand column lists several nonbank financial-service firms. (Those firms foundin the Educational Version of S&P’s Market Insight are noted in the table.) Chooseone banking-oriented firm from the left-hand column and one nonbank financial-service firm from the right-hand column. Using Market Insight, print out the “LongBusiness Description” for your two selected financial firms. Compare and contrast thebusiness descriptions of the two financial-service firms. What are the implications forthese firms of any differences you detect in their business descriptions?


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Identification of a bank to follow throughout the semester (or perhaps for the rest of your life):

A. Choose a bank holding company (BHC) that is both among the25 largest U.S. banking companies and in S&P’s MarketInsight. Do not choose National City Corporation becausethat BHC is used for examples throughout the text. (Yourinstructor may impose constraints to ensure that your classexamines a significant number of institutions, rather than justa few.)The list of the 50 largest U.S. BHCs is found at www.ffiec.gov/nic. Click on the link “Top 50 BHCs/Banks” and choosefrom the top 25.

B. Having chosen a BHC, check to make sure that your bank-ing company is covered by Standard & Poor’s Market

Insight, Educational Version. (At last count, 21 of the 25largest U.S. banking companies were included in MarketInsight.) Using Market Insight, read and print the “LongBusiness Description” for your firm. Also, print and readthe most recent S&P stock report. In Chapter 1 we dis-cussed the traditional financial services that have beenassociated with commercial banking for decades and thenthe services that have recently been added to banks’ finan-cial-service offerings. What do the Market Insight descrip-tions for your chosen banking firm reveal regarding typesof services?

C. In conclusion, write approximately one page on your cho-sen banking company and the focus of its operations.

The Very First AssignmentR E A L N U M B E R SF O R R E A L B A N K S

For a review of the history of banking and nonbank financial firms see especially:

1. Kindleberger, Charles P. A Financial History of Western Europe. Boston: Allen andUnwin, 1984.

For a discussion of the changing role and market share of banking and its competitors see, forexample:

2. Beim, David U. “Why Are Banks Dying?” The Columbia Journal of World Business,Spring 1992, pp. 1–12.

3. Kaufman, George G., and Larry R. Mote. “Is Banking a Declining Industry? A Histor-ical Perspective.” Economic Perspectives, Federal Reserve Bank of Chicago, May/June1994, pp. 2–12.

4. Kwan, Simon. “Banking Consolidation.” FRBSF Economic Letter, Federal ReserveBank of San Francisco, no. 2004-15 (June 2004), pp. 1–3.

5. Poposka, Klimantina, Mark D. Vaughan, and Timothy J. Yeager. “The Two Faces ofBanking.” The Regional Economist, Federal Reserve Bank of St. Louis, October 2004, pp. 10–11.

6. Powell, Donald E., Former Chairman of the Federal Deposit Insurance Corporation.“South America and Emerging Risks in Banking.” Speech to the Florida Bankers Asso-ciation, Orlando, Florida, October 23, 2002.

7. Rose, Peter S., and Milton H. Marquis. Money and Capital Markets: Financial Institu-tions and Instruments in a Global Marketplace. 9th ed. Burr Ridge, IL: McGraw-Hill/Irwin Press, 2006. See especially Chapters 4, 14, and 17.

For a review of the theory of banking and financial intermediation see especially:

8. Rose, John T. “Commercial Banks as Financial Intermediaries and Current Trends inBanking: A Pedagogical Framework.” Financial Practice and Education 3, no. 2 (Fall1993), pp. 113–18.

Selected References



Appendix

Career Opportunities in Financial ServicesIn this chapter, we have focused on the great importance ofbanks and nonbank financial-service firms in the function-ing of the economy and financial system and on the many

roles played by financial firms indealing with the public. Butbanks and their financial com-petitors are more than justfinancial-service providers. Theycan also be the place for a satis-fying professional career. Whatdifferent kinds of professionalswork inside most financial firms?

Loan Officers Many financial managers begin theircareers accepting and analyzing loan applicationssubmitted by business and household customers. Loanofficers make initial contact with potential new customersand assist them in filing loan requests and in developing aservice relationship with a lending institution. Loanofficers are needed in such important financial institutionsas banks, credit unions, finance companies, and savingsassociations.

Credit Analysts The creditanalyst backstops the work of theloan officer by preparing detailedwritten assessments of each loanapplicant’s financial position andadvises management on the

wisdom of granting any particular loan. Credit analysts andloan officers need professional training in accounting,financial statement analysis, and business finance.

Managers of Operations Managers in the operationsdivision are responsible for processing checks and clearingother cash items on behalf of their customers, formaintaining the institution’s computer facilities andelectronic networks, for supervising the activities of tellers,for handling customer problems with services, formaintaining security systems to protect property, and foroverseeing the operation of the personnel (humanresources) department. Managers in the operations divisionneed sound training in the principles of businessmanagement and in computers and managementinformation systems, and they must have the ability tointeract with large groups of people.

Branch Managers When financial service providersoperate large branch systems, many of these functions aresupervised by the manager of each branch office. Branch

managers lead each branch’seffort to attract new accounts,calling on business firms andhouseholds in their local area.They also approve loan requestsand resolve customer complaints.Branch managers must knowhow to motivate employees andhow to represent their institution in the local community.

Systems Analysts These computer specialists work withofficers and staff in all departments, translating theirproduction and information needs into programminglanguage. The systems analyst provides a vital link betweenmanagers and computer programmers in making thecomputer an effective problem-solving tool and anefficient channel for delivering customer services. Systemsanalysts need in-depth training in computer programmingas well as courses emphasizing business problem solving.

Auditing and Control Personnel Keeping abreast of theinflow of revenues and the outflow of expenses andtracking changes in the service provider’s financial positionare the responsibilities of auditors and accountants. Theseare some of the most important tasks within a financialinstitution because they help guard against losses fromcriminal activity and waste. Jobs as important as theserequire considerable training in accounting and auditing.

Trust Department SpecialistsSpecialists in a trust departmentaid companies in managingtheir employee retirementprograms, issuing securities,maintaining business records,and investing funds. Consumers also receive help inmanaging their property and in building an estate forretirement. Men and women employed in trustdepartments usually possess a wide range of backgrounds incommercial and property law, real estate appraisal,securities investment strategies, and marketing.

Tellers One employee thatmany customers see and talkwith at virtually all depositoryinstitutions is the teller—theindividual who occupies a fixedstation within a branch office or at a drive-in window,receiving deposits and dispensing cash and information.Tellers must sort and file deposit receipts and withdrawal

Key URLsTo see what kinds ofjobs are available in thefinancial services fieldsee www.careers-in-finance.com/cb.htmand www.bankjobsearch.com.

Key URLsFor jobs in lending and credit analysis see, for example,www.bankjobs.com andwww.scott watson.com.

Key URLFor opportunities inbranch management,operations, and systemsmanagement see, for example,www.bankstaffers.com.

Key URLFor jobs in trustdepartments see, forexample, ihirebanking.com.

Key URLFor information aboutteller jobs seebankjobs.com.


slips, verify customer signatures, check account balances,and balance their own cash position at least once each day.Because of their pivotal role in communicating withcustomers, tellers must be friendly, accurate, andknowledgeable about other departments and the servicesthey sell.

Security Analysts and Traders Security analysts andtraders are usually found in a financial firm’s bonddepartment and in its trust department. All financialinstitutions have a pressing need for individuals skilled inevaluating the businesses and governments issuingsecurities that the institution might buy and in assessingfinancial market conditions. Such courses as economics,money and capital markets, and investment analysis areusually the best fields of study for a person interested inbecoming a security analyst or security trader.

Marketing Personnel Withgreater competition today,financial-service providers havean urgent need to develop new

services and to more aggressively sell existing services—tasksthat usually fall primarily to the marketing department. Thisimportant function requires an understanding of theproblems involved in producing and selling services and afamiliarity with service advertising techniques. Course workin economics, services marketing, statistics, and businessmanagement is especially helpful in this field.

Human Resources Managers A financial firm’sperformance in serving the public and its owners depends,more than anything else, on the talent, training, anddedication of its management and staff. The job of humanresources managers is to find and hire people with superiorskills and to train them to fill the roles needed by theinstitution. Many institutions provide internal managementtraining programs directed by the human resources divisionor out-source this function to other providers. Humanresources managers keep records on employee performanceand counsel employees on ways to improve theirperformance and opportunities for promotion.

Investment Banking SpecialistsBanks are becoming increasinglyinvolved in assisting their businesscustomers with the issue of bonds,and stock to raise new capital, andthey frequently render advice on


financial market opportunities and on business mergers andacquisitions. This is the dynamic, fast-paced field ofinvestment banking, one of the highest-paid and mostchallenging areas in the financial marketplace. Investmentbanking personnel must have intensive training inaccounting, economics, strategic planning, investments,and international finance.

Bank Examiners and RegulatorsBecause banks are among themost heavily regulated of allbusiness firms, there is anongoing need for men andwomen to examine the financialcondition and operatingprocedures of banks and theirclosest competitors and toprepare and enforce regulations. Regulatory agencies hireexaminers from time to time, often by visiting collegecampuses or as a result of phone calls and letters fromapplicants. Examiners and regulators must have knowledge ofaccounting, business management, economics, and financiallaws and regulations.

Regulatory Compliance Officers Compliance personnelmust make sure the regulated financial firm is in compliancewith state, national, and international rules. Training inbusiness law, economics, and accounting is most useful.

Risk Management Specialists These professionalsmonitor each financial firm’s exposure to a variety of risks(especially market, credit, and operational risks) anddevelop strategies to deal with that exposure. Training ineconomics, statistics, and accounting is especiallyimportant in this rapidly developing field.

In summary, with recent changes in services offered, tech-nology, and regulation, the financial-services field can bean exciting and challenging career. However, finding agood job in this industry will not be easy. Hundreds ofsmaller financial institutions are being absorbed by largerones, with subsequent reductions in staff. Nevertheless, ifsuch a career path sounds interesting to you, there is nosubstitute for further study of the industry and its history,services, and problems. It is also important to visit with cur-rent personnel working in financially oriented businesses tolearn more about the daily work environment. Only thencan you be sure that financial services is really a good careerpath for you.

Key URLFor opportunities inmarketing see, forexample, rite site.com.

Key URLsInvestment bankingcareer opportunities are often found ate.financialcareers.comand bankjobs.com.

Key URLsInformation aboutpossible employment atkey bank regulatoryagencies may be found,for example, atwww.federal.reserve.gov/careers or atwww.fdic.gov/about/jobs


Documents

Introduction to the Business of Banking and Financial-Services (1)