CHAP_01_An overview of banking sector-for student (1).ppt
- 1. William Chittenden edited and updated the PowerPoint slides for this edition. AN OVERVIEW OF BANKING SECTOR Chapter 1 1
- 2. Key topics 1. Bank definitions 2. Bank regulation Goals of regulation Regulators Rationality of regulation 3. Bank functions 4. Bank services 5. Bank organization 6. Fundamental sources of changes 2
- 3. What is a bank? Definition by functions it serves Institutions involves in transferring funds from savers to borrowers (financial intermediation) & in paying for goods and services Definition by services it offers to customers Accept deposits, make commercial loans, offer trust services, manage cash, etc. 3
- 4. What is a bank? Necessity of a legal definition: Regulation purpose Banking service menu is expanding Other financial-service institution provide similar services 4
- 5. What is a bank? Definition by legal basis for regulation US: any institution that could qualify for deposit insurance administered by the FDIC VN: a credit institution permitted to conduct all banking activities and other related business operations. 5
- 6. What is a bank? Definition by legal basis for regulation VN: "Non-bank credit institution" is a credit institution permitted to engage in some banking activities as its regular business, but not permitted to receive individual deposits and to provide payment services. VN: "Banking activities" are monetary business activities and banking services, the regular operation of which is the receipt of deposits and use of that to extend credits, provide payment services; 6
- 7. Financial service competitors of banks Savings associations Credit unions Money market funds Mutual funds (investment companies) Hedge funds Security brokers and dealers Investment banks Finance companies Financial holding companies Life and property-casualty insurance companies 7
- 8. Rationale of regulations on financial firms Regulations of financial firms and experiences of youth – p. 28 Read Insights and Issues – p. 30 8
- 9. Goals of bank regulation Ensure safety and soundness of banks protecting public’s savings and confidence Provide an efficient and competitive financial system Provide monetary stability to achieve national broad economic goals Maintain the integrity of the payments system Ensure equal opportunity and fairness in the public’s access to financial services Provide government with credit, tax revenues and other services Help sectors that have special credit needs 9
- 10. Banking principal regulatory agencies (US) Federal Reserve System (FED) Comptroller of the Currency (OCC) Federal Deposit Insurance Corporation (FDIC) Department of Justice Securities and Exchange Commission (SEC) State Boards of Commissions 10
- 11. Banking principal regulatory agencies (VN) State Bank of Vietnam (SBV) Deposit Insurance of Vietnam (DIV) Ministry of Finance (MOF) State Securities Commission of Vietnam (SSC) 11
- 12. Why banks are closely regulated? Banks are among leading repositories of public’s savings Bank’s power of creating money in form of readily spendable deposits Banks provide individuals and businesses with loans for consumption and investment, which should be equally and adequately supplied. Government rely upon banks in conducting economic policies, collecting taxes and dispensing government payment. 12
- 13. Shortcomings of restrictive bank regulation May encourage monopoly due to conditional entry Does not prevent bank failure Cannot eliminate economic risk Does not guarantee that bank management will make good decisions, but create a struggle between regulators and banks going on definitively Less-regulated business win customers away from more-regulated banks. 13
- 14. The Federal Reserve System The Federal Reserve System Fundamental Functions Conduct monetary policy Provide and maintain the payments system Supervise and regulate banking operations Organization Board of Governors 12 Federal Reserve District Banks 14
- 15. State Bank of Vietnam 15
- 16. The Federal Reserve System Monetary Policy Tools Open Market Operations Open market purchases (sales) increase (decrease) reserves & the money supply Discount Rate Decreasing (Increasing) the discount rate makes bank borrowing less (more) expensive, which leads to an increase (decrease) in the money supply Reserve Requirements Decreasing (Increasing) reserve requirements increases (decreases) the money supply 16
- 17. Commercial banks and the economy Banks are the primary conduit for monetary policy Banks are the primary source of credit for most small businesses and many individuals Banks are the major repository of public savings Banks are the principal operator of payment system. 17
- 18. Traditional services offered by banks 1. Carrying out currency exchange 2. Discounting commercial notes and making business loans 3. Offering savings deposits 4. Safekeeping of valuables 5. Supporting government activities with credit 6. Offering checking accounts 7. Offering trust services 18
- 19. Carrying out currency exchange Bank trade one form of currency to another in return for fee Start from early days of banks Become more complicated in the global financial market Be provided by large and well-experienced banks 19
- 20. Discounting commercial notes and making business loans Discounting commercial notes/making loans to merchants based on accounts receivable Making direct loans for purchasing inventories of goods (short-term) or for constructing new facilities (long-term) Be provided by banks and many other financial- service competitors Be the core and main revenue-earning service of many banks 20
- 21. Offering savings deposits Be the earliest and major source of fund for making loan Compose of many types different in maturity, form of currency, interest, etc. Be the most stable funding source Deposit is subject to reserve requirement and insurance 21
- 22. Safekeeping of valuables Keep gold and other valuables of customers in secure vaults in return for fee Start since the old days of banks in the Middle Ages Question: which banks are famous for this service? Why? 22
- 23. Supporting government with credit Banks in Europe during the Industrial Revolution and in America during the Revolutionary War had to purchase government bonds with a portion of deposits. The custom continues in the modern world Banks use government bond as a shelter of liquidity risk and a source of revenue 23
- 24. Offering checking accounts Demand deposits permit depositors to write draft/cheque for payment of goods and services Be one of the most important offerings of the industry Service is provided by not only banks but also credit unions, savings associations, etc. Today the service is extended to the internet with the use of smart cards Provide banks with cheap source of fund. 24
- 25. Offering trust services Banks manage financial affairs and property of individuals and firms in return for fee In property management, banks acts as a trustee for wills, managing the deceased customer’s estate,… In commercial trust department, bank manages pension plan for businesses and acts as an agent issuing stocks and bonds. 25
- 26. More recent services offered by banks 8. Granting consumer loans 9. Providing financial advice 10. Managing cash 11. Offering equipment leasing 12. Making venture capital loans 13. Selling insurance policies 14. Selling retirement plans 15. Dealing in securities: brokerage and investment banking services 26
- 27. Granting consumer loans By early 20th century, banks started lending consumers given the heavy competition for business deposits and loans The trend has increased rapidly after the World War 2 Other current competitors for the consumer credit accounts are credit unions and credit card companies. The service bears high risk but returns high earnings. 27
- 28. Providing financial advice Banks gains good reputation for understanding and experience in the financial market Customers ask for advice, particularly in credit utilization, saving or investing funds Services provided are plentiful including financial plan preparation, marketing opportunity consultation, fund seeking, investment options, etc. 28
- 29. Managing cash Bank handle cash collection and disbursement for firms, invest temporary cash surpluses Service is expanded to individuals and firms Bank earns not only fee, but also low-cost fund in demand deposit accounts 29
- 31. Making venture capital loans Finance the start-up cost of new companies Implement through a venture capital firm because added risk The venture capital firm raise fund from investors, who are looking for high profit 31
- 32. Selling insurance policies Banks sell insurance policies through acquiring control of insurance companies Banks can gain high earning in the high-risk insurance industry Banks possess privileges over independent insurer in terms of customers, branches, system, etc. Insurance agencies are affiliates or Bank Holding Company (BHC) or Financial Holding Company (FHC) 32
- 33. Selling retirement plans Bank actively involves in managing retirement plan of businesses make available to employees Incoming fund is invested to wisely selected securities ensuring acceptable risk and return Bank also is in charge of dispensing payment to retired or disabled employees. 33
- 34. Dealing in securities Bank provides security brokerage service and security underwriting/investment banking services Bank offer mutual funds, annuities and other investment products with clear consultation to customers regarding higher expected yields and risk Bank temporarily buy stocks of large corporation aiding new business launching or company expansion by offering merchant banking services Bank acts as risk intermediation providing customer with risk hedging tools (e.g. swap, option, future contract) offered by themselves or from third party Services are provided through affiliated securities firms or insurance companies. 34
- 35. Organizational form of the banking industry Unit banking versus Branch banking Offer all Services from one office One of the oldest kinds of banks New banks are generally unit banks until can grow and attract more resources 35
- 36. Organizational form of the banking industry Branch banking Offer full range of services from several locations Senior management at the home office Each branch has its own management team with limited decision making ability Some functions are highly centralized, while others are decentralized 36
- 37. What trend in branch banking has been prominent in the U.S. in recent years? Year # of Bank Main Offices # of Branch Offices Total of U.S. Bank Offices Ave # of Branches/ U.S. Bank 1934 14,146 2,985 17,131 0.21 1970 13,511 21,810 35,321 1.61 1982 14,451 39,784 54,235 1.75 2007 7,241 77,947 85,188 10.76 From Table 3-2; Source: FDIC 3-37 Organizational form of the banking industry 37
- 38. Bank branch policy in Vietnam New branch set up – Circular No. 21/2013/TT-NHNN VND 300 billion x N1 + VND 50 billion x N2 < C Of which: C: the real value of the charter capital of commercial bank till the time of request (VND billion). N1: quantity of branches which have been established and requested for establishment at Hanoi and Ho Chi Minh urban area. N2: quantity of branches which have been established and requested for establishment at Hanoi suburban, Ho Chi Minh suburban; and other provinces and centrally-run cities. 38
- 39. Question for discussion a) Why do the quantity of branches are directly related to equity value? b) What is the difference between head quarter and branch of banks? c) Why quality of bank branches are strictly supervised by Central bank? 39
- 40. Quality of branching c) To comply with limitations to ensure safety in operation of credit institutions specified in Articles 126, 127, 128, 129; Clause 1 Article 130 and Article 135 of Law on Credit Institutions in 2010 and guides of State Bank of Vietnam for this provision uninterruptedly during 12 months before the request month; 40
- 41. Organizational form of the banking industry Bank holding companies Parent Subsidiaries One-Bank holding companies Mutli-Bank holding companies 41
- 42. Organizational form of the banking industry Bank holding companies A corporation chartered for the purpose of holding the stock of one or more banks Control of a bank is assumed when 25% or more of the stock is owned Must get approval from federal reserve board to control a bank One-Bank holding companies vs. multibank holding companies 42
- 43. Bank holding companies vs financial hoding companies BHC: A corporation chartered for the purpose of holding the stock (equity shares) of at least one bank, often along with other businesses. OBHC (One-bank holding company): control one or more non-bank businesses. MBHC (Multibank holding company): a minority of bank holding company organizations. (eg. Exhibit 3.8 + ad/dis on MBHC – p80) 43
- 44. Bank holding companies vs financial hoding companies Affiliated banks: banks acquired by holding companies. Independent bank: Not owned by holding companies FHC: special type of holding company that may offer the broadest range of financial services, including dealing in and underwriting securities, and selling and underwriting insurances. E.g. of FHC: p 83 – Exhibit 3.9 44
- 45. Exhibit 1.10 Organizational structure of the BHC Board of Directors Parent Company Bank Subsidiary Nonbank Subsidiaries Bank Branches Each subsidiary has a president and line officers The bottom four levels have the same organizational form as the independent bank. Single Bank Holding Company Multibank Holding Company Board of Directors Parent Company Bank Subsidiary Nonbank Subsidiaries Bank Subsidiary Bank Branches Bank Branches 45
- 46. Nonbank Businesses of BHCs Finance Companies Mortgage Companies Data Processing Companies Factoring Companies Security Brokerage Firms Financial Advising Credit Insurance Underwriters Merchant Banking Investment Banking Firms Trust Companies Credit Card Companies Leasing Companies Insurance Companies and Agencies Real Estate Services Savings Associations 3-46 Organizational form of the banking industry 46
- 47. Organizational Form of the Banking Industry Financial holding companies Special type of holding company Offers the broadest range of services List of activities offered may expand as regulators decide what services are ‘compatible’ with banking Each affiliated financial firm has its own capital and management and its own profit or loss 47
- 48. Organizational Form of the Banking Industry Financial Holding Companies Can engage in financial activities not permitted in a bank or bank holding company Federal Reserve may not permit a company to form a financial holding company or a bank holding company to convert to a financial holding company if any of its insured depository institution subsidiaries is not well capitalized, well managed, or did not receive a satisfactory rating on its most recent CRA (Community Reinvestment Act) exam. 48
- 49. Exhibit 1.11 Organizational structure of a financial holding company Bank Holding Company Securities Subsidiaries Insurance Subsidiary Thrift Holding Company Real Estate Subsidiary Financial Holding Company Subsidiaries and Service Companies Thrift Company Nonbank Subsidiaries Banking Company 49
- 50. Quick quiz What are the differences between Bank Holding Companies and Financial Holding Companies? 50
- 51. Organizational form of the banking industry Bank subsidiaries Bank controls one or more subsidiaries Subsidiaries offer other services such as insurance and security brokerage services Profits and losses of each subsidiary impact parent Bank Parent company’s net income is typically derived from dividends, interest, management fees from equity in subsidiaries, and interest paid on holding company debt. 51
- 52. Banking Business Models Global Banks International presence Nationwide Banks Coast-to-coast presence Super-Regional Banks Extensive operations in a limited geographic area of the U.S. Regional Banks Specialty Banks 52
- 53. Exhibit 1.17 DISTRIBUTION OF THE NUMBER OF BANKS AND TOTAL ASSETS BY TOTAL ASSETS: 1995 - 2004 Assets Size Number of Banks < $100 M $100M - $1B $1B - $10B > $10B 10,242 7,123 2,741 331 63 1995 (69.55%) (26.76%) (3.23%) (0.62%) 9,451 6,147 2,900 331 73 1997 (65.04%) (30.68%) (3.50%) (0.77%) 8,580 5,157 3,029 318 76 1999 (60.10%) (35.30%) (3.71%) (0.89%) 8,080 4,486 3,194 320 80 2001 (55.52%) (39.53%) (3.96%) (0.99%) 7,769 3,911 3,434 341 83 2003 50.34% 44.20% 4.39% 1.07% 7,630 3,655 3,530 360 85 2004 (47.90%) (46.26%) (4.72%) (1.11%) Asset Size Total Assets < $100 M $100M - $1B $1B - $10B > $10B $4,116 $310 $668 $1,077 $2,061 1995 (7.54%) (16.22%) (26.17%) (50.07%) $4,642 $277 $711 $995 $2,658 1997 (5.97%) (15.32%) (21.45%) (57.27%) $5,735 $243 $755 $915 $3,823 1999 (4.23%) (13.16%) (15.96%) (66.65%) $6,569 $222 $819 $915 $4,613 2001 (3.37%) (12.47%) (13.93%) (70.22%) $7,603 $201 $910 $947 $5,545 2003 (2.64%) (11.97%) (12.46%) (72.93%) $8,413 $189 $953 $973 $6,297 2004 (2.25%) (11.33%) (11.57%) (74.85%) 53
- 54. Banking Business Models Specialty banks Also known as: Community Banks Independent Banks Typically have less than $1 billion in assets Organization 54
- 55. Exhibit 1.18 Organizational structure of an independent bank 55
- 56. Organizational structure – Vietcombank Operation Center 56 DIRECTOR Nguyen My Hao DEPUTY DIRECTOR Nguyen Hung Son DEPUTY DIRECTOR Nguyen Thi Bao DEPUTY DIRECTOR Pham Thi Mai TRANSACTION OFFICES INTERNATIONAL PAYMENT DEPT GUARANTEE DEPT AID AND LOANS SETTELEMENT DEPT FINANCIAL ACCOUNTING DEPT CARDS DEPT PERSONAL BANKING DEPT TRANSACTION ACCOUNTING DEPT DEBT HANDLING DEPT FOREX AND TREASURY DEPT SME CREDIT DEPT ADMINISTRATION DEPT HUMAN RESOURCES MGMT DEPT CORPORATE BANKING DEPT LOAN WORKOUT UNIT PROJECT INVESTMENT DEPT VIP DEPT FOREX AND TREASURY DEPT BUDGET DEPT INFORMATION TECHNOLOGY DEPT INTERNAL AUDIT DEPT SERVICE BUSINESS DEPT
- 57. Banking business models Specialty banks Personnel Senior Credit Officer Cashier/Chief Financial Officer Senior Operations Officer Senior Investment Officer Branch Area Executive 57
- 58. Fundamental forces of change Service Proliferation Rising competition Deregulation/reregulation Crisis, reform and change in banking and financial services Increasingly interest-sensitive mix of funds Tech change and automation Consolidation & geographic expansion Convergence Globalization 58
- 59. Fundamental forces of change: Role of Regulation Regulatory Dialectic Process of regulation, market response, and reregulation Financial Innovation 59
- 60. Fundamental forces of change: Increased Competition For Deposits Interest rate ceilings and inflation For Loans Commercial paper Junk bonds Credit scoring Credit derivatives 60
- 61. Fundamental forces of change: Off-Balance Sheet Activities Loan commitments Loan guarantees Standby letters of credit Interest rate swaps Futures, forwards & options Leases 61
- 62. Fundamental forces of change: Impact of Nonbank Competition Captive Finance Companies A subsidiary whose purpose is to provide financing to customers buying the parent company's product (e.g. General Motors Acceptance Corporation (GMAC)) General Finance Companies Fund their loans by issuing commercial paper and long-term bonds. Their cost of funds is higher than a bank’s, but they charge higher rates. 62
- 63. Fundamental forces of change: Competition for Payments Services Credit Cards Debit Cards Prepaid Cards CHIPS ACH 63
- 64. Fundamental forces of change: Competition for Other Bank Services Trust services Brokerage services Data processing Real estate appraisal Credit life insurance Personal financial consulting 64
- 65. Fundamental forces of change: Change Investment Banking National full-line firms Investment banking firms Underwriter Underwriter syndicate Broker versus Dealer 65
- 66. Fundamental forces of change: Deregulation and Re-regulation Deregulation Eliminating existing regulations Reregulation Implementing new restrictions on banking activities 66
- 67. Fundamental forces of change: Financial Innovation Innovation may be caused by a bank wanting to: Enter into a new geographic market Enter into a new product market Deliver services less expensively etc. 67
- 68. Fundamental forces of change: Securitization Securitization The process of converting assets into marketable securities Mortgages Credit card receivables 68
- 69. Fundamental forces of change: Globalization Globalization Is the evolution of markets and institutions where geographic boundaries do not restrict financial transactions or competition. 69
- 70. Fundamental forces of change: Technology Advances in Technology Advances in technology increase the scope of the global market place and competition Advances in technology also reduce the need for an intermediary by providing easy access to information Increasing competition by reducing the cost of being an information intermediary 70
- 71. Problems You recently graduated from university with a business degree and accepted a position at a major corporation earning more than you could have ever dreamed. You want to 1. Open a checking account for transaction purposes 2. Open a saving account for emergencies 3. Invest in an equity mutual fund for that far-off future called retirement 4. See if you can find more affordable auto insurance, and 5. Borrow fund to buy a condo given you uncle said he was so proud of your grades and he wanted to give $20,000 for a down payment. Make five lists of financial service firms that could provide you with each of these services 71
- 72. Problems - Answers (1) Financial service firms that provide checking account services include banks, credit unions and savings and loan associations. Even securities brokers allow you to open checking accounts. Recently brokers such as Schwab have become more aggressive in offering interest-bearing online checkable accounts that often post higher interest rates than many banks are willing to pay. (2) To open a savings account, one could approach traditional commercial banks, savings associations, credit unions, or online brokerages and banks with higher yields but less ‘brick and mortar’ support. 72
- 73. Problems - Answers (3) For a retirement fund one could choose from a plethora of defined benefit and defined contribution schemes from private pension funds. Banks, brokerages and insurance firms offer a variety of retirement investment options including equity mutual funds. (4) For affordable auto insurance one could use a traditional insurer such as Allstate or State Farm or approach some of the newer discount insurers including Geico and Progressive. Alternatively, one could use a reverse auction service such as Esurance to get the best rate. Note: reverse auction service: http://en.wikipedia.org/wiki/Reverse_auction 73
- 74. Problems - Answers (5) To borrow funds to buy a condo one could approach a traditional bank, savings associations that specialize in granting home mortgage loans, or financial companies such as GMAC. A reverse- auction site such as LendingTree might also be useful in this exercise. The borrower is not limited to a mortgage loan for financing the purchase of a condo. Other lending mechanisms are available to finance such purchases. Note: LendingTree: http://www.answers.com/topic/lendingtree 74
- 75. Joint-venture, foreign branch and 100% foreign banks Allowed to conduct operations similar to domestic banks Obligatorily follow regulations in VN For foreign branch, decisions are made depending on the foreign home bank policy less independence 75
- 76. Rep office of foreign banks 1. Operate as liaison office 2. Conduct market research 3. Develop investment projects of foreign credit institutions in Vietnam ; 4. Promote and monitor the implementation of contracts, agreements signed between foreign credit institutions and Vietnamese credit institutions and enterprises, projects funded by foreign credit institutions in Vietnam No direct profitable activities 76
- 77. William Chittenden edited and updated the PowerPoint slides for this edition. AN OVERVIEW OF BANKING SECTOR Chapter 1 77