Chapter 12 Banking Industry Structure and Competition I Historical Development of Banking System a Multiple Regulatory Agencies II Financial Innovation and th Growth of the Shadow Banking System bank lending has been replaced by lending via a Shadow Banking system the securities market b Financial Innovation 1 i Response to change in demand conditions Interest Rate Volatility large swings in interst rates lead to capital gains or losses and great uncertainty about investment a Adjustable Rate Mortagages b Financial Deritives in which the seller agrees to provide a certain standardized commodity to the buyer on a specific future date on an agreed upon contracts in financial instrumetns ii Financial Derivitives i Future Contracts cretating futures ii Response to change in supply conditions Information Technogy 1 Bank Cards and Credit Cards a Make it easier for customers to make purchases and use credit for purchases b Company makes from swipe fees and loans to people who don t pay off all of credit fees 2 Electronic Banking a ATM b Home Banking c Virtual banks have no brick and mortart locations 3 Junk Bonds and do everything via the internet bonds issued below Baa a Before 1980 no one could issue bonds unless they were investment grade b Some companies who had outstanding bonds credit would be cut called Fallen Angels c With advent in technological innovations people could gain more info about companies and thus the were willing to invest moneyt short term dent security issued 4 Commercial Paper Market by large banks and corporations a Money market instrument b 5 Securitzation Increased with increase of IT is the process of transforming otherwise illiquid financial assets which have typically been the bread and butter of banking into marketable capital market securities a Helps diversify risk iii Avoidance of existing regulation 1 Reserve Requirements a Act as a tax on deposits i Because Fed didn t pay interst on reserves thus there was a high opportunity cost to hold reserves ii Cost i r 1 2 i interst rate r reserve requirement b Restrictions on interst paid on deposits i Fed had a max interest rate that could be paid on Time Deposits ii Fed did not allow Banks to pay interest on iii Checking Accounts If market interest rates rose above the max rate then customers withdrew and deposited it in higher yielding securities 2 Money Market Mutual funds a An investment vehicle that holds short term securities and allows customers to earn an amount above the minimum interst rate for banks 3 Sweep Accounts any balance above a certain amount in a corpotations checking account at the end of a business day are swept out and invested in overnight securites that pay interest c Financial Innovation and the Devline of traditional Banking i The Decline in Cost Advantages in Acquiring Funds Liabilities 1 1 In order to make banks more competitive to compete with Money Market Securites and other financial vehicles the max interst rate was lifterd a This increased the cost of banks in holding deposits ii Decline in the Income Advantage of Use of Funds assets Increase in Commercial Paper and Junk Bonds has led to banks issuing less loans and loss of market share And Growth of Shadow Banking System iii Banks Response 1 Consolidation of Banking Industry in 1980s 2 Seek out riskier loans 3 III Structure of US Commercial Banking System a Restriction on Branching Incresae Off Balance Sheet Transactions i Used to be hard to have different branches outside of one state b Response to Branching Restrictions i Bank Holding Companies 1 allow to own banks in different states 2 can own invetent services 3 can own other lines of business that used to not be allowed to own together ii ATM 1 ATMs were owned by 3rd party companies and thus were not the bank and not considered a branch IV Bank Consolidation and Nationwide Banking a Mergers and Acquisitions i Lifting of interstate banking restrictions 1 could geographically diversify their assets and branches b Economies of Scale c Economies of Scope different products and services Increase in quality and quantity of products that can be serviced the ability to use one resource to provide many d e Riegel Neal Interstate Banking Act of 1994 V Seperateion of the Banking and other Financail Services Industries i Formally lifted the bab on interstate banking a Erosion of Glass Steagall VI Thrift Industry Regulation and Structure a Savings Loans Associtaiton i Are serviced by the Federal Home Loan Bank system NOT the Fed ii Used to have more liberal regulation compared to comemercial banks and this is why they prospered iii FDIC Insured b Mutual Savings Banks i Similar to S L but owned by depositors ii Small in number and size c Credit Unions i Small cooperative lending institutions organized around a particular group of individuals with a common bond 1 union members 2 employers of a particular firm or geographic area Insurance provided by a different federal agency NOT FDIC ii iii Since employees share a common bond they can be very suseptable to collapse if that company lays off employees VII International Banking a Eurodollar Market bank outside the country and kept in the Form of Dollars deposits in accounts in the USA are transferred to a i Used to foster international trade 1 dollar most accepted currency ii side step financial intermediary 1 allow US banks to do business outside USA in Dollars b International Banking Facilities IBF accept time deposits from foreigners but are not subject to either reserve requirments or restrictions on interests payments i Can make loans to foreigners but Not to domestic people ii Encourage banking in USA versus abroad 1 exempt from taxes c