FIN 4280 - Banking Industry Overview

A bank can be defined in terms of:

1. the economic functions it performs

2. the services it offers its customers

3. the legal basis for its existence

Financial Services Modernization Act of 1999 (known as the Gramm - Leach - Bliley or GLB Act after congressional sponsors)

Allows U.S. Banks to enter the securities and insurance industries and permits nonbank financial holding companies to control banking firms.

Commercial Banks

Sell deposits and make loans to business, individuals, and institutions

Money Center Banks

Largest commercial banks based in leading financial centers

Community Banks

Smaller, locally focused commercial and savings banks

Savings Banks

Attract savings deposits and make loans to individuals and families

Cooperative Banks

Help farmers, ranchers, and consumers acquire goods and services

Mortgage Banks

Provide mortgage loans on new homes but do not sell deposits

Investment Banks

Underwrite issues of new securities on behalf of their corporate customers

Merchant Banks

Supply both debt and equity capital to businesses

Industrial Banks

State-chartered loan companies owned by other corporations that provide credit and receive deposits

International Banks

Commercial banks present in more than one nation

Wholesale Banks

Larger commercial banks serving corporations and governments

Retail Banks

Smaller banks serving primarily households and small businesses

Limited-Purpose Banks

Offer a narrow menu of services, such as credit card companies and subprime lenders

Bankers’ Banks

Supply services (e.g., check clearing and security trading) to banks

Minority Banks

Focus primarily on customers belonging to minority groups

National Banks

Function under a federal charter through the Comptroller of the Currency in the United States

State Banks

Function under charters issued by banking commissions in various states

Insured Banks

Maintain deposits backed by federal deposit insurance plans (e.g., the FDIC)

Member Banks

Belong to the Federal Reserve System

Affiliated Banks

Wholly or partially owned by a holding company

Virtual 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 firms

Universal Banks

Offer virtually all financial services available in today’s marketplace

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 writing a check, swiping a plastic card through a card reader, other otherwise completing an electronic transfer of funds) and making loans of a commercial or business nature (such as granting credit to private business seeking to expand the inventory of goods on their shelves or purchase new equipment).

Congress then defined a bank as any institution that could qualify for deposit insurance administered by the Federal Deposit Insurance Corporation (FDIC).

Leading Competitors with Banks:

• Savings Associations

• Credit Unions

• Fringe Banks

• Money Market Funds

• Mutual Funds

• Hedge Funds

• Security Brokers and Dealers

• Investment Banks

• Finance Companies

• Financial Holding Companies (FHCs)

• Life and Property/Casualty Insurance Companies

Savings Associations

Specialize in selling savings deposits and granting home mortgage loans and other forms of household credit to individuals and families, illustrated by such financial firms as Atlas Savings and American Federal Savings Bank.

Credit Unions

Collect deposits from and male loans to their members as nonprofit associations of individuals sharing a common bond (such as the same employer), including such firms as American Credit Union of Milwaukee and Navy Federal Credit Union.

Fringe Banks

Include payday lenders, pawn shops, and check-cashing outlets, offering small loans bearing high risk and high interest rates to cover the immediate financial needs of cash-short individuals and families, such as First Cash Financial Services and Pawn Trader.

Money Market Funds

Collect liquid funds from individuals and institutions and invest these monies in quality securities of short duration, including such firms as Franklin Templeton and DWS Investments.

Mutual Funds (Investment Companies):

Sell shares to the public representing an interest in a professionally managed pool of stocks, bonds, and other securities, including such financial firms as Fidelity and The Vanguard Group.

Hedge Funds

Sell shares in a pool of assets mainly to upscale investors that typically include many different kinds of assets (including nontraditional investments  in commodities, real estate, loans to new and ailing companies, and other risky assets).

Security Brokers and Dealers

 Buy and sell securities on behalf of their customers and for their own accounts, such as Charles Schwab. Recently brokers like 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.

Investment Banks

Provide professional advice to corporations and governments, help clients raise funds in the financial marketplace, seek possible business acquisitions, and trade securities, including such prominent investment banking houses like Goldman Sachs and Raymond James Financial.

Finance Companies

Offer loans to commercial enterprises (such as auto and appliance dealers) and to individuals and families using funds borrowed in the open market or from other financial institutions.

Financial Holding Companies (FHCs)

Often include credit card companies, insurance and finance companies, and security broker/dealer firms operating under one corporate umbrella.

Life and Property/Casualty Insurance Companies

Protect against risks to persons or property and manage the pension plans of business and the retirement funds of individuals.

Services Bank Have Offered for Centuries:

• Carrying out Currency Exchanges

• Discounting Commercial Notes and Making Business Loans

• Offering Savings Deposits 

  • Interest-bearing funds left with depository institutions for a specific period of time.

• Supporting Government Activities with Credit

• Offering Checking Accounts (Demand Deposits)

  • Demand Deposits: A checking account that permitted depositors to write drafts in payment for goods and services that the bank or other service provider had to honor immediately

• Offering Trust Services

  • Trust Services: Involves acting as trustees for willing, managing a deceased customer’s estate by paying claims against that estate, keeping valuable assets safe, and seeing to it the legal heir receive their rightful inheritance.

Services Bank and Many of Their Financial-Service Competitors Began Offering in the Past Century:

• Granting Consumer Loans

• Financial Advising

• Managing Cash

  • Cash Management Services: When a financial intermediary agrees to handle cash collections and disbursements for a business firm and to invest any temporary cash surplus in interest-bearing assets until cash is needed to pay bills.

• Offering Equipment Leasing

• Making Venture Capital Loans

• Selling Insurance Policies

• Selling and Managing Retirement PLans

• Dealing in Securities: Offering Security Brokerage and Investment Banking Services

• Offering Mutual Funds, Annuities, and Other Investment Products

  • Annuities: Long-term savings plans the promise the payment of a stream of income to the annuity holder beginning on a designated future date (ex. retirement)

  • Mutual Funds: Professionally managed investment programs that acquire stocks, bonds, and other assets the appear to “fit” the funds announced goals.

• Offering Merchant Banking Services

  • Merchant Banking Services: Temporary purchase of corporate stock to aid the launching of a new business venture or to support the expansion of an existing company. A merchant banker becomes a temporary stockholder and bears the risk that the stock purchased may decline in value.

• Offering Risk Management and Hedging Services

Roles of the Modern Bank

• The Intermediation Role

• The Payments Role

• The Guarantor Role

• The Risk Management Role

• The Investment Banking Role

• The Savings/Investment Adviser Role

• The Safekeeping/Certification of Value Role

• The Agency Role

• The Policy Role

The Intermediation Role

Transforming savings received primarily from households into credit (loans) for business firms and others in order to make investments in new 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 for electronic payments).

The Guarantor Role

Standing behind their customers to pay off customer debts when those customers 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 to property, persons, and financial assets.

The Investment Banking Role

Assisting corporations and governments in raising new funds, pursuing acquisitions, and exploring new markets.

The Savings/Investment Adviser Role

Aiding customers in fulfilling their long-range goals for a better life by building and investing savings.

The Safekeeping/Certification of Value Role

Safeguarding a customer’s valuables and certifying their true value.

The 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

Fintech:

Technology firms that are disrupting the finance industry. They take pieces of business from banks and perform those functions faster, more efficiently, or in a way that works better than traditional financial institutions are able to do. 

Lending Club Overall Takeaway

• Lending Club is using more alternative data over time and as its algorithms learn, its is doing a better job deciding/pricing loans than banks.

• Pros: good for borrowers with short credit histories; more fair pricing for borrowers; more profitable for lender

• (potential) Cons: bias; privacy; models untested during economic downturns

Digital footprint variables

• Device type (mobile phones vs desktops)

• Operating System (Apple or Android)

• Email Provider (free or paid service)

• Channel (accessing through ad or individual access)

• Time (daytime or late night)

• Typo

• Number in email address

• Name in email address

• Lowercase typing

Digital Footprint Overall Takeaways

• Relatively easy to gather digital footprint improves default predictability

• This could clearly benefit lenders

• Is it fair to borrowers who have not consented to this data collection?

• Is it fair to borrowers to be judged on something (at least partially) out of their control?

• Should banks be allowed to do this?

TBTF

Too Big Too Fail

SIFI

Systemically Important Financial Institution

G-SIB

Global Systemically Important Bank

G-SIB Indicators

• Size

  • Total assets plus off-balance sheet items (derivatives, unused commitments, etc.)

• Interconnectedness

  • Deposits at other FIs, borrowings from other FIs, investments in FIs stocks and bonds

• Substitutability

  • Can another FI do the same as this FI

  • Assets under custody(assets bank managing for a client), payments activities, securities underwriting (selling stocks and bonds for companies)

• Complexity

  • Notional amount of over-the-counter derivatives, trading and available-for-sale assets, amount of level 3 assets 

• Cross-Jurisdictional Activities

  • Assets and liabilities outside of home country

Each of the 5 indicators get an equal weight and are combined into an index. The higher the G-SIB score, the more capital a bank must hold