Chapter 11: Banking industry; Structure and competition

Question 1

Banking Industry: structure and competition (overview)

Answer 1

1. Singles banking market in Europe
2. Competition and bank consolidation
3. Financial innovation and growth of the ‘shadow banking system’
4. Structure of the european commercial banking industry

Question 2

The Single Banking Market in Europe

Answer 2

1980 – 2000: deregulation and globalization of international banking
to Increased competitive pressure.

Open bank services across national boundaries

• Objective: any banking service provided in EU can establish an equivalent provision, or acquire another banking service across the EU

• Goal: Improve welfare by promoting lower interest rates for loans and
mortgages, higher interest rates on savings and deposits

Question 3

: First banking directive

Answer 3

1977;
• Integration of the banking market in the EU
• Banks with branches in other member states – branche operated under host-country regulations.

Question 4

Second banking directive

Answer 4

1988:
• Principle of home-country control or mutual recognition of regulatory
authorities
• Single banking passport

Question 5

Solvency Ratio Directive

Answer 5

1989, 1991: Own funds directive, 1989:

• Set common capital adequacy standards across EU to enable greater cross border activity

Question 6

Financial Service Action Plan

Answer 6

1999:
• Time frame creation single market in wholesale financial services, open retail banking
• Strengthen rules on prudential supervision

Question 7

European Banking Authority

Answer 7

2011: European bank regulatory agency, that oversees national regulatory agencies

• Objective: common set of regulations to avoid ‘regulatory arbitrage’
but
• Obstacles remain to full integration of EU banking markets (language,
culture, home-bias for retail banking, differences in legal systems, tax
treatment)

Question 8

The Single Banking Market in Europe are Based on Directives: which ones?

Answer 8

• First banking directive
• Second banking directive
• Own funds directive/ Solvency Ratio Directive
• Financial Service Action Plan
• European Banking Authority

Question 9

Based on Directives:

Answer 9

issues of barriers to cross-border activity, Capital ratios and deposit protection

Question 10

Deregulation and competition

- Three phases:

Answer 10

1. Removal of quantitative barriers to growth in banking (restrictions
   on bank lending)
2. Increase in competition from new entrants from overseas, non-bank
   financial institutions, non-financial institutions
3. Growth of non-traditional businesses (revenu from off-balance-sheet
   activities: financial market trading, derivatives, securitization

Question 11

consolidation ( )

Answer 11

in technical analysis refers to an asset oscillating between a well-defined pattern of trading levels. Consolidation is generally interpreted as market indecisiveness, which ends when the asset’s price moves above or below the trading pattern.

is to combine assets, liabilities, and other financial items of two or more entities into one

Question 12

Is consolidation a good thing?

Bigger is better?

Answer 12

• No: Eliminate small banks, resulting in less lending to small
businesses, dominating banks, making banking less competitive

• Yes: Efficiency (economies of scale and scope), healthier banking
system, less bank failures (increased diversification of banks’ loan
portfolio)

Question 13

shadow banking system

Answer 13

bank lending is replaced by lending via the securities market.

is a term used to describe bank-like activities (mainly lending) that take place outside the traditional banking sector.

Question 14

financial innovation

Answer 14

– financial institutions develop new products to satisfy their own needs (as well as those of their customers): driven by the desire to get (or stay) rich.

A change in the financial environment will stimulate a search by
financial institutions for innovations that are likely to be profitable

Question 15

Financial engineering:

Answer 15

research and develop new products and services taht would meet customers needs and prove profitable

Question 16

3 basic types of financial innovation

Answer 16

1. Responses to changes in demand conditions
2. Responses to changes in supply conditions
3. Avoidance of existing regulations

Question 17

1. Responses to changes in demand conditions: interest-rate volatility

Answer 17

Interest-rate risk: risk related to uncertainty about interest rate
movements and yields

Increased demand for financial products and services that could reduce
that risk, resulted in an increase creation of new financial instruments to
help lower interest-rate risk.

Question 18

1. Interest-rate volatility

Answer 18

refers to the variability of interest rates on loans and savings over time.
with Financial derivatives: commodity exchanges, future contracts

Question 19

Commodity exchanges:

Answer 19

Offer products that help investors and financial institutions to protect themselves from (=hedge) interest-rate risk

Question 20

Future contracts:

Answer 20

seller agrees to provide a certain standardized commodity to the buyer on a specific future date at an agreed-on price

Question 21

2. Response to changes in supply conditions:

Information Technology

Answer 21

Improvements in computer and telecommunications technology

• Lowering the cost of processing financial transactions, making it
more profitable for financial institutions to create new financial
products and services for the public
• Investors have better access to information, it is easier for firms to
issue securities

Question 22

Information Technology: new products and services (kinds?)

Answer 22

• Bank credit and debit cards
• Electronic banking: the ATM – home banking
• Junk bonds
• Commercial paper market
• Securitization

Question 23

Junk bonds

Answer 23

with easier screening: investors willing to buy long-term debt from less-well- known firms with lower ratings

Question 24

Commercial paper market

Answer 24

CP: short term debt security issued by large banks and corporates
easier screening for investors: easier for corporations to issue debt securities

Question 25

Securitization

Answer 25

Process of transforming otherwise illiquid financial assets (residential
mortgages, car loans, credit card receivables) into marketable capital market securities

Question 26

3. Avoidance of existing regulations

Answer 26

Because financial industry is more heavily regulated than other
industries, government regulation leads to financial innovation by
creating incentives for firms to avoid regulations that restrict the ability
to earn profits: ‘loophole mining’

Question 27

Asset side: (in financial innovations and the decline of the traditional banking)

Answer 27

Decline in income advantage of banks due to junk bonds, securitization
and the rise of commercial paper.

Question 28

Structure of the European Commercial banking industry in Continental Europe

Answer 28

Universal banking: no separation between banking and securities
industries (combinations of banking and insurance firms)

Question 29

Structure of the European Commercial banking industry in British-style universal banking system

Answer 29

universal banks for securities underwriting with separate legal subsidiaries

Question 30

Structure of the European Commercial banking industry in Japan

Answer 30

some legal separation of the banking and other financial services industries. These banks can hold substantial equity stakes in
commercial firms

Question 31

1970s: Disintermediation

Answer 31

depositors were finding homes for their funds outside of the banking system, because traditionnally they did not receive interest on deposits (on liability side)