Chapter 11: Banking industry; Structure and competition Flashcards
Banking Industry: structure and competition (overview)
- Singles banking market in Europe
- Competition and bank consolidation
- Financial innovation and growth of the ‘shadow banking system’
- Structure of the european commercial banking industry
The Single Banking Market in Europe
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
: First banking directive
1977;
• Integration of the banking market in the EU
• Banks with branches in other member states – branche operated under host-country regulations.
Second banking directive
1988:
• Principle of home-country control or mutual recognition of regulatory
authorities
• Single banking passport
Solvency Ratio Directive
1989, 1991: Own funds directive, 1989:
• Set common capital adequacy standards across EU to enable greater cross border activity
Financial Service Action Plan
1999:
• Time frame creation single market in wholesale financial services, open retail banking
• Strengthen rules on prudential supervision
European Banking Authority
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)
The Single Banking Market in Europe are Based on Directives: which ones?
- First banking directive
- Second banking directive
- Own funds directive/ Solvency Ratio Directive
- Financial Service Action Plan
- European Banking Authority
Based on Directives:
issues of barriers to cross-border activity, Capital ratios and deposit protection
Deregulation and competition
- Three phases:
- Removal of quantitative barriers to growth in banking (restrictions
on bank lending) - Increase in competition from new entrants from overseas, non-bank
financial institutions, non-financial institutions - Growth of non-traditional businesses (revenu from off-balance-sheet
activities: financial market trading, derivatives, securitization
consolidation ( )
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
Is consolidation a good thing?
Bigger is better?
• 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)
shadow banking system
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.
financial innovation
– 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
Financial engineering:
research and develop new products and services taht would meet customers needs and prove profitable
3 basic types of financial innovation
- Responses to changes in demand conditions
- Responses to changes in supply conditions
- Avoidance of existing regulations
- Responses to changes in demand conditions: interest-rate volatility
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.
- Interest-rate volatility
refers to the variability of interest rates on loans and savings over time.
with Financial derivatives: commodity exchanges, future contracts
Commodity exchanges:
Offer products that help investors and financial institutions to protect themselves from (=hedge) interest-rate risk
Future contracts:
seller agrees to provide a certain standardized commodity to the buyer on a specific future date at an agreed-on price
- Response to changes in supply conditions:
Information Technology
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
Information Technology: new products and services (kinds?)
- Bank credit and debit cards
- Electronic banking: the ATM – home banking
- Junk bonds
- Commercial paper market
- Securitization
Junk bonds
with easier screening: investors willing to buy long-term debt from less-well- known firms with lower ratings
Commercial paper market
CP: short term debt security issued by large banks and corporates
easier screening for investors: easier for corporations to issue debt securities
Securitization
Process of transforming otherwise illiquid financial assets (residential
mortgages, car loans, credit card receivables) into marketable capital market securities
- Avoidance of existing regulations
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’
Asset side: (in financial innovations and the decline of the traditional banking)
Decline in income advantage of banks due to junk bonds, securitization
and the rise of commercial paper.
Structure of the European Commercial banking industry in Continental Europe
Universal banking: no separation between banking and securities
industries (combinations of banking and insurance firms)
Structure of the European Commercial banking industry in British-style universal banking system
universal banks for securities underwriting with separate legal subsidiaries
Structure of the European Commercial banking industry in Japan
some legal separation of the banking and other financial services industries. These banks can hold substantial equity stakes in
commercial firms
1970s: Disintermediation
depositors were finding homes for their funds outside of the banking system, because traditionnally they did not receive interest on deposits (on liability side)
