T2 Structure & Competition in the Banking Industry Flashcards
Banks remain most important financial institutions in financial system however their business of making loans funded by deposits is declining
Some businesses replaced by shadow banking system i.e. lending via securities markets involving different institutions who raise funds by short term borrowing and use those funds to buy assets with longer term maturities
Financial Engineering
R&D for new profitable products that meet consumer needs. Innovation driven by desire to earn profits
Securitization
Transform illiquid financial assets into marketable capital market securities
Responses to changes in demand conditions: IR volatility
Adjustable rate mortgages - flexible IR keeps profits high when rates high
Lower initial IR makes them attractive to buyers
Financial derivatives - ability to hedge IR risk, commodity futures
Responses to changes in supply conditions: Information technology
Bank & Credit cards - lower transaction costs, allow consumers to take out loans more easily
Electronic banking
Junk bonds - IT makes it easier to acquire financial information about firms making it possible for investors to buy securities
Response to regulatory conditions: avoidance of existing regulations
Loophole mining: reserve requirements is a tax on deposits
Bank innovations: Money market mutual funds - issues shares that are redeemable at a fixed price by writing checks to invest in short term money market securities that provide interest payments
Sweep accounts - balances above a certain amount in a corporation checking account at the end of a business day are invested in overnight securities that pay interest They are taxed
Decline of traditional banking
Decline in cost advantage in acquiring funds (liabilities)
Decline in income advantages on uses of funds (assets)
Information technology has decreased need for banks to finance short term credit needs or issue loans also lowered transaction costs for other financial intuitions increasing competition
Banks responses - expand into new riskier areas of lending e.g. commercial real estate loans and commercial takeovers
Are bank consolidation & nationwide banking good things
Benefits - increased competition driving inefficient banks out of business, EoS, lower probability of bank failure from more diversified portfolios
Cons - Elimination of community banks leads to less lending to small business, banks expanding into new areas may take increased risk & fail
