2. Leading money center banks in the United States have accelerated their
investment banking activities all over the globe in recent years, purchasing corporate debt securities and stock from their business customers and reselling those securities to investors in the open market. Is this a desirable move by these banking
organizations from a profit standpoint? From a risk standpoint? From the public interest point of view? How would you research their question? If you were
managing a corporation that had placed large deposits with a bank engaged in such activities, would you be concerned about the risk to your company's funds? What could you do to better safeguard those funds?
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In the 1970's and early 1980's investment banking was so profitable that commercial bankers were lured into the investment banking business largely because of its greater profit potential than possessed by more traditional commercial banking activities. Later foreign banks, particularly the British and Japanese banking firms, began to attract away large corporate customers from U.S. banks, who were
restrained by regulation from offering many investment banking services. Thus, U.S. banks ran into severe difficulty in simply trying to hold onto their traditional
corporate credit and deposit accounts because they could not compete service-wise in the investment banking field. Today, banks are allowed to underwrite securities through either a subsidiary or through a holding company structure. This change occurred as part of the Gramm-Leach-Bliley Act (Financial Services Modernization Act).
Unfortunately, if investment banking is more profitable than traditional banking product lines, it is also more risky, consistent with the basic tenet of finance that risk and return are directly related. That is why the Federal Reserve Board has placed such strict limits on the type of organization that can offer these services. Currently, the underwriting of most corporate securities must be done through a subsidiary or as a separate part of the holding company so that, in theory at least, the bank is not responsible for any losses incurred. For this reason there may be little reason for depositors (including large corporate depositors) to be concerned about risk
exposure from investment banking. Moreover, the ability to offer such services may make U.S. banks more viable in the long run which helps their corporate customers who depend upon them for credit.
On the other hand, opponents of investment banking powers for bank operations inside the U.S. have some reasonable concerns that must be addressed. There are, for example, possible conflicts of interest. Information gathered in the investment
banking division could be used to the detriment of customers purchasing other bank services. For example, a customer seeking a loan may be told that he or she must buy securities from the bank's investment banking division in order to receive a loan. Moreover, banks could gain effective control over some nonblank industrial
corporations which might subject them to added risk exposure and place industrial firms not allied with banks at a competitive disadvantage. As a result the Gramm-Leach-Bliley Act has built in some protections to prevent this from happening.
3. The term bank has been applied broadly over the years to include a diverse set of financial-service institutions, which offer different financial service packages.
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Identify as many of the different kinds of “banks” as you can. How do the “banks” you have identified compare to the largest banking group of all – the commercial banks? Why do you think so many different financial firms have been called banks? How might this terminological confusion affect financial-service customers?
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The general public tends to classify anything as a bank that offers some sort of financial service, especially deposit and loan services. Other institutions that are often referred to as a bank without being one are savings associations, credit unions, money market funds, mutual funds, hedge funds, security brokers and dealers, investment banks, finance companies, financial holding companies and life and property/casualty insurance companies. All of these institutions offer some of the services that a commercial bank offers, but generally not the entire scope of services. Since providers of financial services are normally called banks by the general public they are able to take away business from traditional banks and it is of utmost importance for commercial banks to clarify their unique position among financial services providers.
4. What advantages can you see to banks affiliating with insurance companies? How might such an affiliation benefit a bank? An insurer? Can you identify any possible disadvantages to such an affiliation? Can you cite any real world examples of bank-insurer affiliations? How well do they appear to have worked out in practice?
Before Glass-Steagall banks used to sell insurance services to their customers on a regular basis. in particular, banks would sell life insurance companies to loan customers to ensure repayment of the loan in case of death or disablement. These reasons still exist today and the right to sell insurances to customers again benefits banks in allowing them to offer their customers complete financial packages from financing the home or car to insure it, from giving investment advice to selling life insurance policies and annuities for retirement planning. Generally, a bank
customer who is already purchasing a service from a bank might feel compelled to purchase an insurance product, as well. On the other hand, insurance companies sometimes have a negative image, which makes it more difficult to sell certain insurance products. Combining their products with the trust that people generally have in banks will make it easier for them to sell their products. The most prominent example of a bank-insurer affiliation is the merger of Citicorp and Traveler’s
Insurance to Citigroup. However, given that Citigroup has sold Traveler’s Insurance indicates that the anticipated synergy effects did not materialize.
5. Explain the difference between consolidation and convergence. Are these trends in banking and financial services related? Do they influence each other? How?
Consolidation refers to increase in the size of financial institutions and the decline in the number of small independently owned banks and financial service providers. Convergence is the bringing together of firms from different industries to create
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conglomerate firms offering multiple services. Clearly, these two trends are related. In their effort to compete with each other, banks and their closest competitors have acquired other firms in their industry as well across industries to provide multiple financial services in multiple markets.
6. What is a financial intermediary? What are their key characteristics? Is a bank a type of financial intermediary? Why? What other financial-services companies are financial intermediaries? What important role within the financial system do financial intermediaries play?
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A financial intermediary is a business that interacts with deficit spending individuals and institutions and surplus spending individuals and institutions. For that reason any financial service provider (including banks) is considered a financial
intermediary. In their function as intermediaries they act as a bridge between the deficit and surplus spending units by offering financial services to the surplus
spending individuals and then loaning those funds to the deficit spending individuals. Financial intermediaries accelerate economic growth by increasing the pool of available funds and lowering the risk of investments through diversification.
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