Chapter 01 – An Overview of the Changing Financial-Services Sector
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CHAPTER 1
AN OVERVIEW OF THE CHANGING FINANCIAL-SERVICES SECTOR
Goal of This Chapter: In this chapter you will learn about the many roles financial service-
providers play in the economy today. You will examine how and why the banking industry and
the financial services marketplace as a whole is rapidly changing, becoming new and different as
we move forward into the future. You will also learn about new and old services offered to the
public.
Key Topics in This Chapter
• Powerful Forces Reshaping the Industry
• What Is a Bank?
• The Financial System and Competing Financial-Service Institutions
• Old and New Services Offered to the Public
• Key Trends Affecting All Financial-Service Firms
• Appendix: Career Opportunities in Banking and Financial Services
Chapter Outline
I.Introduction: Powerful Forces Reshaping the Industry
II. What Is a Bank?
A. Defined by the Functions:
B. Banks and their Principal Competitors
C. Many Kinds of Banks
D. Money-Centered Banks vs. Community Banks
E. The Legal Basis for Banking
III. The Financial System and Competing Financial-Service Institutions
A. Roles of the Financial System
B. The Competitive Challenge for Banks
C. Leading Competitors with Banks
1. Savings Associations
2. Credit Unions
3. Fringe Banks
4. Money Market Funds
5. Mutual Funds
6. Hedge Funds
7. Security Brokers and Dealers
8. Investment Banks
9. Finance Companies
10. Financial Holding Companies
11. Life and Property/Casualty Insurance Companies
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IV. Services Banks and Many of Their Closest Competitors Offer the Public
A. Services Banks Have Offered for Centuries
1. Carrying Out Currency Exchanges
2. Discounting Commercial Notes and Making Business Loans
3. Offering Savings Deposits
4. Safekeeping of Valuables and Certification of Value
5. Supporting Government Activities with Credit
6. Offering Checking Accounts (Demand Deposits)
7. Offering Trust Services
B. Services Banks and Many of Their Financial-Service Competitors Began Offering in
the Past Cent ury
1. Granting Consumer Loans
2. Financial Advising
3. Managing Cash
4. Offering Equipment Leasing
5. Making Venture Capital Loans
6. Selling Insurance Policies
7. Selling and Managing Retirement Plans
8. Dealing in Securities: Offering Security Brokerage and Investment Banking
Services
9. Offering Mutual Funds, Annuities, and Other Investment Products
10. Offering Merchant Banking Services
11. Offering Risk Management and Hedging Services
C. Convenience: The Sum Total of All Banking and Financial Services
V. Key Trends Affecting All Financial-Service Firms—Crises, Reform, and Change
1. Service Proliferation
2. Rising Competition
3. Government Deregulation and then Reregulation
4. Crisis, Reform, and Change in Banking and Financial Services
5. An Increasingly Interest-Sensitive Mix of Funds
6. Technological Change and Automation
7. Consolidation and Geographic Expansion
8. Convergence
9. Globalization
VI. The Plan of This Book
VII. Summary
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Concept Checks
1-1. What is a bank? How does a bank differ from most other financial-service providers?
A bank can be defined by what economic function it performs, what services it offers its
customers, or the legal basis for its existence. Historically, banks have been offering a great
1-2. Under U.S. law what must a corporation do to qualify and be regulated as a commercial
bank?
Under U.S. law, commercial banks must offer two essential services to qualify as banks for
1-3. Why are some banks reaching out to become one-stop financial-service conglomerates? Is
this a good idea, in your opinion?
Banks and various financial institutions are converging in terms of the services they offer and
embracing each other’s innovations. There are two reasons that banks are increasingly becoming
1-4. Which businesses are banking’s closest and toughest competitors? What services do they
offer that compete directly with banks’ services?
Among a bank’s closest competitors are savings associations, credit unions, fringe banks, money
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1-5. What is happening to banking’s share of the financial marketplace and why? What kind of
banking and financial system do you foresee for the future if present trends continue?
The Financial Services Modernization Act of 1999 allowed many of the banks’ closest
1-6. What different kinds of services do banks offer the public today? What services do their
closest competitors offer?
Banks offer the widest range of services of any financial institution. They offer thrift deposits to
encourage saving and checkable (demand) deposits to provide a means of payment for purchases
1-7. What is a financial department store? A universal bank? Why do you think these
institutions have become so important in the modern financial system?
location.
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1-8. Why do banks and other financial intermediaries exist in modern society, according to the
theory of finance?
The traditional view of banks as financial intermediaries sees them as simultaneously fulfilling
the financial-service needs of savers (surplus-spending units) and borrowers (deficit-spending
1-9. How have banking and the financial-services market changed in recent years? What
powerful forces are shaping financial markets and institutions today? Which of these forces do
you think will continue into the future?
Banking is becoming a more volatile industry due, in part, to deregulation which has opened up
individual banks to the full force of the financial marketplace. However, under the new
1-10. Can you explain why many of the forces you named in the answer to the previous question
have led to significant problems for the management of banks and other financial firms and for
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lowered the per-unit costs associated with high-volume transactions, but they have also
depersonalized financial services. Due to consolidation of financial institutions, there has been a
1-11. What do you think the financial-services industry will look like 20 years from now? What
are the implications of your projections for its management today?
There appears to be a trend toward continuing consolidation and convergence. There are likely to
1-1. You recently graduated from college with a business degree and accepted a position at a
major corporation earning more than you could have ever dreamed. You want to (1) open a
(1) Financial service firms that provide checking account services include banks, fringe banks,
credit unions, and savings and loan associations. Even securities brokers allow you to open
checking accounts. Recently brokers such as Schwab have become more aggressive in offering
interest-bearing online checkable accounts that often post higher interest rates than many banks
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GMAC. A reverse-auction site such as LendingTree might also be useful in this exercise. The
1-2. 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 banking organizations from a profit standpoint? From a risk
standpoint? From the public interest point of view? How would you research these questions? If
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
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 nonbank
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
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1-3. 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. 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
1-4. 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?
Banks used to sell insurance services to their customers on a regular basis before the beginning
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1-5. 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. The number of small,
1-6. What is a financial intermediary? What are its key characteristics? Is a bank a type of
financial intermediary? What other financial-services companies are financial intermediaries?
What important roles within the financial system do financial intermediaries play?
A financial intermediary is a business that interacts with deficit spending individuals and