Read Financial Markets Operations Management Online
Authors: Keith Dickinson
At the start of this chapter, we discussed the relationship between the lender and borrower. In addition to this, we added the term
intermediary
â see
Figure 4.1
. The question then is: “Who is the intermediary?”
The purpose of this section is to define what a bank is and to describe some of the main services offered by the banking industry.
The simple answer to the question raised above is that it is a bank which acts as the intermediary. Banks do this by accepting deposits and using them for lending activities, either directly by lending to borrowers or indirectly through the capital markets. A bank, therefore, connects clients with excess capital with clients with a capital deficit.
From a borrower's perspective, there is a barrier to “direct financing”, mainly through (a) the difficulty and expense of matching the complex needs of individual borrowers and lenders and (b) the incompatibility of the financial needs of lenders and borrowers. Without exploring the details, we can summarise the needs of lenders and borrowers as follows.
Lenders want to lend their assets for short periods of time and for the highest possible return. They wish to:
In contrast, borrowers demand liabilities that are cheap and for longer periods. They wish to:
You can appreciate that there are conflicting points of view between lenders and borrowers; hence the need for an intermediary (i.e. the banks) that can transform small-scale, low-risk and liquid deposits into large-scale, riskier and more illiquid loans.
What do the banks offer the clients by way of products and services? As we will see later, the banks tend to classify their clients in terms of size, as shown in
Table 4.11
.
TABLE 4.11
Client classification
Banking Focus | Product/Service | Examples |
Personal banking | Everyday banking | Current accounts Savings accounts Credit/debit cards International currency Payment services |
Borrowing | Overdrafts Personal loans Student loans Mortgages | |
Investing | Investment funds Online trading Investment advice | |
Insurance | Property Family Car Travel | |
Planning | Retirement Marriage Growing wealth | |
Business banking | Starting a business | Some or all of these: Bank/deposit accounts Finance and borrowing Debit/credit cards Payment services Business insurance International business Company pensions Cash-flow management Leveraged finance Trade finance Equity and debt issuance, etc. |
Business banking for clients with up to GBP 2Â m turnover | ||
Commercial banking (turnover from GBP 2Â m to GBP 30Â m) | ||
Corporate banking (turnover over GBP 30Â m) |
There are several ways that the banks are able to deliver their services through so-called
delivery channels
. These include one or more of the following:
The world's 14 largest banks by market capitalisation are listed in
Table 4.12
.
TABLE 4.12
World's largest banks as at 31 March 2014
Rank | Bank | Country | Market Cap (USD bn) |
 1 | Wells Fargo & Co | USA | 261.72 |
 2 | JP Morgan Chase & Co | USA | 229.90 |
 3 | ICBC | China | 196.21 |
 4 | HSBC | UK | 191.43 |
 5 | Bank of America | USA | 181.77 |
 6 | China Construction Bank | China | 160.83 |
 7 | Citigroup | USA | 144.63 |
 8 | Agricultural Bank of China | China | 126.41 |
 9 | Bank of China | China | 115.92 |
10 | Commonwealth Bank of Australia | Australia | 115.35 |
11 | Banco Santander | Spain | 110.57 |
12 | Westpac Banking Corporation | Australia | 99.22 |
13 | BNP Paribas | France | 96.03 |
14 | Royal Bank of Canada | Canada | 95.18 |
Source:
Relbanks (online). Available from
www.relbanks.com/worlds-top-banks/market-cap
. [Accessed Wednesday, 30 April 2014]
Following the banking crisis of the mid-2000s, organisations such as the Financial Stability Board (FSB) have been asked by the leaders of the G20 countries to: “⦠develop a policy framework to address the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs)”.
In November 2011, the FSB published a document entitled
Policy Measures to Address Systemically Important Financial Institutions
15
in which SIFIs were defined as: “⦠financial institutions whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity. To avoid this outcome, authorities have all too frequently had no choice but to forestall the failure of such institutions through public solvency support. As underscored by this crisis, this has deleterious consequences for private incentives and for public finances.” The initial list of G-SIFIs contains nothing but banks.
We will examine the different types of bank; please be aware that whilst there are banks that operate in perhaps only one of these capacities, many banks operate in most, if not all, of them. Experience has shown that combining investment banking with retail, commercial and corporate banking can cause problems, hence the introduction in the USA of the 1933 Banking Act (known as the GlassâSteagall Act, after the Act's two legislative sponsors). Most elements of this Act were later repealed by US President Bill Clinton in 1999, and it has been argued that allowing banks to re-combine banking-, insurance- and securities-related businesses led
to the banking crisis mentioned earlier. The arguments “for” and “against” the repeal are topics for another time and place.
In today's world, you and I have a relationship with a bank. You might take some or all of the services shown in
Table 4.13
.
TABLE 4.13
Typical retail banking services
Your Banking Needs | Bank's Service | |
Monthly salary | Current account | Employer instructs its bank to pay your salary into your current account maintained by your bank. |
Excess cash/cash to be saved | Deposit/savings account | You request your bank to transfer funds from your current account to your deposit account. |
Earn interest on your cash | Interest | Bank pays interest into your account(s) on a periodic basis (monthly, annually, etc.). |
Need to borrow cash | Credit cards, overdrafts and short-term loans | These can be secured or unsecured but are readily available and repayable. |
Need to buy a property | Mortgages | Bank will lend you part of the market value of your property for a long period of time using the property as collateral. |
Legal tax-avoidance schemes | Funds designed to meet Inland Revenue schemes that permit cash and certain non-cash products to attract gross (tax-free) benefits | Cash and cash invested in certain investments are “wrapped” in a tax-free package. Interest and dividends are paid gross. |
Whether you take one or more of these services and products, the key point is that the bank is dealing with you as an individual and not as a company. The downside, however, is that the products and services are not tailored to suit particular client needs; they are designed to be mass produced and mass purchased.
We discussed high-net-worth individuals earlier, in the section on Private Wealth Management. Private banking is an extension of personal banking; there are certain similarities (e.g. bank accounts) but differences too. Whilst most personal bank accounts can be opened with as little cash as GBP 1.00, the minimum amount of assets required for an HNWI to benefit from the services of a private bank can be measured in millions of US dollars or equivalent. Even here, the clientele will be sub-divided into “mass affluent” at the lower end and “ultra affluent” at the top end. The key features of private banking can be summarised as follows:
By contrast to retail and private banking, corporate banking focuses on companies, be they regarded as small, medium or large firms. In addition, for the larger firms, the banks will offer services specific to the type of industry the firm is involved in.
The larger the client firm, the more specialised the services required. We will refer to some of these needs later when we cover products.
Products and services for the smaller firm include:
Products and services for the medium-sized and larger firms include:
We have seen that the types of services and products offered by the banks to their commercial and retail banking clients are similar, i.e. deposit taking and lending, but differ in variety, complexity and scale. Investment banks, by contrast, are in the business of:
Unlike the commercial/retail banks, investment banks do not hold retail deposits. The various business lines, noted above, are associated with higher levels of risk when compared with the commercial/retail banking business.
In the USA, specialist investment banks dominated this business, as commercial banks were not permitted to provide investment banking (refer to the GlassâSteagall Act, 1933). Since the Act was repealed in 1999, commercial banks have taken over investment banks; for example, Citigroup includes Citibank (commercial), Salomon Brothers (investment bank) and Smith Barney (brokerage firm).
According to the
Financial Times
,
16
five of the top ten investment banks (by fees earned) are from the USA, with two Swiss banks, one German, one Canadian and one British, as shown in
Table 4.16
.
TABLE 4.16
Top ten investment banks
% of Fees Earned by Product in 1Q 2014 | |||||
Bank | Fees (USDm) | M&A | Equity | Bonds | Loans |
JP Morgan | 1,369.47 | 25 | 22 | 30 | 22 |
Goldman Sachs | 1,319.09 | 40 | 25 | 23 | 12 |
Bank of America Merrill Lynch | 1,159.28 | 22 | 19 | 31 | 28 |
Morgan Stanley | 1,058.50 | 28 | 33 | 28 | 11 |
Deutsche Bank | 904.00 | 18 | 23 | 33 | 25 |
Citi | 873.24 | 18 | 25 | 37 | 19 |
Credit Suisse | 862.55 | 26 | 24 | 29 | 20 |
Barclays | 817.76 | 28 | 19 | 33 | 20 |
UBS | 488.96 | 24 | 28 | 29 | 19 |
RBC Capital Markets | 449.26 | 27 | 24 | 27 | 22 |
Total: | 9,302.11 |
Source:
FT.com (online). League Tables, Top 10 Banks â 1H 2014 Fees for M&A, Equity, Bonds and Loans Products. Available from
http://markets.ft.com/investmentBanking/tablesAndTrends.asp?ftauth=1398866069529
. [Accessed Wednesday, 30 April 2014]
These ten banks can be regarded as “full-service” investment banks; in addition there are financial service conglomerates that combine commercial banking, investment banking and, sometimes, insurance (e.g. Daiwa Securities, Crédit Agricole, Rabobank and Standard Chartered Bank), and independent investment banks (e.g. Cantor Fitzgerald, Cowen Group, Investec and Piper Jaffray).
Notable casualties from the 2008 banking crisis were investment banks such as: