chapter 4 the future of the financial system and the money and capital markets mcgraw-hill/irwin...

Chapter 4Chapter 4

The Future of the Financial The Future of the Financial System and the Money System and the Money

and Capital Marketsand Capital Markets

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.

Learning Objectives Learning Objectives

To explore the economic, demographic, To explore the economic, demographic, social, and technological forces social, and technological forces reshaping the financial system today.reshaping the financial system today.

To learn about recent trends in the To learn about recent trends in the financial system and how they may financial system and how they may affect us in the future.affect us in the future.

To learn about how your behavior and To learn about how your behavior and decisions, along with millions of others, decisions, along with millions of others, may plan an important role in shaping may plan an important role in shaping the future of the financial systemthe future of the financial system

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IntroductionIntroduction

Powerful forces are reshaping today’s Powerful forces are reshaping today’s financial marketplacefinancial marketplace

Forces for changeForces for change Powerful new trends within the financial Powerful new trends within the financial

marketplace itselfmarketplace itself Major changes in the structure and Major changes in the structure and

functioning of the economyfunctioning of the economy New social and demographic trendsNew social and demographic trends

Altering the public’s need for new Altering the public’s need for new financial servicesfinancial services

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Financial Forces: Reshaping the Money Financial Forces: Reshaping the Money and Capital Markets Todayand Capital Markets Today

Financial innovationFinancial innovation - the development of - the development of many new financial services and instrumentsmany new financial services and instruments

Service proliferationService proliferation - the expansion of the - the expansion of the menu of financial services offeredmenu of financial services offered

CompetitionCompetition - the intense struggle for the - the intense struggle for the customer’s businesscustomer’s business

ConsolidationConsolidation - - mergers and acquisitionsmergers and acquisitions have created financial giants out of have created financial giants out of numerous smaller financial-service providersnumerous smaller financial-service providers

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Financial Forces: Reshaping the Money Financial Forces: Reshaping the Money and Capital Markets Todayand Capital Markets Today

DeregulationDeregulation - the lightening or elimination of - the lightening or elimination of government rules brought about by a government rules brought about by a strategy of strategy of privatizationprivatization of the financial of the financial sectorsector

ConvergenceConvergence - the blurring of the traditional - the blurring of the traditional distinctions among different types of distinctions among different types of financial-service institutionsfinancial-service institutions

HomogenizationHomogenization - the growing similarity in - the growing similarity in the service menus offered by financial the service menus offered by financial institutionsinstitutions

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Financial ForcesFinancial Forces: Reshaping the Money : Reshaping the Money and Capital Markets Todayand Capital Markets Today

GlobalizationGlobalization - the global expansion of - the global expansion of operations and the falling of geographical operations and the falling of geographical barriersbarriers

Market broadeningMarket broadening - the expansion of - the expansion of traditionally local markets to become traditionally local markets to become regional, national, or even international in regional, national, or even international in scopescope

SecuritizationSecuritization - - the pooling of loans and the the pooling of loans and the issuance of securities as claims against the issuance of securities as claims against the loan poolloan pool

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Economic & Demographic ForcesEconomic & Demographic ForcesReshaping the Financial SystemReshaping the Financial System

Aging population has greater needsAging population has greater needs Retirement Retirement Tax and estate planningTax and estate planning

Changing basic family unitChanging basic family unit Rise in proportion of nontraditional Rise in proportion of nontraditional

households (single-parent, well-educated households (single-parent, well-educated working women, parents and children working women, parents and children living apart, immigrants)living apart, immigrants)

Increases demand (new forms housing, Increases demand (new forms housing, daycare facilities, flexible work schedule, daycare facilities, flexible work schedule, less expensive medical care)less expensive medical care)

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Life Cycle HypothesisLife Cycle Hypothesis

Life cycle hypothesisLife cycle hypothesis Aging individuals reduce expectations of Aging individuals reduce expectations of

lifetime incomelifetime income As retirement approaches, consumption As retirement approaches, consumption

declines to matchdeclines to match As US population agesAs US population ages

Tend to consume lessTend to consume less Tend to save moreTend to save more

ChallengeChallenge Provide for older saversProvide for older savers Including retirement and estate planningIncluding retirement and estate planning

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Economic & Demographic ForcesEconomic & Demographic ForcesReshaping the Financial SystemReshaping the Financial System

Displacement of manufacturing Displacement of manufacturing industries by service industries in more industries by service industries in more developed economiesdeveloped economies

Technological innovation - the Technological innovation - the dissemination and storage of dissemination and storage of information today is broader, cheaper, information today is broader, cheaper, faster, and more accuratefaster, and more accurate

Internationalization of markets - such as Internationalization of markets - such as the emergence of the European Unionthe emergence of the European Union

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Forces Affecting the Financial Forces Affecting the Financial System of the FutureSystem of the Future

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Dealing with Risk in the Financial System:Dealing with Risk in the Financial System:The Challenges and OpportunitiesThe Challenges and Opportunities

The financial marketplaces depends on The financial marketplaces depends on public confidencepublic confidence Induces parties to provide credit to the marketInduces parties to provide credit to the market Honesty and reliability often as important as Honesty and reliability often as important as

priceprice Loss of public confidenceLoss of public confidence

Produces adverse consequences for individual Produces adverse consequences for individual financial institutionsfinancial institutions

Damages the efficiency of market processesDamages the efficiency of market processes Flight of fundsFlight of funds Higher costs for remaining fundsHigher costs for remaining funds

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Dealing with Risk in the Financial System:Dealing with Risk in the Financial System:The Challenges and OpportunitiesThe Challenges and Opportunities

Public confidence can be promotedPublic confidence can be promoted Government insurance systemsGovernment insurance systems

Federal Deposit Insurance Corporation Federal Deposit Insurance Corporation (FDIC)(FDIC)

Pension Benefit Guaranty Corporation Pension Benefit Guaranty Corporation (PBGC)(PBGC)

Regulation of capital – equity requirements Regulation of capital – equity requirements Private responses - Private responses - market disciplinemarket discipline Developing better risk-management toolsDeveloping better risk-management tools

DerivativesDerivatives Stress testingStress testing

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Risk in the Financial System:Risk in the Financial System:The Challenges and OpportunitiesThe Challenges and Opportunities

Government actions limited by problemsGovernment actions limited by problems Government-provided insurance can distort Government-provided insurance can distort

risk-takingrisk-taking Excess restrictions can reduce international Excess restrictions can reduce international

competitivenesscompetitiveness

Private response limited Private response limited Limited information disclosureLimited information disclosure Market investors can only Market investors can only

approximatelyapproximately price these securities price these securities

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New TechnologyNew Technology::The Challenges and OpportunitiesThe Challenges and Opportunities

Financial informationFinancial information Essential to provision of financial Essential to provision of financial

servicesservices Technological revolution – analysis, Technological revolution – analysis,

storage, and transferstorage, and transfer Electronic-based communications Electronic-based communications

systems annually improving at systems annually improving at accelerating paceaccelerating pace

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New Technology:New Technology:The Challenges and OpportunitiesThe Challenges and Opportunities

Global integrated electronic networksGlobal integrated electronic networks Changing financial services design and Changing financial services design and

deliverydelivery InternetInternet Cellular phones and smart phonesCellular phones and smart phones Pocket and hand-held computersPocket and hand-held computers Smart cardsSmart cards

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AdvertisingAdvertisingTransactionTransaction

Internet bankingInternet banking Internet investmentInternet investment PurchasesPurchases Financial transfersFinancial transfers

InformationInformation

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Adjustment to technology lags the Adjustment to technology lags the technological revolutiontechnological revolution Many still prefer paper transactionsMany still prefer paper transactions Preference for direct interactionPreference for direct interaction

ChallengesChallenges Maximize friendliness of user interfaceMaximize friendliness of user interface Minimize operating costs and service pricesMinimize operating costs and service prices Ensure ease of technological upgradesEnsure ease of technological upgrades Strengthen data integrity and system securityStrengthen data integrity and system security Manage greater level of external information Manage greater level of external information

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The Changing Mix of Financial-Service The Changing Mix of Financial-Service Suppliers: Challenges and OpportunitiesSuppliers: Challenges and Opportunities

Who will offer financial servicesWho will offer financial services Erosion of traditional area separationErosion of traditional area separation Greater competitionGreater competition

Price competitionPrice competition Nonprice featuresNonprice features

Likely remainder of differentiation will Likely remainder of differentiation will disappeardisappear

Better-informed customers likely to be Better-informed customers likely to be willing to move businesswilling to move business

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Extensive delivery systemExtensive delivery system Cost advantageCost advantage Productivity advantageProductivity advantage

Emerging financial service needsEmerging financial service needs Need for new financial institutionsNeed for new financial institutions Develop to manage evolution in financial Develop to manage evolution in financial

instrumentsinstruments Loans to remodel residentialLoans to remodel residential Small business loansSmall business loans Credit risk derivativesCredit risk derivatives

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SecuritizationSecuritization Mortgage-backed securities very Mortgage-backed securities very

successfulsuccessful Spawned other marketsSpawned other markets

Credit card receivablesCredit card receivables Auto and boat loansAuto and boat loans Equipment leases, among othersEquipment leases, among others

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Consolidations and Convergences:Consolidations and Convergences:The Challenges and OpportunitiesThe Challenges and Opportunities

Merger and acquisition activityMerger and acquisition activity Consolidation Consolidation ConvergenceConvergence

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AdvantagesAdvantages Elimination of duplication brings about Elimination of duplication brings about

substantial operating costs savingssubstantial operating costs savings Broadening of services and customer Broadening of services and customer

segments accelerate revenue growthsegments accelerate revenue growth Greater diversification reduces overall riskGreater diversification reduces overall risk Combination of expertise results in higher-Combination of expertise results in higher-

quality products and servicesquality products and services Greater economies of scale increases the Greater economies of scale increases the

affordability of technologiesaffordability of technologies Greater efficiency in joint marketing and cross-Greater efficiency in joint marketing and cross-

sellingselling

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DisadvantageDisadvantage Greater complexities of managing the firm Greater complexities of managing the firm

may increase operating costsmay increase operating costs May have overestimated public’s demand May have overestimated public’s demand

for “one stop” financial shopping for “one stop” financial shopping Smaller financial firms may provide more Smaller financial firms may provide more

personalized servicespersonalized services Smaller financial firms may compete Smaller financial firms may compete

effectively by outsourcingeffectively by outsourcing

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Financial Services RegulationFinancial Services Regulation

Consolidation and convergence Consolidation and convergence Major challenges for the regulatory Major challenges for the regulatory

agencies agencies Safe financial systemSafe financial system Stable financial systemStable financial system

Regulators cannot stop the market Regulators cannot stop the market evolutionevolution

Challenge to merge safety and stability Challenge to merge safety and stability with market forceswith market forces

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Different regulatory approachesDifferent regulatory approaches Holding companyHolding company Single regulatorSingle regulator Functional regulationFunctional regulation HarmonizationHarmonization

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Financial Holding Company

InsuranceCompanies,

Underwritersand Agents

Security Brokers,

Dealers and Underwriters

BankingFirms

OtherFinancial-

ServiceCompanies


Financial Holding Company Organizational FormFinancial Holding Company Organizational Form

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Financial Subsidiaries Organization FormFinancial Subsidiaries Organization Form

Banking or Other Controlling Firm

SecuritiesSubsidiary

InsuranceSubsidiary

Other Financial-

ServiceSubsidiaries

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Single Regulator ModelSingle Regulator Model

Holding Company or Parent Firm

Affiliated and/or Subsidiary Companies

One Regulatory Agency Supervises the Operations of the Whole Financial Service Firm

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Functional Regulator ModelFunctional Regulator Model

Holding Company or Parent Firm

SecuritiesFirm

InsuranceCompanyBank

Holding Company Regulator

SecuritiesRegulator

InsuranceRegulator

Bank Regulator

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Difficulty of coordination and control in Difficulty of coordination and control in larger and more diversified financial larger and more diversified financial institutions require,institutions require, Employees who are well trained in Employees who are well trained in

coordination and control skillscoordination and control skills Strong internal auditing procedures and Strong internal auditing procedures and

management information systems, andmanagement information systems, and Continual evaluation of subsidiary firms, Continual evaluation of subsidiary firms,

profit centers, and service functions for profit centers, and service functions for their contributions to the firm’s goalstheir contributions to the firm’s goals

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The Payments System: Current and FutureThe Payments System: Current and Future

Retail Retail Small paymentsSmall payments Largely between individuals and firmsLargely between individuals and firms

WholesaleWholesale Large paymentsLarge payments Mainly banks, business firms, and Mainly banks, business firms, and

government agenciesgovernment agencies Typically pass through automatic Typically pass through automatic

clearinghouses, fedwire and other clearinghouses, fedwire and other clearinghousesclearinghouses

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The Payments System: Current and FutureThe Payments System: Current and Future

Retail payments system lags Retail payments system lags behind the wholesale payments behind the wholesale payments system in converting from system in converting from expensive paper transactions to expensive paper transactions to electronic systemselectronic systems

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The Current and Future Need forThe Current and Future Need forRegulation of Financial Regulation of Financial

InstitutionsInstitutions Recent deregulatory trend likely to Recent deregulatory trend likely to

continuecontinue reduced barriers to geographic expansionreduced barriers to geographic expansion reduced restrictions on the portfolio choices reduced restrictions on the portfolio choices

by financial institutions,by financial institutions, reorganization of regulatory agencies,reorganization of regulatory agencies, reduced barriers to the development and reduced barriers to the development and

offering of new services to the publicoffering of new services to the public Contentious debate on new services from Contentious debate on new services from

depository institutionsdepository institutions The pace of government deregulation The pace of government deregulation

appears to be accelerating (GATT, NAFTA)appears to be accelerating (GATT, NAFTA)4-34

The Current and Future Need forThe Current and Future Need forRegulation of Financial Regulation of Financial

InstitutionsInstitutions Not all government regulations will Not all government regulations will

disappeardisappear Concern over safetyConcern over safety Concern over confidenceConcern over confidence

Shifting regulationShifting regulation Financial disclosureFinancial disclosure Consumer privacy protectionConsumer privacy protection Social responsibilitySocial responsibility Promote a level playing fieldPromote a level playing field

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Shifting Regulation: DisclosureShifting Regulation: Disclosure

Require more release of informationRequire more release of informationPotential riskPotential risk

Potential public disfavorPotential public disfavor Discipline of the marketDiscipline of the market

Potential gainPotential gain Greater confidenceGreater confidence More intelligent decisionsMore intelligent decisions Most economical use of resourcesMost economical use of resources

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Shifting Regulation: Privacy ProtectionShifting Regulation: Privacy Protection

Privacy protectionPrivacy protection Many regulations on release of Many regulations on release of

informationinformation Fight identity theftFight identity theft

Each year thousands become victim of Each year thousands become victim of fraudfraud

Information stolen to access accounts Information stolen to access accounts and assetsand assets

Has been used by terrorist groupsHas been used by terrorist groups

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Shifting Regulation: Privacy ProtectionShifting Regulation: Privacy Protection

More customer privacy protectionMore customer privacy protection Require customer permissionRequire customer permission More securityMore security

Federal Financial Institutions Federal Financial Institutions Examination CouncilExamination Council

Depository institutions beginning to Depository institutions beginning to require more than name and password require more than name and password to access informationto access information

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Shifting Regulation: Social ResponsibilityShifting Regulation: Social Responsibility

Greater scrutiny of fairnessGreater scrutiny of fairness Resources usedResources used Service distributionService distribution

NondiscriminationNondiscrimination Serving all neighborhoodsServing all neighborhoods

Pressure will growPressure will grow Have all institutionsHave all institutions Serve all customersServe all customers

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Shifting Regulation: Level Playing FieldShifting Regulation: Level Playing Field

Fair and equal regulatory treatmentFair and equal regulatory treatment Important issue for bankersImportant issue for bankers Various institutions have differential Various institutions have differential

treatmenttreatment TaxationTaxation InstrumentsInstruments ServicesServices

Differential treatment may lead to Differential treatment may lead to differential competitivenessdifferential competitiveness

Pressure for convergence across Pressure for convergence across different types of institutionsdifferent types of institutions

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Markets on the NetMarkets on the Net

Accuity at Accuity at www.bankinfo.comwww.bankinfo.com American Bankers Association at American Bankers Association at

www.aba.com/Industry+Issueswww.aba.com/Industry+Issues Australian Prudential Regulatory Authority at Australian Prudential Regulatory Authority at

www.apra.gov.auwww.apra.gov.au Citi Identity Theft Solutions at Citi Identity Theft Solutions at

citibank.com/us/cards/cardserv/advice/victim.htmcitibank.com/us/cards/cardserv/advice/victim.htm Consumer Law at Consumer Law at www.consumerlaw.orgwww.consumerlaw.org Federal Deposit Insurance Corporation at Federal Deposit Insurance Corporation at http://http://

www.fdic.govwww.fdic.gov/consumers/consumers Federal Reserve System at Federal Reserve System at www.federalreserve.govwww.federalreserve.gov

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Federal Trade Commission at Federal Trade Commission at www.ftc.govwww.ftc.gov FinPipe at FinPipe at www.finpipe.com/derivglossary.htmwww.finpipe.com/derivglossary.htm Google at Google at www.google.com/xhtmlwww.google.com/xhtml Government Computer News at Government Computer News at gcn.comgcn.com Hoovers at Hoovers at hoovers.comhoovers.com Identity Theft Assistance Center at Identity Theft Assistance Center at

identitytheftassistance.comidentitytheftassistance.com Identity Theft 911 LLC at Identity Theft 911 LLC at identitytheft911.orgidentitytheft911.org Imenu at Imenu at www.imenu.comwww.imenu.com Managing Automation at Managing Automation at ManagingAutomation.comManagingAutomation.com

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Mobile Answers at Mobile Answers at www.mobile.answers.comwww.mobile.answers.com National Consumer Law Center at National Consumer Law Center at

www.consumerlaw.orgwww.consumerlaw.org New York Stock Exchange at New York Stock Exchange at www.nyse.comwww.nyse.com Pension Benefit Guaranty Corporation at Pension Benefit Guaranty Corporation at

www.pbgc.govwww.pbgc.gov Quote.com at Quote.com at www.quote.comwww.quote.com Rfid Journal at Rfid Journal at www.rfidjournal.comwww.rfidjournal.com U.S. Bureau of the Census at U.S. Bureau of the Census at www.census.govwww.census.gov Wells Fargo Bank at Wells Fargo Bank at www.wellsfargo.comwww.wellsfargo.com Yahoo at Yahoo at wap.oa.yahoo.comwap.oa.yahoo.com

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Chapter ReviewChapter Review

Introduction: The financial markets in Introduction: The financial markets in changechange

Financial forces reshaping the money Financial forces reshaping the money and capital markets todayand capital markets today

Social, economic, and demographic Social, economic, and demographic forces reshaping the financial systemforces reshaping the financial system

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The challenges and opportunities The challenges and opportunities presented by recent trendspresented by recent trends Dealing with risk in the financial system: Dealing with risk in the financial system:

Ensuring the strength and viability of Financial Ensuring the strength and viability of Financial institutions and increasing public confidenceinstitutions and increasing public confidence

Effect of new technology on the design and Effect of new technology on the design and delivery of financial servicesdelivery of financial services

Changing mix of financial-service suppliersChanging mix of financial-service suppliers Consolidations and convergencesConsolidations and convergences

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A new role for financial-services regulation A new role for financial-services regulation in an age of financial-services in an age of financial-services consolidation and convergenceconsolidation and convergence

The future of the payments systemThe future of the payments system The future need for regulation of financial The future need for regulation of financial

institutionsinstitutions Regulations that could growRegulations that could grow Level playing fieldLevel playing field

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chapter 4 the future of the financial system and the money and capital markets mcgraw-hill/irwin...

Documents

financial forces

financial innovation

financial institutions

financial giants

new financial services

menu of financial services

different types of financial

financial sector convergence