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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New Technology:New Technology:The Challenges and OpportunitiesThe Challenges and Opportunities
AdvertisingAdvertisingTransactionTransaction
Internet bankingInternet banking Internet investmentInternet investment PurchasesPurchases Financial transfersFinancial transfers
InformationInformation
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New Technology:New Technology:The Challenges and OpportunitiesThe Challenges and Opportunities
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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The Changing Mix of Financial-Service The Changing Mix of Financial-Service Suppliers: Challenges and OpportunitiesSuppliers: Challenges and Opportunities
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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The Changing Mix of Financial-Service The Changing Mix of Financial-Service Suppliers: Challenges and OpportunitiesSuppliers: Challenges and Opportunities
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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Consolidations and Convergences:Consolidations and Convergences:The Challenges and OpportunitiesThe Challenges and Opportunities
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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Consolidations and Convergences:Consolidations and Convergences:The Challenges and OpportunitiesThe Challenges and Opportunities
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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Financial Services RegulationFinancial Services Regulation
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 Services RegulationFinancial Services Regulation
Financial Holding Company Organizational FormFinancial Holding Company Organizational Form
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Financial Services RegulationFinancial Services Regulation
Financial Subsidiaries Organization FormFinancial Subsidiaries Organization Form
Banking or Other Controlling Firm
SecuritiesSubsidiary
InsuranceSubsidiary
Other Financial-
ServiceSubsidiaries
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Financial Services RegulationFinancial Services Regulation
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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Financial Services RegulationFinancial Services Regulation
Functional Regulator ModelFunctional Regulator Model
Holding Company or Parent Firm
SecuritiesFirm
InsuranceCompanyBank
Holding Company Regulator
SecuritiesRegulator
InsuranceRegulator
Bank Regulator
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Financial Services RegulationFinancial Services Regulation
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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Markets on the NetMarkets on the Net
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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Markets on the NetMarkets on the Net
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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Chapter ReviewChapter Review
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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Chapter ReviewChapter Review
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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