US BANKING INDUSTRY

Prepared By:-•Ankit Gupta (11DM-020)•Kanishka Rao (11FN-049)•Rohit Iyer (11FN-082)•Simran Preet (11FN-105)•Sahil Gupta (11IB-069)•Sahil Singhal (11FN-087)•Sri Lasya Gade (11FN-037)

US Banking Industry RiskStrengths:

•Highly diversified and market-oriented economy, with an adaptable and resilient economic structure.

•Core retail deposits constitute a large share of system wide funding needs.

•The U.S. benefits from the dollar's standing as a key reserve currency, which helps compensate for the country's external debt and leads to minimal foreign-currency funding of the banking system.

Weaknesses:

•Even though losses on loans have abated in recent quarters, continued weakness in the real estate segment poses latent credit risks.

•Large and active nonbank competitors should continue to undermine the "competitive dynamics" of U.S. banks.

•The supervisory challenges of monitoring the U.S.' innovative, complex, and dynamic financial system remain formidable, despite the regulatory overhaul underway.

Time Line of the Early History of US Banking

A timeline of Banking Regulation

1863 1927

1933

1980

1956 1999

1994

Res

tric

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ns

on

ac

tivi

ties

Res

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on

C

om

pet

itio

n McFadden Act

Banking Act

Holding Company Act

Monetary Control Act

Riegle-Neal

Holding Company Act

Glass - Steagall

Graham - Leach - Bliley

Great Depression

A Brief HistoryDUAL BANKING SYSTEM• Banking at state level until Civil War

• state charters, regulation• banknotes as local currency• failures, fraud were common

• National Bank Act 1963• federal charters for banks• Comptroller of the Currency• federal banknotes• tax on state banknotes• state banks survived by accepting deposits

-- dual banking system

CENTRAL BANK• U.S. had two prior central banks

• the Bank of the U.S. (1791-1811))• the Second Bank of the U.S.

(1816-63)• U.S. central banks not popular

• ranchers & farmers• states rights

• 1863-1907• no central bank• regular financial crises• panic of 1907

--bankers demanded a central bank• Federal Reserve System (1913)

Branching Restrictions

• McFadden Act 1927• restricted intra and interstate branching of national banks• meant to protect small banks & increase competition• repealed 1994

(Riegle-Neal)

• Glass-Steagall Act• separated permissible activities of commercial, investment banks• idea: limit risk for commercial banks• weakened over time• repealed 1999

Great Depression

• 1930-33, 1/3 of all U.S. banks failed• Congress responded to legislation• FDIC

• federal insurance for bank deposits• banks pay premiums

Regulators• Comptroller of the Currency

• national banks

• Federal Reserve• bank holding companies• state member banks• national banks (secondary)

• FDIC• nonmember state banks

• state regulators• state banks (secondary)

Five Largest Financial Institutions By Assets

 

Long-term counterparty credit

rating/ outlookAssets (bil. $) Systemic

Importance

JP Morgan Chase & Co. A/ Negative 2290 High

Bank of America Corp. A-/ Negative 2161 High

Citigroup Inc. A-/ Negative 1916 High

Wells Fargo & Co. A+/ Negative 1336 High

The Goldman Sachs Group Inc. A-/ Negative 951 High

Source:- Standard & Poor's Financial Institutions Ratings

Loans62%

Bonds30%

Stocks2%

Other6%

A majority of external funds raised by non-financial businesses come from bank loans. In particular, small businesses rely entirely on banks for financing

LoansBankDepositors

There is a moral hazard problem/adverse selection problem between both the bank and its depositors as well as between the bank and its potential loan customers

A bank can deal with this problem with:

•Credit Scoring

•Collateral

•Optimal Debt Contracts

This problem must be dealt with through regulation

Depository Institutions are broadly defined as businesses that accept deposits and make loans

Depository Institutions

Commercial Banks

Savings & Loans

Savings Banks

Credit Unions

Non-Bank Thrifts

•Deal almost exclusively in short term deposits and mortgages

•Are generally mutual companies (depositors are the owners)

•Are allowed to hold corporate equities/bonds

All Depository Institutions in the US are chartered

Depository Institutions

Commercial Banks

Savings & Loans

Savings Banks

Credit Unions

National Banks Comptroller of the Currency

State Banks State Authority

Federal Associations Office of Thrift Supervision

State Associations State Authority

Federal Unions National Credit Union Administration

State Unions State Authority

Federal Reserve Membership (1913)

• National Banks are Required to be members of the Federal Reserve System (Membership is optional for state banks)• Federal Reserve members are required to purchase

stock in the federal reserve system.• Federal Reserve members provide input to the

election of Federal Reserve Board Members• The Federal Reserve provides check clearing

services

National Banks 2001

State Banks (Non-Member)

935

State Banks (Non-Member)

4833

Of the 7,769 banks in 2003, a vast majority are non-member state banks

Federal Deposit Insurance (1934)

• Federal reserve members are required to purchase deposit insurance. Insurance is optional for state banks (98% of all banks have deposit insurance)• FDIC insured banks are charged up to 27 cents per $100 of eligible

deposits• All deposits up to $100,000 are insured by the FDIC.

Decentralization & Consolidation

McFadden Act resulted in many small banks • Meant to protect small banks & increase competition

-- but protected inefficient banks

-- limited economies of scale• Loopholes

-- bank holding companies

-- owned several banks

-- limited service banks

-- deposits or loans, not both

-- ATMs• Repealed 1994

Consolidation

• Bank failures in 1980s• Loopholes in McFadden• Repeal of McFadden• Over 14,000 banks in 1985

• less than 8,000 today

Commercial Banks in the US

Shaded areas indicate US recessions. Source:- Federal Financial Institutions Examination Council

Year Number of Banks Total Branches

1900 12,500 13,000

2000 7800 68,000

Until the mid 1900’s, US was a nation of unit banks

Main Office

Branch Offices

National Banks

Prohibited from interstate branching

Must comply with state branching rules

McFadden Act (1927)

State Banks

Unit Banking

Limited Branching

Statewide Branching

A good thing?

• Economies of scale• Diversification• But

• risks with expansion?• responsive to small customers?

Following the great depression, the activities of commercial banks were severely restricted

The Glass-Steagall Act of 1934 was designed to put a wall between commercial banking and investment banking

Glass-Steagall (1934)

Commercial Banks are restricted from participating in equities markets

Interest rates on non- transaction deposits is restricted to be below 5.25%

No interest allowed on transaction deposits

Regulation Q

Branching Restrictions could be avoided by forming holding companies

Main Office

Branch Offices

Illegal under the McFadden Act

Holding Company

Subsidiaries

Legal under the McFadden Act

The Bank Holding Company act allowed holding companies with only one bank to provide limited non-bank financial services on an interstate basis. This created a loophole around Glass-Steagall!!

Holding Company

Prior to Bank Holding Company Act

Bank Bank Bank

Holding Company

After Bank Holding Company Act

Non-Bank Branches

Non- Bank Offices

Collects deposits, but doesn’t make loans

Makes loans, but doesn’t collect deposits

Financial Services

Deregulation of the Financial Services sector began in the 1980’s.

The Monetary Control Act (1980)

Began the phase out of interest rate ceilings at depository institutions

Imposed uniform reserve requirements on Banks and Thrifts

Riegle-Neal Interstate Banking and Branching Efficiency Act (1994)

Allowed holding companies to acquire banks in any state

Allowed banks to branch across state lines

Financial Services Modernization Act (Graham Leach-Bliley) (1996)

Permitted financial holding companies offering banking, insurance, securities and other services under one controlling corporation (allowed Citicorp to buy Traveler’s Insurance)

Capital AdequacyAsset QualityManagementEarningsLiquiditySensitivity to Interest Rate Risk

Problems with Monitoring

Banks are monitored using the camels system. However, It’s not always easy to accurately assess the risk a bank is taking on

Off Balance Sheet Activities

Derivatives

Financial Guarantees (SLC)

Asset Securitization

In 1995, Barings Bank went bankrupt due to losses in the Derivatives market. At the time, it was holding $60B worth of derivative contracts – a staggering number when compared to Baring’s reported equity of $615M!!

The CAMELS System

Problems with Restricting Activities Banks compete with other financial services companies as well as other banks!!

During the late 1970’s, market interest rates rose well above 10%, but banks were restricted by regulation Q to pay only 5.25% in savings accounts and 0% on checking accounts

Banks Financial Companies

Checking Accounts (0%) Money Markey Mutual Funds (10%)

As households pulled their money out of banks, mortgage and small business lending was seriously curtailed!

Problems with Restricting Competition (Branching)

Restricting entry gives banks limited monopoly power, they can use this to increase profits at the customers expense!

Banking is a decreasing cost industry (i.e. large startup costs, but small marginal costs). By forcing banks to remain small and local, they are forced to operate at an inefficiently small scale!

By forcing banks to remain in a confined geographical location, you are forcing them to take on idiosyncratic (area specific) risk!

Decline of Traditional Banking

• Traditional bank activities• decline in profitability• decline in importance

Declining share of loans

Rising profitability

But due to nontraditional activities

share of incomeNOT from interest

Why the decline?• Liability side:

• cost of acquiring funds has risen

• Asset side:• income generated has declined

• Causes:• financial innovation since 1970s

Money market mutual funds• Substitute for checking account from investment

companies• pay interest• not insured (but low risk)

• Banks had to offer own version• raised the cost of funds

Junk bond market• No market for new, low-rated debt prior to 1980

• only for ratings of Baa (BBB) or better

• Improvements in credit risk screening created market for new risky debt

• Before 1980• low-rated firms relied on banks

• After 1980• low-rated firms could borrow by issuing junk bonds

• Junk bond markets competing with banks for lending business

Commercial Paper• Easier to issue with improvements in credit risk screening• Demanded by money market mutual funds• Replaced corporate short-term borrowing from banks

Securitization• Transform illiquid loans into liquid debt securities• Individual loans bundled together• Debt securities issued, backed by pool of loans

• owners of security get a share of the loan payments

The implications..• other financial institutions take a part of the lending process

-- originate the loan

-- service the loan

-- issue and sell security• finance companies that just specialize in originating loans

In total• Higher cost of obtaining funds

• due to competition from money market

• Lower income from loans• due to competition from

-- junk bond market

-- commercial paper market

-- financial companies

Result of decline

•Bank failures•Newer activities

•fee income•credit cards•commercial real estate

0

1

2

3

4

5

6

1979 1986 1989 1992 1995 1998

Since the 1970’s, there has been tremendous growth in international trade

World Trade (in Trillions of $s)

Globalization- The Final Frontier

0

50

100

150

200

250

300

350

400

1979 1986 1989 1992 1995 1998

Even more impressive is the growth in foreign exchange

Currency Transactions (in Trillions of $s)

Globalization- The Final Frontier

US Banks Operating Abroad

Subsidiaries: Governed by Federal Reserve Regulation K – must be involved in business “closely related to banking.

International Banking Facilities: Accepts time deposits and makes loans to foreign households & firms. Exempt from reserve requirements, but may not do business in the US.

Edge Act Corporations: Makes loans/accepts deposits. Can deal with both US and foreign citizens , but is limited to international trade transactions

Branches: Offer a full line of banking services, but are subject to foreign laws

US Banks locate facilities abroad to aid in international trade as well as to avoid regulation and taxes

Foreign Banks Operating in the US

Agency Office: Can’t accept deposits from US citizens, but can transfer funds from abroad and make loans in the US

Subsidiaries: Treated as a US bank. Subject to all US regulations. Subsidiaries may also set up edge act corporations and international lending facilities

Branches: Offers a full range of banking services for US citizens

Likewise for Foreign Banks…

Important Dates in International Banking

1930 1978 1988 1991

Bank for International (BIS) Settlements Created

International Banking Act Basle Accords I

Foreign Bank Supervision Act

BCCI Scandal

Bank of EnglandFederal Reserve

United States

Under whose jurisdiction do international banks fall? (it’s a gray area)

United Kingdom

Regulating International Banking

International Banking Act (1978)

Brought foreign banks operating in the US under federal regulation for the first time

Foreign banks, however, were not monitored as closely as US banks

Foreign Bank Supervision Act (1991)

Passed shortly after the BCCI scandal

Gave the Federal Reserve and the Comptroller of the Currency greater control over foreign banks operating in the US

Bank For International Settlements (1930)

• Established to handle German WWI reparations, the BIS has become a center for international cooperation.• Played a central role in the Bretton Woods Exchange Rate System• Integral in the Establishment of the Euro

• The BIS is like a central bank for central banks.

Risk weighted assets

Asset Risk Weight

Cash and equivalents 0

Government securities 0

Interbank loans 0.2

Mortgage loans 0.5

Ordinary loans 1.0

Standby letters of credit 1.0

The Basle Accords established uniform capital requirements for banks around the world. Equity capital was required to equal at least 4% of a bank’s risk weighted assets.

Risk Weighted Assets

Assets Liabilities

$ 2,000 (T-Bills)

$1,000B (Equity)

US Banking Sector

$ 3,000 (Other)

$ 54B (Cash)$ 46B (Reserves)

Res. Req. = 5%

$ 2,701 (Mortgage)

$ 800B (Checking)$ 4,500B (Saving)

$ 1B (Discount)

Loans Loans

(0)( $54B)

(0)($46B)

(0)($2,000B)

(.5)($2,701B)

(1)($3,000B)

= $0

= $0

= $3,000B

= $0

= $1,350.5B

$4,350.5B

Required Equity = (.04)($4350.5B) = $174.2B

+

Problems with International Regulation

• The key issue is that the banking industry in Japan and Europe is Fundamentally different from the US.

Why BOFA?Rank Institution Name Location

Total Assets 09/30/2012

Total Assets 06/30/2012

1 JPMORGAN CHASE & CO. NEW YORK, NY $2,321,284,000 $2,290,146,000

2BANK OF AMERICA CORPORATION

CHARLOTTE, NC

$2,168,023,105 $2,162,083,396

3 CITIGROUP INC. NEW YORK, NY $1,931,346,000 $1,916,451,000

4WELLS FARGO & COMPANY

SAN FRANCISCO, CA

$1,374,715,000 $1,336,204,000

5GOLDMAN SACHS GROUP, INC., THE

NEW YORK, NY $949,475,000 $948,981,000

6 METLIFE, INC. NEW YORK, NY $846,285,485 $825,188,490

7 MORGAN STANLEY NEW YORK, NY $764,985,000 $748,517,000

8 U.S. BANCORP MINNEAPOLIS, MN

$352,253,000 $353,136,000

9BANK OF NEW YORK MELLON CORPORATION, THE

NEW YORK, NY $340,102,000 $330,490,000

10HSBC NORTH AMERICA HOLDINGS INC.

NEW YORK, NY $320,833,451 $317,482,381Source:http://www.ffiec.gov/nicpubweb/nicweb

Asset Size:US vs World

Source:www.relbanks.com

Market Capitalization:US vs World

Source:www.relbanks.com

INTRODUCTION•American multinational banking and financial services corporation headquartered in Charlotte, North Carolina.

•Largest bank holding company in the United States by assets.

•As of 2010, Bank of America is the fifth-largest company in the United States by total revenue, as well as the third-largest non-oil company in the U.S.

•The bank's 2008 acquisition of Merrill Lynch made Bank of America the world's largest wealth management corporation and a major player in the investment banking market.

• One of the Big Four banks in the United States, along with Citigroup, JPMorgan Chase and Wells Fargo—its main competitors.

• Bank of America operates in all 50 states of the U.S., the District of Columbia and more than 40 other countries.

• It has a retail banking footprint that covers approximately 80 percent of the U.S. population and serves approximately 57 million consumer and small business relationships at 5,600 banking centers and 16,200 ATMs.

HISTORYBank of Italy• The history of Bank of America dates back to 1904,

when Amadeo Giannini founded the Bank of Italy in San Francisco in an effort to cater to immigrants denied service by other banks.

• In 1922, Giannini established Bank of America and Italy in Italy by buying Banca dell'Italia Meridionale, the latter established in 1918.

• On March 7, 1927, Giannini consolidated his Bank of Italy (101 branches) with the newly formed Liberty Bank of America (175 branches).

• In 1928, A. P. Giannini merged with Bank of America, Los Angeles. He renamed the Bank of Italy on November 3, 1930, calling it Bank of America.

Growth in California

• Federal banking regulators prohibited Bank of America's interstate banking activity, and Bank of America's domestic banks outside California were forced into a separate company.

• It was not until the 1980s with a change in federal banking legislation and regulation that Bank of America was again able to expand its domestic consumer banking activity outside California.

• In 1958, the bank introduced the BankAmericard, which changed its name to Visa in 1975.

• A consortium of other California banks introduced Master Charge (now MasterCard) to compete with BankAmericard.

Expansion outside California

• In 1983, acquired Seafirst Corporation of Seattle,  Washington, as well as its wholly owned banking subsidiary, Seattle-First National Bank.  

• BankAmerica experienced huge losses in 1986 and 1987 by the placement of a series of bad loans in the Third World, particularly in Latin America.

• In 1992, acquired its California rival, Security Pacific Corporation and its subsidiary Security Pacific National Bank in California. Later that year, BankAmerica expanded into Nevada by acquiring Valley Bank of Nevada.

• In 1994, BankAmerica acquired the Continental Illinois National Bank and Trust Co. of Chicago.

• In 1997, BankAmerica acquired Robertson Stephens, a San Francisco-based investment bank specializing in high technology for $540 million. Robertson Stephens was integrated into BancAmerica Securities and the combined subsidiary was renamed BancAmerica Robertson Stephens

Merger of NationsBank and BankAmerica

• In 1997, BankAmerica lent D. E. Shaw & Co., a large hedge fund, $1.4 billion in order to run various businesses for the bank. 

• BankAmerica was acquired by Nations Bank of Charlotte in October 1998.

• The merged bank took the name Bank of America Corporation.

• the integration of BancAmerica Robertson Stephens and NationsBanc Montgomery Securities, was renamed Banc of America Securities in 1998.

SWOT

Product Developments

KEY HAPPENINGS• In 2004, Bank of America announced it would purchase

Boston-based bank FleetBoston Financial for $47 billion in cash and stock. 

• On June 30, 2005, Bank of America announced it would purchase credit card giant MBNA for $35 billion in cash and stock.  

• In May 2006, Bank of America and Banco Itaú entered into an acquisition agreement through which Itaú agreed to acquire BankBoston's operations in Brazil and was granted an exclusive right to purchase Bank of America's operations in Chile and Uruguay.

• On November 20, 2006, Bank of America announced the purchase of The United States Trust Company for $3.3 billion.

• On September 14, 2007, Bank of America won approval from the Federal Reserve to acquire LaSalle Bank Corporation from Netherlands's ABN AMRO for $21 billion. With this purchase, Bank of America possessed 1.7 trillion in assets.

• The deal increased Bank of America's presence in Illinois, Michigan, and Indiana by 411 branches, 17,000 commercial bank clients, 1.4 million retail customers, and 1,500 ATMs.

• Bank of America became the largest bank in the Chicago market with 197 offices and 14% of the deposit share, surpassing JPMorgan Chase.

• LaSalle Bank and LaSalle Bank Midwest branches adopted the Bank of America name on May 5, 2008.

Acquisition of Countrywide Financial• On August 23, 2007, the company announced a $2 billion

repurchase agreement for Countrywide Financial.

• This purchase of preferred stock was arranged to provide a return on investment of 7.25% per annum and provided the option to purchase common stock at a price of $18 per share.

• On January 11, 2008, Bank of America announced they would buy Countrywide Financial for $4.1 billion.

• This purchase made Bank of America Corporation the leading mortgage originator and servicer in the U.S., controlling 20–25% of the home loan market.

• Countrywide Financial has changed its name to Bank of America Home Loans.

Acquisition of Merrill Lynch• On September 14, 2008, Bank of America announced its intentions to

purchase Merrill Lynch & Co., Inc. in an all-stock deal worth approximately $50 billion.

• At the same time Bank of America was reportedly also in talks to purchase Lehman Brothers.

• The market capitalization of Bank of America, including Merrill Lynch, was then $45 billion, less than the $50 billion it offered for Merrill just four months earlier, and down $108 billion from the merger announcement.

• The acquisition made Bank of America the number one underwriter of global high-yield debt, the third largest underwriter of global equity and the ninth largest adviser on global mergers and acquisitions.

• As the credit crisis eased, losses at Merrill Lynch subsided, and the subsidiary generated 3.7 billion of Bank of America's 4.2 billion in profit by the end of quarter one in 2009, and over 25% in quarter 3 2009.

Federal Troubled Asset Relief Program (TARP)• Bank of America received $20 billion in the federal bailout from

the U.S. government through the Troubled Asset Relief Program (TARP) on January 16, 2009, along with a guarantee of $118 billion in potential losses at the company.

• The additional payment was part of a deal with the U.S. government to preserve Bank of America's merger with the troubled investment firm Merrill Lynch.

• On December 2, 2009, Bank of America announced it would repay the entire $45 billion it received in TARP and exit the program, using $26.2 billion of excess liquidity along with $18.6 billion to be gained in "common equivalent securities"

Downsizing (2011 to 2014)

• During 2011, Bank of America began conducting personnel reductions of an estimated 36,000 people, contributing to intended savings of $5 billion per year by 2014.

• Bank of America will cut around 16,000 jobs in a quicker fashion by the end of 2012 as revenue continues to decline because of new regulations and a slow economy.

• This will put a plan one year ahead of a time to eliminate 30,000 jobs under a cost-cutting program called Project New BAC.

Operations

• Bank of America generates 90% of its revenues in its domestic market and continues to buy businesses in the U.S.

Consumer• The Consumer Banking organization includes over 5,800 retail

branches and over 18,000 ATMs across the United States. 

• Competes with the retail banking arms of America's three other megabanks: Citigroup, JPMorgan Chase, and Wells Fargo.

• member of the Global ATM Alliance

Corporate

• The bank's investment banking activities operate under the Merrill Lynch subsidiary and provides mergers and acquisitions advisory, underwriting, capital markets, as well as sales & trading in fixed income and equities markets.

• Its strongest groups include Leveraged Finance, Syndicated Loans, and mortgage-backed securities.

Investment management

• Global Wealth and Investment Management manages assets of institutions and individuals. It is among the 10 largest U.S. wealth managers.

• Bank of America has recently spent $675 million building its U.S. investment banking business

• looking to become one of the top five investment banks worldwide.

• Its clients include 98% of the Fortune 500 companies in the U.S. and 79% of the Global Fortune 500. 

International operations

• In 2005, Bank of America acquired a 9% stake in China Construction Bank, one of the Big Four banks in China, for $3 billion.

• Bank of America currently has offices in Hong Kong, Shanghai, and Guangzhou and was looking to greatly expand its Chinese business as a result of this deal.

• In 2008, Bank of America was awarded Project Finance Deal of the Year at the 2008 ALB Hong Kong Law Awards. 

• In November 2011, Bank of America announced plans to divest most of its stake in the China Construction Bank.

• Bank of America operated under the name BankBoston in many other Latin American countries, including Brazil. In 2006, Bank of America sold BankBoston's operations to Brazilian bank Banco Itaú, in exchange for Itaú shares. 

• Bank of America's Global Corporate and Investment Banking spans the Globe with divisions in United States, Europe, and Asia.

FinancialsParameters 2011 2010

Tier 1 Capital Adequacy Ratio(%) 9.86 8.60

Debt Service Coverage ratio(%) 0.50 1.08

Current ratio 2.30 2.41

Assets to deposits ratio 2.06 2.24

Efficiency ratio  (%)   85.01 74.61

Loans to deposits (%) 89.66 93.07

Cash Deposit ratio(%) 11 17

Net interest yield  (%) 2.78 1.96

Earnings (loss) per common share  ($)  0.01 -0.37

Diluted earnings (loss) per common share  ($) 0.01 -0.37