Retail banking

From Wikipedia, the free encyclopedia

Banking
A series on financial services

Types of banks[show]

Bank accounts[show]

Bank cards[show]

Funds transfer[show]

Banking terms[show]

Finance series[show]

Retail banking is banking in which banking institutions execute transactions directly with consumers, rather than corporations or other banks. Services offered include savings and transactional accounts, mortgages, personal loans, debit cards, and credit cards.

Commercial bank is the term used for a normal bank to distinguish it from an investment bank. (After the great depression, the U.S. Congress required that banks only engage in banking activities, whereas investment banks were limited to capital markets activities. This separation is no longer mandatory.)

Commercial bank can also refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses, as opposed to normal individual members of the public (retail banking). It is the most successful department of banking.

Community development bank are regulated banks that provide financial services and credit to underserved markets or populations.

Private Banks manage the assets of high net worth individuals.

Offshore banks are banks located in jurisdictions with low taxation and regulation. Many offshore banks are essentially private banks.

Savings banks accept savings deposits.

Postal savings banks are savings banks associated with national postal systems.

Retail Banking services are also termed as Personal Banking services

What It Is: Retail banking refers to the consumer-oriented services offered by commercial banks. These services include checking and savings accounts, mortgages and various types of loans and investment services relating to retirement and educational planning. How It Works/Example: Retail banking encompasses the services offered to consumers by commercial banks. The term "retail" refers to the almost storefront-shopping nature of commercial banking services. Most commercial banks have extensive retail banking services and products to reach a wide consumer base. Here's a brief story about Bob's day at his bank XYZ. He arrives at the bank one day to deposit a $2000 paycheck into his account. He decides to deposit $1000 of the paycheck into his existing checking account. The other $1000 he decides to use to open a savings account. Bob sits with a bank representative who explains the various savings account options and helps him with opening an account once he's made a decision. Additionally, the account representative informs Bob of retirement plans the bank offers as well as educational savings plans for his children. Before he leaves, Bob also takes information on auto loans offered by the bank since he is considering purchasing a new car. While at the bank, Bob was able, in one place, to deposit money, open a savings account and find information relating to banking products he may need in the future. Why It Matters: Retail banking is a framework that allows commercial banks to offer banking products and services in one place at virtually any of their branch locations. The retail banking aspect turns commercial banks into a kind of "store" (or retailer) where clients are able to purchase multiple banking products.
What is Retail Banking?

Retail banking is, however, quite broad in nature - it refers to the dealing of commercial banks with individual customers, both on liabilities and assets sides of the balance sheet. Fixed, current / savings accounts on the liabilities side; and mortgages, loans (e.g., personal, housing, auto, and educational) on the assets side, are the more important of the products offered by banks. Related ancillary services include credit cards, or depository services. Todays retail ba nking sector is characterized by three basic characteristics: multiple products (deposits, credit cards, insurance, investments and securities); multiple channels of distribution (call centre, branch, Internet and kiosk); and multiple customer groups (consumer, small business, and corporate).

What is the nature of retail banking? In a recent book, retail banking has been described as 'hotter than vindaloo'. Considering the fact that vindaloo, the Indian-English innovative curry available in umpteen numbers of restaurants of London, is indeed very hot and spicy, it seems that retail banking is perceived to be the in-thing in todays world of banking. Retail banking in India Retail banking in India is not a new phenomenon. It has always been prevalent in India in various forms. For the last few years it has become synonymous with mainstream banking for many banks. The typical products offered in the Indian retail banking segment are housing loans, consumption loans for purchase of durables, auto loans, credit cards and educational loans. The loans are marketed under attractive brand names to differentiate the products offered by different banks. As the Report on Trend and Progress of India, 2003-04 has shown that the loan values of these retail lending typically range between Rs.20,000 to Rs.100 lakh. The loans are generally for duration of five to seven years with housing loans granted for a longer duration of 15 years. Credit card is another rapidly growing sub-segment of this product group. In recent past retail lending has turned out to be a key profit driver for banks with retail portfolio constituting 21.5 per cent of total outstanding advances as on March 2004. The overall impairment of the retail loan portfolio worked out much less then the Gross NPA ratio for the entire loan portfolio. Within the retail segment, the housing loans had the least gross asset impairment. In fact, retailing make ample business sense in the banking sector. While new generation private sector banks have been able to create a niche in this regard, the public sector banks have not lagged behind. Leveraging their vast branch network and outreach, public sector banks have aggressively forayed to garner a larger slice of the retail pie. By international standards, however, there is still much scope for retail banking in India. After all, retail loans constitute less than seven per cent of GDP in India vis--vis about 35 per cent for other Asian economies South Korea (55 per cent), Taiwan (52 per cent), Malaysia (33 per cent) and Thailand (18 per cent). As retail banking in India is still growing from modest base, there is a likelihood that the growth numbers seem to get somewhat exaggerated. One, thus, has to exercise caution is interpreting the growth of retail banking in India. Drivers of retail business in India What has contributed to this retail growth? Let me briefly highlight some of the basic reasons. First, economic prosperity and the consequent increase in purchasing power has given a fillip to a consumer boom. Note that during the 10 years after 1992, India's economy grew at an average rate of 6.8 percent and continues to grow at the almost the same rate not many countries in the world match this performance. Second, changing consumer demographics indicate vast potential for growth in consumption both qualitatively and quantitatively. India is one of the countries having highest proportion (70%) of the population below 35 years of age (young population). The BRIC report of the Goldman-Sachs, which

predicted a bright future for Brazil, Russia, India and China, mentioned Indian demographic advantage as an important positive factor for India. Third, technological factors played a major role. Convenience banking in the form of debit cards, internet and phone-banking, anywhere and anytime banking has attracted many new customers into the banking field. Technological innovations relating to increasing use of credit / debit cards, ATMs, direct debits and phone banking has contributed to the growth of retail banking in India. Fourth, the Treasury income of the banks, which had strengthened the bottom lines of banks for the past few years, has been on the decline during the last two years. In such a scenario, retail business provides a good vehicle of profit maximisation. Considering the fact that retails share in impaired assets is far lower than the overall bank loans and advances, retail loans have put comparatively less provisioning burden on banks apart from diversifying their income streams. Fifth, decline in interest rates have also contributed to the growth of retail credit by generating the demand for such credit. In this backdrop let me now come two specific domains of retail lending in India, viz., (a) credit cards and (b) housing. Credit Cards in India While usage of cards by customers of banks in India has been in vogue since the mid-1980s, it is only since the early 1990s that the market had witnessed a quantum jump. The total number of cards issued by 42 banks and outstanding, increased from 2.69 crore as on end December 2003 to 4.33 crore as on end December 2004. The actual usage too has registered increases both in terms of volume and value. Almost all the categories of banks issue credit cards. Credit cards have found greater acceptance in terms of usage in the major cities of the country, with the four major metropolitan cities accounting for the bulk of the transactions. In view of this ever increasing role of credit cards a Working Group was set up for regulatory mechanism for cards. The terms of reference of the Working Group were fairly broad and the Group was to look into the type of regulatory measures that are to be introduced for plastic cards (credit, debit and smart cards) for encouraging their growth in a safe, secure and efficient manner, as also to take care of the best customer practices and grievances redressal mechanism for the card users. The Reserve Bank has been receiving a number of complaints regarding various undesirable practices by credit card issuing institutions and their agents. Some of them are: Unsolicited calls to members of the public by card issuing banks/ direct selling agents pressurising them to apply for credit card. Communicating misleading / wrong information regarding credit cards regarding conditions for issue, amount of service charges/ waiver of fees, gifts/prizes. Sending credit cards to persons who have not applied for them / activating unsolicited cards without the approval of the recipient. Charging very high interest rates /service charges. Lack of transparency in disclosing fees/charges/penalties. Non-disclosure of detailed billing procedure.

The Working Group deliberated a number of major issues relating to: a) to customer grievances and rights: a) Transparency and Disclosure, b) Customer Rights Protection, and c) Code of Conduct. The Group recommended that the Most Important Terms and Conditions should be highlighted and advertised and sent separately to the prospective customer. These terms and conditions include various issues relating to: a) fees and charges, (b) drawal limits, (c) billing, (d) default, (e) termination / revocation of card membership, (f) loss / theft / misuse of card, and (g) disclosure. These recommendations are being processed within the RBI and a set of guidelines would be issued which are going to pave the path of a healthy growth in the development of plastic money in India. The RBI is also considering bringing credit card disputes within the ambit of the Banking Ombudsman

scheme. While building a regulatory oversight in this regard we need to ensure that neither does it reduce the efficiency of the system nor does it hamper the credit card usage. Housing Credit in India In view of its backward and forward linkages with other sectors of the economy, housing finance in developing countries is seen as a social good. In India, growth of housing finance segment has accelerated in recent years. Several supporting policy measures (like tax benefits) and the supervisory incentives instituted had played a major role in this market. Housing credit has increased substantially over last few years, but from a very low base. During the period 1993-2004, outstanding housing loans by scheduled commercial banks and housing finance companies grew at a trend rate of 23 per cent. The share of housing loans in total non-food credit of scheduled commercial banks has increased from about 3 per cent in 1992-93 to about 7 per cent in 2003-04. Recent data reveal that non-priority sector housing loans outstanding as on February 18, 2005 were around Rs. 74 thousand crore, which is, however, only 8.0 per cent of the gross bank credit. As already pointed out, direct housing loans up to Rs. 15 lakh irrespective of the location now qualify as priority sector lending; housing loans are understood to form a large component of such lending. In addition, housing credit is also being provided by housing finance companies, which in turn are also receiving some bank finance. Thus, from miniscule amounts, the exposure of the banking sector to housing loans has gone up. Unlike many other countries, asset impairment on account of housing finance constitutes a very small portion. However, with growing competition in the housing finance market, there has been a growing concern over its likely impact on the asset quality. While no immediate financial stability concerns exist, there is a need to put in place appropriate risk management systems, strengthen internal control procedures and also improve regulatory oversight in this area. Banks also need to monitor their exposure and the credit quality. In a fiercely competitive market, there may be some temptation to slacken the loan scrutiny procedures and this needs to be severely checked. Having delineated the broad contours of retail banking in India let me now come to its opportunities and challenges. Opportunities and Challenges of Retail Banking in India Retail banking has immense opportunities in a growing economy like India. As the growth story gets unfolded in India, retail banking is going to emerge a major driver. How does the world view us? I have already referred to the BRIC Report talking India as an economic superpower. A. T. Kearney, a global management consulting firm, recently identified India as the 'second most attractive retail destination' of 30 emergent markets. The rise of the Indian middle class is an important contributory factor in this regard. The percentage of middle to high income Indian households is expected to continue rising. The younger population not only wields increasing purchasing power, but as far as acquiring personal debt is concerned, they are perhaps more comfortable than previous generations. Improving consumer purchasing power, coupled with more liberal attitudes toward personal debt, is contributing to India's retail banking segment. The combination of the above factors promises substantial growth in the retail sector, which at present is in the nascent stage. Due to bundling of services and delivery channels, the areas of potential conflicts of interest tend to increase in universal banks and financial conglomerates. Some of the key policy issues relevant to the retail banking sector are: financial inclusion, responsible lending, access to finance, long-term savings, financial capability, consumer protection, regulation and financial crime prevention. What are the challenges for the industry and its stakeholders? First, retention of customers is going to be a major challenge. According to a research by Reichheld and Sasser in the Harvard Business Review, 5 per cent increase in customer retention can increase profitability by 35 per cent in banking business, 50 per cent in insurance and brokerage, and 125 per

cent in the consumer credit card market. Thus, banks need to emphasise retaining customers and increasing market share. Second, rising indebtedness could turn out to be a cause for concern in the future. India's position, of course, is not comparable to that of the developed world where household debt as a proportion of disposable income is much higher. Such a scenario creates high uncertainty. Expressing concerns about the high growth witnessed in the consumer credit segments the Reserve Bank has, as a temporary measure, put in place risk containment measures and increased the risk weight from 100 per cent to 125 per cent in the case of consumer credit including personal loans and credit cards (Mid-term Review of Annual Policy, 2004-05). Third, information technology poses both opportunities and challenges. Even with ATM machines and Internet Banking, many consumers still prefer the personal touch of their neighbourhood branch bank. Technology has made it possible to deliver services throughout the branch bank network, providing instant updates to checking accounts and rapid movement of money for stock transfers. However, this dependency on the network has brought IT departments additional responsibilities and challenges in managing, maintaining and optimizing the performance of retail banking networks. Illustratively, ensuring that all bank products and services are available, at all times, and across the entire organization is essential for todays retails banks to generate revenues and remain competitive. Besides, there are network management challenges, whereby keeping these complex, distributed networks and applications operating properly in support of business objectives becomes essential. Specific challenges include ensuring that account transaction applications run efficiently between the branch offices and data centres. Fourth, KYC Issues and money laundering risks in retail banking is yet another important issue. Retail lending is often regarded as a low risk area for money laundering because of the perception of the sums involved. However, competition for clients may also lead to KYC procedures being waived in the bid for new business. Banks must also consider seriously the type of identification documents they will accept and other processes to be completed. The Reserve Bank has issued details guidelines on application of KYC norms in November 2004. Some Random Thoughts How do we see the future of retail banking? What are the major attributes of the shape of things to come in this sector? Let me share with you some of my random thoughts. First, customer service should be the be-all and end-all of retail banking. The other day a document released by the British Bankers Association, entitled UK Retail Banking Manifesto: addressing the challenges that lie ahead for the industry and its stakeholders on September 29, 2004 came to my notice. This document analysed the key policy issues relevant to the retail banking sector and highlighted the role of financial inclusion, responsible lending, access to finance, and consumer protection. It is in this context that that one is reminded of the needs to develop the standards and codes for banking. The contribution of the Committee on Procedure & Performance Audit on Public Services (CPPAPS) (Chairman: Shri S.S. Tarapore) has been invaluable and has provided great insight. Based on the recommendation of the CPPAPS, the Annual Policy Statement for 2005-06 announced the decision to set up an independent Banking Codes & Standards Board of India on the model of the mechanism in the UK in order to ensure that comprehensive code of conduct for fair treatment of customers is evolved and adhered to. The codes and standards, together with the institutional mechanism to monitor them, are expected to enhance the quality of customer service, to the individual customer in particular. The codes will bring about greater transparency in the system and also tackle the issue of information asymmetry. The Board would function as an industry-wide watchdog of the banking code and ensure that the banks comply with the banking codes. The codes would establish the banking industrys key commitments and obligations to customers on standards of practice, disclosure and principles of conduct for their banking services. The Board will monitor compliance with the Codes by the affiliated banks. Second, sharing of information about the credit history of households is extremely important as far retail banking is concerned. Perhaps due the confidential nature of banker-customer, banks have a traditional resistance to share credit information on the client, not only with one another, but also

across sectors. Globally, Credit Information Bureaus have, therefore, been set up to function as a repository of credit information - both current and historical data on existing and potential borrowers. The database maintained by these institutions can be accessed by the lending institutions. Credit Bureaus have been established not only in countries with developed financial systems but also in countries with relatively less developed financial markets, such as, Sri Lanka, Mexico, Bangladesh and the Philippines. In Indian case, the Credit Information Bureau (India) Limited (CIBIL), incorporated in 2000, aims at fulfilling the need of credit granting institutions for comprehensive credit information by collecting, collating and disseminating credit information pertaining to both commercial and consumer borrowers. At the same time banks must exercise due diligence before declaring a borrower as defaulter. Third, outsourcing has become an important issue in the recent past. With the increasing market orientation of the financial system and to cope with the competition as also to benefit from the technological innovations such as, e-banking, the banks are making increasing use of 'outsourcing' as a means of both reducing costs and achieving better efficiency. While outsourcing does have various cost advantages, it has the potential to transfer risk, management and compliance to third parties who may not be regulated. A recent BIS Report on 'Outsourcing in Financial Services' developed some high-level principles. A basic requirement in this context is that a regulated entity seeking to outsource activities should have in place a comprehensive policy on outsourcing including a comprehensive outsourcing risk management programme to address the outsourced activities and the relationship with the service provider. Application of these principles in the Indian context is under consideration. Finally, retail banking does not refer to lending only. In the whole story of retailing one should not forget the role played by retail depositors. The homemaker, the retail shop keeper, the pensioners, self-employed and those employed in unorganised sector - all need to get a place in the banks. It is in this backdrop that the Annual Policy for 2005-06 pointed out issues relating to financial exclusion and had announced that the RBI would implement policies to encourage banks which provide extensive services while disincentivising those which are not responsive to the banking needs of the community, including the underprivileged. Furthermore, the nature, scope and cost of services need to be monitored to assess whether there is any denial, implicit or explicit, of basic banking services to the common person and banks have been urged to review their existing practices to align them with the objective of financial inclusion. Conclusion There is a need of constant innovation in retail banking. In bracing for tomorrow, a paradigm shift in bank financing through innovative products and mechanisms involving constant upgradation and revalidation of the banks internal systems and processes is called for. Banks now need to use retail as a growth trigger. This requires product development and differentiation, innovation and business process reengineering, micro-planning, marketing, prudent pricing, customisation, technological upgradation, home / electronic / mobile banking, cost reduction and cross-selling. While retail banking offers phenomenal opportunities for growth, the challenges are equally daunting. How far the retail banking is able to lead growth of the banking industry in future would depend upon the capacity building of the banks to meet the challenges and make use of the opportunities profitably. However, the kind of technology used and the efficiency of operations would provide the much needed competitive edge for success in retail banking business. Furthermore, in all these customers interest is of paramount importance. The banking sector in India is demonstrating this and I do hope they would continue to chart in this traded path. Thank You.

The Functions and Future of Retail Banking

by Jerry L. Jordan
September 15, 1996

Introduction Origins of Banks The Functional Approach to Financial Services Money Implications of the Functional Approach Regulation Conclusion Footnotes

Introduction

At the turn of the century, one of the largest employers in America was the U.S.
Ice Trust, which cut, stored, and delivered ice for peoples "iceboxes." Today, that industry employs only a fraction of the workforce it once did. This happened not because people stopped consuming cool fresh food, but because the refrigeratora product born of new technologyall but eliminated the need for ice blocks. In contrast, the Fisher Company, which produced carriages and buggies in the early years of the century, is still in the business of making automotive bodies. What does the future hold for the retail banking industry? That depends on whether it continues to provide value to its customers. The challenge for bank managers and supervisors is to understand what customers wantto distinguish between cutting ice and keeping food cold. In my view, understanding the services that people demand and exploring banks comparative advantage in supplying them will be crucial in determining the future of the retail banking industry. By considering the value-adding activities of banks, I hope to provide a framework for evaluating profitable opportunities and assessing competition from other banks, money market funds, or even phone and computer software companies. I also examine how new methods of delivering financial services may affect the role of the Federal Reserve in regard to money, the payments system, and banking supervision. Return to Index

Origins of Banks

Economies have always developed methods for providing financial services. Over time, the providers of these services have adapted to changes in technology and customer preferences. Functions that today are identified with "banking" were performed by the organizers of the Champagne Fairs in the twelfth and thirteenth centuries. They issued tokens to participating merchants, with each token representing deposits of coin, plate, and bullion that had been tested. The merchants used these tokens to net out their accounts before settling in the deposited gold. At the same time, scrivenersclerks who wrote letters and contracts in an illiterate agereduced transaction costs. Most professors of money and banking fondly describe how medieval goldsmiths accepted gold for safekeeping, and how the receipts they issued eventually became money. The goldsmiths assayed bullion samples, certified their quality, and issued receipts that were easier to carry than metal. Thus, they added value by producing verifiable information and reducing transaction costs. From here, it was but a short step to making loans.1 Institutions more recognizable as banks, such as the Casa de San Giorgio in 1407 and the Bank of Amsterdam in 1609, arose on the continent.2 These firms provided safekeeping and security, assessed and certified quality, and enabled transfer payments. Although fund transfers had to be conducted at the bank, transaction costs were relatively low compared to carting gold through the streets. 3 This brief history holds several lessons. First, many of these functions still survive, though modern banks methods of providing loans and a convenient means of payment are considerably different. Second, the institutional form has changed dramaticallyfrom guild to corporation. For example, banking and goldsmithing are no longer combined.4 Return to Index
The Functional Approach to Financial Services

There have been several government attempts, particularly in the United States since the 1930s, to separate "financial service" activities into distinct industries. These industries can, and do, exist separately in market economies, as long as they perform functions that people value. Adopting a functional perspective, therefore, permits a deeper look into the well of issues surrounding the future of banking. When firms adapt to competitive forces, we should expect them to alter their product mixes, delivery vehicles, and corporate structures to fulfill their functional role.5

As financial intermediaries, banks perform six broad functions: 1) conducting exchange (clearing and settling claims), 2) funding large-scale enterprises (pooling resources), 3) transferring purchasing power across time and distance, 4) providing risk management (hedging, diversification, and insurance), 5) monitoring borrower performance (mitigating adverse incentives), and 6) providing information about the relative supply and demand for credit. Commercial banks perform all of these functions, but so do other organizations. Although people will continue to make payments, save for the future, and insure themselves, one cannot assume that the existing corporate forms will survive (remember the goldsmiths). For economic reasons, combinations of products may exist at a certain time within one industry, such as "commercial banking" or "insurance underwriting." However, there is no guarantee that one type of heavily taxed, heavily regulated industry that has been granted a particular "charter" will survivequite the opposite. Consider savings accounts, which transfer purchasing power from the present to the future. This saving function can also be accomplished by investing in common stock. Although these methods involve different risks, buying a put option can remove an important element of risk from holding stock.6 The functions provided by savings accounts need not be provided by a depository institution. Something similar has happened with mortgages. In years past, people purchased houses by using personal savings. Later, the funds came from mortgage loans using the savings of other families within the community. Now, home purchases are financed by non-bank loans funded by investors in the mortgage-backed securities market. Characteristically, commercial banks have funded themselves with liquid liabilities and have made illiquid loans. They do, however, provide various other services to their customers. Functionally, then, a "bank" is a combination of financial service activities. Legally, however, it is a corporation that receives a banking charter and is subject to the rules and regulations thereof. Typically, these strictures prevent banks or their holding companies from offering some services that are readily available in the marketplace because of concerns about safety and soundness. This prompts two important observations: First, the functional definition of "banking" is not synonymous with the legal definition. Thus, a financial holding company owning a finance company, a venture capital firm, and a money market mutual fund has a fair claim to be called a bank under the functional approach. Conversely, a chartered bank that specializes in global custody arrangements or serves only as a clearinghouse for credit cards is, functionally speaking, not a bank. Second, commercial banks as legally defined today may disappear in the future, but some organization will perform the functions they now provide: payments,

pooling, and risk management on the liabilities side, and resource transfers and risk management on the assets side. Again, these particular combinations may not be undertaken by a single entity, just as the functions of making jewelry and accepting deposits no longer exist jointly. In the future, firms may serve customers by bundling certain financial services that are currently provided separately, or may even merge banking-like services with non-banking services such as concert and sporting event tickets, vacation planning, and so on. They may utilize electronic delivery vehicles accessible via the Internet. Some activities that we regard today as inappropriate, difficult, or even illegal for banks will most likely change, and may do so sooner than we expect. In the end, firms that find ways to deliver the services that the public wants will prosper. Already, the New Zealand government appears open to the idea of eliminating the distinction between corporations chartered as commercial banks and those incorporated for other business purposes. Customers of public utilities, such as phone companies, may carry interest-bearing balances and instruct these organizations to credit the accounts of other merchants. Indeed, the government may even permit some non-bank businesses to maintain settlement accounts at the Reserve Bank of New Zealand. What, then, would be called a "bank"? Return to Index
Money

Evolution of the financial services industry carries implications for money and monetary policy. Just as we are challenged to rethink what a bank is, we will be challenged to rethink what money is. Money will, of course, remain the same from an economists perspectivea medium commonly accepted in trade for goods and services. But in practical terms, if the set of firms engaged in banking broadens, then might not the liabilities of the new entrants also circulate among the public as exchange media? If people wish to conduct transactions with electronic vehicles that todays banks are slow to develop and offer, is it unreasonable to conjecture that other commercial firms will step into the marketing void? New payment technologies should be regarded as innovations that enhance productivity and welfare just as surely as any other new product. The challenge faced by the Federal Reserve is to ensure that we can adapt our own operating practices and monetary policies to maintain financial stability and control the price level. Today, banks hold our liabilities because they must meet reserve requirements, because they find having Reserve Bank balances instrumental in settling transactions with other banks, and because the public uses Federal Reserve notes in transactions.

Required reserves are already declining. In the future, the demand for central bank money will depend on the Feds usefulness in net settlement and on the publics interest in using Fed liabilities for transactions instead of those of another issuer. Does the public want to use an electronic travelers check issued by American Express, or an electronic Federal Reserve note? Return to Index
Implications of the Functional Approach

The functional approach, by focusing on banks comparative advantages, helps bankers determine the most efficient way to provide the financial services their customers desire. A complementary approach is to think about what functions can be profitably outsourced. Money market mutual funds, for example, outsource some risk management. Unlike banks, they do not handle loan portfolios. By engaging in loan sales and securitization, a banking firm can outsource the transfer and pooling functions, but retain the credit evaluation and monitoring (for example, risk management and incentive) functions. In thinking functionally, the initial tendency is to assume that everything can be outsourced, broken up, and reduced to a commodity. Experience, however, suggests otherwise. For example, until recently, people diversified the risk in their stock portfolio by purchasing a lot of different stocks themselves. Now a mutual fund does this for many investors, but they still incur the search and transaction costs of finding a good fund. Very sophisticated investors bypass mutual funds and invest directly in stock index futures. Others have moved to a new class of intermediary, the fund family (such as Schwab or Fidelity), which makes it easy to choose, evaluate, and transfer between different mutual funds. (An Internet search engine that does this is probably not far behind.) Still others have returned to commercial banks, trusting them to assist in seeking out and evaluating funds. The collection of functions currently known as banking has survivedso far for several reasons. It provides services more efficiently, effectively, and cheaply than if they were handled separately. Banks can use the information from deposits to better price and monitor loans. This gives bankers a decisive information advantage because the unique information content of illiquid loans, such as small business loans, prevents them from being easily pooled and securitized. Banks have also survived because their organization solves incentive problems. Funding themselves with a liquid liability having a specific payout guarantee gives banks a strong incentive to monitor the illiquid loans on their asset side. Indeed, we trust banks as "delegated monitors" precisely because their structure has evolved to solve this incentive problem.

The question for the future is, "What is the cheapest way to integrate and deliver banking functions?" Generally, people and technology will matter more than physical location. People will phone or e-mail an expert rather than talk face-toface with a local teller, especially when expertise is vitalin life insurance, financial planning, and mutual funds, for example. Sears, whose strategy had been to rely on the physical location of its stores as a means of delivering financial services, provides proof by counterexample. What underlies this trend away from physical location? As Adam Smith pointed out long ago, specialization makes knowledge "lumpy." According to Milton Friedmans more modern example, no single person knows how to make a pencil; its production requires the coordinated activity of many experts. Banks can use technology to deliver experts from afar, and this allows further specialization. Hiring an expert in options, although uneconomical for a local branch, would prove useful for the 0.1 percent of clients nationwide who trade options. Despite the risk of bedazzlement (or cynicism) with the glories of information technology, it is worth asking what functions this technology can perform. Because people care about changes in their overall portfolio, new technology can be used to integrate different types of financial accountsacross multiple vendors, checking and mortgage accounts, car loans, mutual funds, stocks, bonds, and so on. It can also be used to reduce search coststhe program or search engine on a home computer can act as an intelligent agent on the users behalf.7 All of this is far removed from the fourteenth century scrivener dispensing advice, but it serves the same functionthat of reducing transaction and information costs. Information technology also aids in automating the delivery of payment services, thereby reducing the need for paper checks, paper records, and brick-and-mortar bank branches. Some problems will persist, although in a different form: Complaints about long lines or surly tellers will be replaced by complaints about computer programs that crash. Technology also aids in making payments, a fascinating area that raises important issues for both monetary policy and banking. Will future deposits assume a different form, and if so, will the combination of assets and liabilities that defines banking remain profitable? Technology can be readily used to provide substitutes for banks. As people increasingly make payments electronically, and as software searches the Web for the best loan rates, banks may be reduced to mere commodity providers. Examples abound of businesses that were once strictly wholesalers, but that now deal directly with the public. Technology is an integral part of this retailing transformation. In time, network interface programssuch as Java, Netscape, or their successors may become identified with banks in peoples minds, and in reality.

Goldsmiths receipts did not start out as moneythey were receipts for money but in time, the interface became the reality. New technology might also enable banks to become the interface, however. Already, banks are becoming mutual funds for some people. Apollo Bank in Pennsylvania has become an Internet service provider. One scenario is that on-line, banks will become like a store in the mall. Another scenario is that banks may become the mall, with financial planning software that lists their customers bank accounts, credit card limits, and home equity balances on-screen, and that provides the ease of navigation and delivery that lets people transact with confidence. Return to Index
Regulation

As the financial marketplace evolves, so too must financial regulation and regulating institutions. Just as "banking" functions need not be provided by banks, those functions known as "regulation" need not be provided by regulators. Regulators should be clear about what function they are providing and about how they provide it. An insightful set of reform proposals comes from the Bank Administration Institute (BAI).8 Although from a functional viewpoint the report concentrates excessively on the health of the banking industry, it nevertheless provides a wealth of ideas on how regulation can stop hindering banks from providing these functions. From my broader perspective, regulatory reform must rest on three principles: A Level Playing Field. Like the Champagne Fairs of old, in which merchants could participate if they agreed to obey certain rules (such as having their gold assayed), regulation must not discriminate between different financial service providers. Banks generally applaud this rule when they talk about finance companies, mutual funds, and insurance companies not facing Community Reinvestment Act exams, but are less enthusiastic about allowing Goldman Sachs or Microsoft Corporation access to FedWire. The BAI report hoped to advance the goal of a level playing field when it called for eliminating outmoded compliance burdens, such as dual antitrust reviews.9 Functional Regulation. Regulation should focus less on institutions and more on functions. The Securities and Exchange Commission is well equipped to handle securities-related problems. Let them do so and make the regulations, whether the securities are underwritten by Merrill Lynch or the local bank. Conversely, the extensionwhich again banks may not like to contemplate is that Merrill Lynch must submit to Federal Reserve examinations when making loans or using FedWire.10

Value-added Supervision. Supervision and regulation must consider the dynamic combination and recombination of functions occurring today. It should be less concerned with playing "financial cop" and more concerned with helping firms work safely and efficiently. Ideally, banks will one day treat Federal Reserve exams more like a report from Arthur Anderson or Moodys than an ordeal to be survived. The removal of unfair taxes and subsidies posited under the levelplaying-field principle should make regulations less burdensome, and banks less eager to find ways around them.11 In the end, functional regulation may not be adequate, because some functional combinations pose incentive and informational problems. After all, it was the combination of long-term assets and short-term liabilities that got the savings and loans in trouble. Still, with these principles, the new financial landscape may benefit from a regulatory environment that promotes economic efficiency. Return to Index
Conclusion

Laws and regulations that attempt to "wall off" certain business lines from others in the same corporate entity create strong reactions in the marketplace. Unregulated competitors rush to fill the void, and the regulated firms attempt to avoid the regulatory barriers by creating new products that offer their clients the desired functionality.12 Even if regulatory barriers initially can be justified due to some threat to financial stability, the justification may become outmoded over time. Ultimately, the greatest disaster would not be a world without banks or bank regulators, uncomfortable as that transition might be. Rather, it would be a drastic failure of innovation. People today are far better off for having refrigerators even if the ice-cutters union disagrees.

Retail Banks: Their Structure and Function

Checklist Description
This checklist describes the structure and function of retail banks, what services they provide, and the factors to be considered when selecting one. In the United Kingdom retail banks are also known as high street banks. Back to top

Definition
Retail banks offer a range of services to individual customers and small businesses, rather than to large companies and other banks. The services can include current accounts, savings accounts, investment advice and broking, and loans and mortgages. Retail banks perform two crucial functions for customers: firstly, they enable customers to bank their money securely, access it easily, and conduct transactions; and secondly, they provide access to additional money to fund large purchases, such as buying a home. In return for holding customers funds, which they can then invest, banks pay customers interest. Traditionally, retail banks have provided these services directly to the customer via branches. While many still do this, retail banks now offer their services by telephone and the internet as well. Some operate solely via the internet and do not have facilities to serve customers at physical outlets. Other organizations, such as supermarkets, have now entered the banking sector and also offer a wide range of banking services. It has become more difficult to identify the traditional retail banka bank that funds itself through customer deposits and lendingbecause retail banks now often combine retail and wholesale banking. It is therefore more relevant to todays banking structure to regard retail banking as a series of processes rather than as an institution. The intermediation services offered by retail banks (such as looking after customers money an d making loans) and the payment services (allowing customers to make transactions using debit cards, checks, etc.) mean that they have to make funds available to customers at very short or immediate notice. This inevitably means that a retail bank has to manage the risk that more money will be requested by customers than it has available and of customers defaulting on loans. Banks do this by holding stocks ofliquid assets, maintaining a cushion of capital, lending to different types of borrower, adjusting interest rates, and screening potential borrowers (credit scoring). Back to top

Advantages

Your money is much more secure than in a box under your bed and you can buy goods, be paid, and sell things without cash changing hands. The bank you are familiar with and which knows you can also offer you a wide range of other services, such as mortgages and insurance. Your bank may be able to offer you competitive deals in return for your loyalty as a customer. Retail banks offer a variety of ways you can access your account and manage your money, most notably via internet banking. This means that you can keep a close eye on your finances and avert many potential problems. Back to top

Disadvantages

Banks are a business, and they need to make money from looking after yours. If the bank decides to apply charges to your account (within the terms of the account), you may only find out about it afterwards for example if you accidentally go overdrawn without permission. If you disagree with a charge, you will need to contest it to recover the money. Back to top

Action Checklist

Think carefully about what you want from a bank account and what is important to you. For example, if you are not concerned about having face-to-face contact with your bank, an internet-only bank may suit you.

When choosing an account, check the interest rate offered and how quickly and by what methods you can access your money. When looking for a current or checking account, find out what extra services the bank can offer you, such as a debit card,overdraft facility, free or cheap insurance policies, etc. Does the bank have local branches, or is it internet only? Are you comfortable with the ways in which you can communicate with the bank? Most importantly, find out what charges apply to various transactions and events, such as going overdrawn without the banks approval. Back to top

Dos and Donts

Do

Compare different banks and their products and services. Look for added value, such as free insurance. Challenge charges you feel are unfair or wrongly applied to your account. Regularly review your savings accounts to make sure you continue to get the best interest rates available.

Dont

Dont let financial problems get out of control, and dont put off talking to your bank about them if they do. Dont be afraid to move to a new bank if you are not happy with your current one and if, via sound research, you have found something better. The bank you want to move to will be happy to take on the transfer arrangements for you.

ADVANTAGES Retail banking has inherent advantages outweighing certain disadvantages. Advantages are analyzed from the resource angle and asset angle.

RESOURCE SIDE o Retail deposits are stable and constitute core deposits. o They are interest insensitive and less bargaining for additional interest. o They constitute low cost funds for the banks. o Effective customer relationship management with the retail customers built a strong customer base.

o Retail banking increases the subsidiary business of the banks.

ASSETS SIDE o Retail banking results in better yield and improved bottom line for a bank.

o Retail segment is a good avenue for funds deployment. o Consumer loans are presumed to be of lower risk and NPA perception. o Helps economic revival of the nation through increased production activity.

o Improves lifestyle and fulfils aspirations of the people through affordable credit.

o Innovative product development credit.

o Retail banking involves minimum marketing efforts in a demand driven economy.

o Diversified portfolio due to huge customer base enables bank to reduce their dependence on few or single borrower o Banks can earn good profits by providing non fund based or fee based services without deploying their funds.

DISADVANTAGES

o Designing own and new financial products is very costly and time consuming for the bank.

o Customers now-a-days prefer net banking to branch banking. The banks that are slow in introducing technology-based products, are finding it difficult to retain the customers who wish to opt for net banking.

o Customers are attracted towards other financial products like mutual funds etc.

o Though banks are investing heavily in technology, they are not able to exploit the same to the full extent.

o A major disadvantage is monitoring and follow up of huge volume of loan accounts inducing banks to spend heavily in human resource department.

o Long term loans like housing loan due to its long repayment term in the absence of proper follow-up, can become NPAs.

o The volume of amount borrowed by a single customer is very low as compared to wholesale banking. This does not allow banks to to exploit the advantage of earning huge profits from single customer as in case of wholesale banking