Chapter Three

The Organization and Structure of Banking and the FinancialServices Industry

Key Topics
The Organization and Structure of the Commercial Banking Industry The Array of Organizational Structures in Banking Interstate Banking and the Riegle-Neal Act The Financial Holding Company Mergers and Acquisition Banking Structure and Organization in Europe and Asia The Changing Organization and Structure of Bankings Principal Competitors Economies of Scale and Scope McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Assets Held by U.S. FDIC-Insured Commercial Banks, 2007

2%
11%
Assets Held By Large Banks Assets Held By Medium Banks Assets Held By Small Banks

87%

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Number of U.S. FDIC-insured Commercial Banks, 2007

7%
43% 50%

Small $100 Million Medium $100 Million $1 Billion Large > $1 Billion

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Community Banks or Retail Banks

Typical Size is $300 Million Organizational Chart is Not Complicated Significantly Affected by Health of Local Economy Generally Know their Customers Well Relationship Lending

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Money Center or Wholesale Banks

Generally Multi-Billion Dollar Company Organizational Chart is Much More Complex Serve Many Different Markets with Many Different Services so are Better Diversified Geographically and by Product Able to Raise Large Amounts of Capital at Relatively Low Costs

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Quick Quiz
What are the general trends in the size distribution and asset concentration of American banking industry? Describe differences between a typical organizational structure of smaller community bank and a larger money-center bank. What trends are affecting the way banks and their competitors are organized today?
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Common Classifications of U.S. Banks

FDI C I ns ur ed B ank s 98%

Not FDI C I ns ur ed

2%

0%

20%

40%

60%

80%

100%

120%

Nat i onal B anks

25%

St at e B anks

75%

0%

10%

20%

30%

40%

50%

60%

70%

80%

M ember B anks

36%

Non M ember B anks

64%

0%

10%

20%

30%

40%

50%

60%

70%

Source: FRB and FDIC, 2005 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Deposits Held By Banks

Deposi t s of Nat i onal B anks 55%

Deposi t s of St at e B anks

45%

0%

10%

20%

30%

40%

50%

60%

Deposi t s of M ember B anks

77%

Deposi t s of Non M ember B anks

23%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Source: FRB and FDIC, 2005 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

10

Unit Banks
Offer All Services From One Office One of the Oldest Kinds of Banks New Banks are Generally Unit Banks Until Can Grow and Attract More Resources

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

11

Branch Banks
Offer Full Range of Services from Several Locations Senior Management at the Home Office Each Branch has its Own Management Team with Limited Decision Making Ability Some Functions are Highly Centralized, While Others are Decentralized

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

12

Reasons for Growth of Branching

Exodus of Population to Suburban Communities Increased Bank Failures in Recent Years Business Growth

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

13

What Trend in Branch Banking Has Been Prominent in the U.S. in Recent Years?
Year # of Bank Main Offices 14,146 13,511 14,451 7,241 # of Branch Offices 2,985 21,810 39,784 77,947 Total of U.S. Bank Offices 17,131 35,321 54,235 85,188 Ave # of Branches/ U.S. Bank 0.21 1.61 1.75 10.76

1934 1970 1982 2007

From Table 3-2; Source: FDIC

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

14

Electronic Branches
Internet Banking Services Automated Teller Machines (ATMs) Point of Sale (POS) Terminals

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

15

Virtual Banks
Provide their Services Exclusively Through the Web Can Generate Cost Savings Over Traditional Brick-and-Mortar Banks Have Not Yet Demonstrated They Can Be Consistently Profitable

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

16

Bank Holding Companies (BHC)

A Corporation Chartered for the Purpose of Holding the Stock of One or More Banks Control of a bank is Assumed When 25% or More of the Stock is Owned Must Get Approval from Federal Reserve Board to Control a Bank One-Bank Holding Companies vs. Multibank Holding Companies

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

17

Organizational Structure of a BHC

Single Bank Holding Company
Board of Direct ors

Parent Company

Bank Subsidiary

Each subsidiary has a president and line officers

Nonbank Subsidiaries

Bank Branches The bottom four levels have the same organizational form as the independent bank. Mult ibank Holding Company

Board of Direct ors

Parent Company

Bank Subsidiary

Nonbank Subsidiaries

Bank Subsidiary

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e Bank Branches

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Bank Branches

18

Nonbank Businesses of BHCs

Finance Companies Mortgage Companies Data Processing Companies Factoring Companies Security Brokerage Firms Financial Advising Credit Insurance Underwriters Merchant Banking
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

Investment Banking Firms Trust Companies Credit Card Companies Leasing Companies Insurance Companies and Agencies Real Estate Services Savings Associations

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

19

Reasons for the Growth of BHCs

Geographic Diversification Product Line Diversification Tax Sheltering Double Leveraging Source of Strength A Way Around Regulatory Restrictions

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

20

Reasons for Full-Service Interstate Banking

Need to Bring New Capital to Revive Struggling Local Economies The Expansion by Non Bank Financial Institutions with Fewer Restrictions A Strong Desire by Large Banks to Expand Geographically Belief Among Regulators that Large Banks are More Efficient and Less Prone to Failure Advances in Technology
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

21

Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994

Allows BHCs to Acquire Banks Anywhere in the U.S. Allows BHCs to Convert Banks to Branches June 1997 States Can Opt Out and Not Allow BHCs to Convert to Branches States Can Opt In Early Limits Deposits of One BHC to 10% Nationwide and 30% Within One State
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

22

Proponents and Opponents of Interstate Banking

Proponents
Efficient Use of Scarce Resources Lower Prices for Services Geographic Diversification Efficient Flow of Credit in the System

Opponents
Increased Bank Concentration Less Competition Higher Prices for Services Drain Resources from Community

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

23

Financial Holding Companies: GLB Act of 1999

Special Type of Holding Company Offers the Broadest Range of Services List of Activities Offered May Expand as Regulators Decide What Services are Compatible with Banking Each Affiliated Financial Firm has its Own Capital and Management and its Own Profit or Loss
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

24

Sample Organizational Structure of FHC

Financial Holding Company

Bank Holding Company

Securities Subsidiaries

Insurance Subsidiary

Thrift Holding Company

Real Estate Subsidiary

Commercial Banking Company

Nonbank Subsidiaries

Thrift Company

Subsidiaries and Service Companies

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

25

Bank Subsidiaries
Bank Controls One or More Subsidiaries Subsidiaries Offer Other Services Such as Insurance and Security Brokerage Services Profits and Losses of Each Subsidiary Impact Parent Bank

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

26

The Changing Organization and Structure

Rise in Branching, BHCs, and FHCs Consolidation among Banks and Nonbanks Convergence Other forces of change:
Deregulation/Reregulation Financial Innovation Securitization Globalization Advances in Technology
2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

27

Do Bigger Firms Operate at Lower Cost?

Economies of Scale
Economies of Scope Banking and Financial Firm Goals and Motivations
Expense-Preference Behavior Agency Theory Corporate Governance Exhibit 3-10

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

28

Structure and Organization of Banks in Europe

Germany Largest European Banking Industry France Second in Number of Banks Belgium Dominated by Five Large Banks Great Britain Dominated by a Half Dozen Banking Firms Switzerland Credit Suisse and UBS and Many Smaller Firms Italy Privatized Banking in the 1990s
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Private Sector Banks Public Sector Banks

29

Structure and Organization of Banks in Asia

China Large Dominating Government Sector, Although Private Banks are Expanding Japan Dominated by the Big Four Financial Group with More than One Hundred Smaller Domestic Banks and Seventy Foreign Banks

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

30

Quick Quiz
Which type of corporations chartered for the simple purpose of holding the stock of at least one bank? What were the reasons for the Riegle Neal Act of1994? When the banking industry moves toward larger but fewer organizations, what is it known as? What relationship appears to exist between bank size, efficiency, and operating costs per unit of service produced and delivered?
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.